QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended January 31, 2022
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 001-40240
The Duckhorn Portfolio, Inc.
(Exact name of registrant as specified in its charter)
Delaware
81-3866305
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
1201 Dowdell Lane
Saint Helena, CA94574
(Address, including zip code, of Principal Executive Offices)
(707) 302-2658
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, par value $0.01 per share
NAPA
New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes☒No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
☐
Accelerated filer
☐
Non-accelerated filer
☒
Smaller reporting company
☐
Emerging growth company
☒
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes☐No☒
The registrant had outstanding 115,065,210 shares of common stock, $0.01 par value per share, as of February 28, 2022.
The following terms are used in this quarterly report unless otherwise noted or indicated by the context:
•"Company," "we," "us," "our," "Duckhorn" and "The Duckhorn Portfolio" refer to The Duckhorn Portfolio, Inc. and its consolidated subsidiaries.
•"2016 Equity Plan" refers to the Company's board approved 2016 Equity Incentive Plan.
•"2021 Plan" refers to the Company's board approved 2021 Equity Incentive Plan.
•"ASC" refers to Accounting Standards Codification developed by the FASB.
•"ASU" refers to Accounting Standards Updates issued by the FASB to communicate changes to the ASC.
•"Controlled Company" refers to a company of which more than 50% of the voting power for the election of its directors is held by a single person, entity or group.
•"COVID-19" refers to the ongoing pandemic surrounding COVID-19, the disease caused by a novel strain of coronavirus that was declared a global pandemic by the World Health Organization in March 2020.
•"Credit Facility" refers to the existing first lien credit facility pursuant to that certain First Lien Loan and Security Agreement, dated as of October 14, 2016 (as amended by Amendment No. 1, dated July 28, 2017, as amended by Amendment No. 2, dated as of April 19, 2018, as amended by Amendment No. 3 dated as of August 1, 2018, as amended by Amendment No. 4 dated as of October 30, 2018, as amended by Amendment No. 5 dated as of June 7, 2019, as amended by Amendment No. 6 dated as of August 17, 2020 and as amended by Amendment No. 7 dated as of February 22, 2021), by and among the Company, the borrowers named therein, the lenders named therein and the Bank of the West, as administrative agent.
•"DTC channel" and "DTC" refers to our sales and distribution channel through which we sell wine directly to consumers without any licensee intermediaries (wholesale or retail), which is permissible through in-person sales at one of our tasting rooms or, where permitted by law, through our multi-winery e-commerce website.
•"ESPP" refers to Employee Stock Purchase Plan
•"Estate vineyards" refers to vineyards controlled or owned by the Company.
•"Estate wines" refers to wine made with grapes that share geographical provenance and are farmed, fermented, aged and bottled on-site at Company controlled facilities.
•"Exchange Act" refers to the Securities Exchange Act of 1934.
•"FASB" refers to Financial Accounting Standards Board.
•"First Lien Loan Agreement " see Credit Facility.
•"Fiscal 2017" refers to our fiscal year ended July 31, 2017.
•"Fiscal 2018" refers to our fiscal year ended July 31, 2018.
•"Fiscal 2019" refers to our fiscal year ended July 31, 2019.
•"Fiscal 2020" refers to our fiscal year ended July 31, 2020.
•"Fiscal 2021" refers to our fiscal year ended July 31, 2021.
•"Fiscal 2022" refers to our fiscal year ended July 31, 2022.
•"IPO" refers to our initial public offering completed in March 2021.
•"JOBS Act" refers to the Jumpstart Our Business Startups Act of 2015.
•"LIBOR" refers to London Interbank Offered Rate.
•"Luxury wine" refers to wines with suggested retail prices of $15 or higher per 750ml bottle.
•"Off-premise" refers to retail accounts that are a business with a license that allows a customer to purchase our wines for consumption at a location other than the retailer’s licensed location, such as grocery stores and liquor stores.
•"On-premise" refers to retail accounts that are a business with a license that allows a customer to purchase our wines and consume them at the licensed location, such as restaurants, bars and hotels.
•"Retail" refers to establishments that are licensed to purchase our wine for resale to consumers, such as grocery stores, liquor stores and restaurants.
•"SEC" refers to U.S. Securities and Exchange Commission.
•"Securities Act" refers to The Securities Act of 1933.
•"TSG" refers to TSG Consumer Partners LLC, together with certain affiliates.
•"Ultra-luxury wine" refers to wines with suggested retail prices of $25 or higher per 750ml bottle.
•"U.S." refers to the United States.
•"U.S. GAAP" refers to accounting principles generally accepted in the United States.
•"VIE" refers to variable interest entity.
•"Wholesale channel" refers to our sales and distribution channel through which we sell wine to distributors and, in California, directly to retail accounts.
This Quarterly Report on Form 10-Q and other materials filed or to be filed by us with the Securities and Exchange Commission contains statements that are or may be considered to be, forward-looking statements. Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies and other future conditions. Forward-looking statements can be identified by words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “target,” “potential,” “will,” “would,” “could,” “should,” “continue,” “contemplate” and other similar expressions, although not all forward-looking statements contain these identifying words. Important factors that could cause actual results and events to differ materially from those indicated in the forward-looking statements include, among others, the following:
• our ability to manage the growth of our business;
• our reliance on our brand name, reputation and product quality;
• the effectiveness of our marketing and advertising programs, including the consumer reception of the launch and expansion of our product offerings;
• general competitive conditions, including actions our competitors may take to grow their businesses;
• overall decline in the health of the economy, consumer discretionary spending and consumer demand for wine;
• the occurrence of severe weather events (including fires, floods and earthquakes), catastrophic health events, natural or man-made disasters, social and political conditions or civil unrest;
• risks associated with disruptions in our supply chain for grapes and raw and processed materials, including corks, glass bottles, barrels, winemaking additives and agents, water and other supplies;
• the impact of COVID-19 on our customers, suppliers, business operations and financial results;
• disrupted or delayed service by the distributors and government agencies we rely on for the distribution of our wines outside of California;
• our ability to successfully execute our growth strategy;
• decreases in our wine score ratings by wine rating organizations;
• quarterly and seasonal fluctuations in our operating results;
• our success in retaining or recruiting, or changes required in, our officers, key employees or directors;
• our ability to protect our trademarks and other intellectual property rights, including our brand and reputation;
• our ability to comply with laws and regulations affecting our business, including those relating to the manufacture, sale and distribution of wine;
• the risks associated with the legislative, judicial, accounting, regulatory, political and economic risks and conditions specific to both domestic and to international markets;
• claims, demands and lawsuits to which we are, and may in the future, be subject and the risk that our insurance or indemnities coverage may not be sufficient;
• our ability to operate, update or implement our IT systems;
• our ability to successfully pursue strategic acquisitions and integrate acquired businesses;
• our potential ability to obtain additional financing when and if needed;
• our substantial indebtedness and our ability to maintain compliance with restrictive covenants in the documents governing such indebtedness;
• TSG’s significant influence over us and our status as a “controlled company” under the rules of the New York Stock Exchange;
• the potential liquidity and trading of our securities; and
• the future trading prices of our common stock and the impact of securities analysts’ reports on these prices.
You should not rely on forward-looking statements as predictions of future events. We have based the forward-looking statements contained in this Quarterly Report on Form 10-Q primarily on our current expectations and projections about future events, and trends that we believe may affect our business, financial condition and operating results. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties and other factors described in the section titled “Risk factors” in our Fiscal 2021 Annual Report on Form 10-K and elsewhere in this Quarterly Report on Form 10-Q. Moreover, we operate in a highly competitive
environment. New risks and uncertainties emerge from time to time, and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained in this Quarterly Report on Form 10-Q. The results, events and circumstances reflected in the forward-looking statements may not be achieved or occur, and actual results, events or circumstances could differ materially from those described in the forward-looking statements.
In addition, statements that “we believe” and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based on information available to us as of the date of this Quarterly Report on Form 10-Q. And while we believe that information provides a reasonable basis for these statements, that information may be limited or incomplete. Our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all relevant information. These statements are inherently uncertain, and investors are cautioned not to unduly rely on these statements.
The forward-looking statements in this Quarterly Report on Form 10-Q represent our views as of the date on which the statements are made. We undertake no obligation to update any forward-looking statements whether as a result of new information, future developments or otherwise. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements, and you should not rely on our forward-looking statements in making your investment decision. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments.
Investors and others should note that we may announce material information to our investors using our investor relations website (https://ir.duckhorn.com), SEC filings, press releases, public conference calls and webcasts. We use these channels, as well as social media, to communicate with our investors and the public about our Company, our business and other issues. It is possible that the information we post on social media could be deemed to be material information. We therefore encourage investors to visit these websites from time to time. The information contained on such websites and social media posts is not incorporated into this filing. Further, our references to website URLs in this filing are intended to be inactive textual references only.
Condensed Consolidated Statements of Financial Position
(in thousands, except share and per share amounts)
January 31, 2022
July 31, 2021
ASSETS
(unaudited)
Current assets
Cash
$
4,770
$
4,244
Accounts receivable trade (net of allowance of $400 and $800, respectively)
43,008
33,253
Inventories
297,531
267,737
Prepaid expenses and other current assets
9,524
9,167
Total current assets
354,833
314,401
Long-term assets
Property and equipment, net
255,845
240,939
Intangible assets, net
196,705
200,547
Goodwill
425,209
425,209
Other long-term assets
2,719
2,021
Total long-term assets
880,478
868,716
Total assets
$
1,235,311
$
1,183,117
LIABILITIES AND EQUITY
Current liabilities
Accounts payable
$
9,858
$
3,556
Accrued expenses
27,076
21,557
Accrued compensation
12,716
16,845
Deferred revenue
143
3,102
Current maturities of long-term debt
11,244
11,324
Other current liabilities
377
397
Total current liabilities
61,414
56,781
Long-term liabilities
Revolving line of credit, net
133,011
121,348
Long-term debt, net of current maturities and debt issuance costs
109,149
114,625
Deferred income taxes
86,667
86,667
Other long-term liabilities
986
1,458
Total long-term liabilities
329,813
324,098
Total liabilities
391,227
380,879
Commitments and Contingencies (Note 11)
Equity
Common stock, $0.01 par value; 500,000,000 shares authorized, 115,065,210 issued and outstanding at January 31, 2022 and 115,046,793 issued and outstanding at July 31, 2021
1,151
1,150
Additional paid-in capital
729,508
726,903
Retained earnings
112,839
73,634
Total The Duckhorn Portfolio, Inc. equity
843,498
801,687
Non-controlling interest
586
551
Total equity
844,084
802,238
Total liabilities and equity
$
1,235,311
$
1,183,117
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements (unaudited).
Notes to Condensed Consolidated Financial Statements (unaudited)
1. Description of business
The Duckhorn Portfolio, Inc. and its subsidiaries (the "Company" or "Management") headquartered in St. Helena, CA, produces luxury and ultra-luxury wine across a portfolio of winery brands, including Duckhorn Vineyards, Paraduxx, Goldeneye, Migration, Decoy, Canvasback, Calera, Kosta Browne, Greenwing and Postmark.
The Company's revenue is comprised of wholesale and DTC sales. Wholesale revenue is generated through sales directly to California retailers and restaurants, sales to distributors and agents located in other states throughout the U.S. and sales to export distributors that sell internationally. DTC revenue results from individual consumers purchasing wine directly from the Company through club membership, the Company's website or tasting rooms located in Napa Valley, California; Anderson Valley, California; Sebastopol, California; Hollister, California; and Walla Walla, Washington.
The Company owns or controls through long-term leases certain high-quality vineyards throughout Northern and Central California and Washington. Vinification takes place at wineries owned, leased or under contract with third parties predominately located in Napa Valley, California; Anderson Valley, California; Hopland, California; Hollister, California; Sebastopol, California; and Walla Walla, Washington.
Fiscal year
The Company's fiscal year ends on July 31.
Secondary offering
In the first quarter of Fiscal 2022, the Company completed a secondary offering where certain existing shareholders sold 12,000,000 shares of common stock at a price of $20.50 per share. In November 2021, an additional 626,467 shares of common stock were sold pursuant to the partial exercise of the underwriters' option to purchase additional shares. The Company did not receive any of the proceeds from the sale of the shares by the existing stockholders. In connection with the offering, the Company incurred costs of $1.0 million of which $0.4 million was incurred in the fourth quarter of Fiscal 2021. These costs are reflected in selling, general and administrative expenses on the Condensed Consolidated Statement of Operations.
2.Basis of presentation and recent accounting pronouncements
Basis of presentation
The Company’s Condensed Consolidated Financial Statements are prepared in accordance with U.S. GAAP and Article 10 of the Securities and Exchange Commission’s Regulation S-X. As permitted under those rules, certain footnotes or other financial information that are normally required by U.S. GAAP may be condensed or omitted. These Condensed Consolidated Financial Statements have been prepared on the same basis as the Company's audited annual financial statements and, in the opinion of Management, reflect all adjustments, consisting only of normal recurring adjustments, which are necessary for the fair statement of the Company's financial information for the interim periods presented. These interim results are not necessarily indicative of the results to be expected for the year ending July 31, 2022, for any other interim period or for any future year.
The Condensed Consolidated Financial Statements are unaudited and should be read in conjunction with the audited consolidated financial statements and related notes thereto for the year ended July 31, 2021.
Principles of consolidation
The Condensed Consolidated Financial Statements include the accounts of The Duckhorn Portfolio, Inc. and its subsidiaries, including a consolidated VIE of which the Company has determined it is the primary beneficiary. All intercompany balances and transactions are eliminated in consolidation.
Accounting estimates
The preparation of Condensed Consolidated Financial Statements 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 Condensed Consolidated Financial Statements and the reported amounts of revenues
and expenses during the reporting period. Such estimates include, but are not limited to, the following: useful lives and recoverability of long-lived assets, inventory obsolescence and reserves, capitalized indirect inventory costs, allowance for doubtful accounts receivable, calculation of accrued liabilities, customer incentive reserves, uncertain tax positions, contingent liabilities, fair value of assets and liabilities acquired in connection with business combinations, equity-based compensation and deferred revenues. Actual results could differ from those estimates.
Preferred stock
The Company has 100,000,000 shares of $0.01 par value preferred stock authorized, none of which are issued and outstanding.
Variable interest entities
The Company evaluates its ownership, contractual relationships and other interests in entities to determine the nature and extent of the interests, whether such interests are variable interests and whether the entities are VIEs in accordance with ASC 810, Consolidations. These evaluations can be complex and involve Management judgment as well as the use of estimates and assumptions based on available historical information, among other factors. Based on these evaluations, if the Company determines that it is the primary beneficiary of a VIE, the entity is consolidated into the financial statements. At January 31, 2022 and July 31, 2021, the Company's ownership percentage of the sole identified VIE was 76.2%. The VIE's net assets were $2.4 million and $2.2 million at January 31, 2022 and July 31, 2021, respectively. The assets and liabilities, which may only be used to settle its own obligations, are primarily related to property, equipment and working capital accounts, which generally represent the amounts owed by or to the Company for goods under current contracts.
Recent accounting pronouncements
As an “emerging growth company” as established by the JOBS Act, the Company is permitted to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. The Company has elected to use the adoption dates available to private companies. As a result, the Company’s financial statements may not be comparable to the financial statements of issuers who are required to comply with the effective date for new or revised accounting standards that are applicable to public companies. Based on the Company's aggregate worldwide market value of voting and non-voting common equity held by non-affiliates as of January 31, 2022, the Company will become a “large accelerated filer” and lose emerging growth company status beginning with its Annual Report on Form 10-K for the year ending July 31, 2022.
Recently issued accounting pronouncements not yet adopted:
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), and several amendments, codified as ASC 842, which supersedes prior guidance on accounting for leases under FASB ASC 840, Leases. ASU No. 2016-02, among other provisions, (i) requires lessees to classify leases as either finance or operating leases, (ii) generally requires all leases to be recorded on the Condensed Consolidated Statements of Financial Position through the recognition of right-of-use assets and corresponding lease liabilities and (iii) expands mandatory qualitative and quantitative disclosures regarding leasing activities. The FASB issued ASU No. 2020-05, “Revenue from Contracts with Customers (Topic 606) and Leases (Topic 842) Effective dates for certain entities”, which extends the effective date for all other entities, for annual reporting periods beginning after December 15, 2021, and for interim periods within fiscal years beginning after December 15, 2022. The amended standard is effective for the Company beginning with the year ended July 31, 2022. Early adoption is permitted. The Company’s assessment of the new lease accounting standard’s impact on the Condensed Consolidated Financial Statements is ongoing. The Company is evaluating the optional practical expedients and assessing the Company's existing lease portfolio in order to determine the impact to the financial statements, accounting systems, processes, and internal control over financial reporting. While the Company has not yet quantified the impact, adjustments resulting from the adoption of this standard will materially increase total assets and total liabilities with the recognition of right of use assets and lease liabilities related to the Company's operating leases.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments–Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments, and also issued subsequent amendments to the initial guidance, collectively, ASC 326, to replace the incurred loss impairment methodology in current U.S. GAAP with a
methodology that requires the reflection of expected credit losses and will also require consideration of a broader range of reasonable and supportable information to determine credit loss estimates. For many entities with financial instruments, the standard will require the use of a forward-looking expected loss model rather than the incurred loss model for recognizing credit losses, which may result in the earlier recognition of credit losses on financial instruments. This guidance will be effective for the Company beginning with the year ended July 31, 2022, with early adoption permitted. The Company is currently evaluating the impact this standard could have on the Condensed Consolidated Financial Statements.
In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting (“ASU 2020-04”), and further issued subsequent amendments to the initial guidance. In order to ease the potential burden in accounting for reference rate reform, ASU 2020-04 provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships and other transactions that reference the LIBOR or another reference rate expected to be discontinued because of reference rate reform, if certain criteria are met. ASU 2020-04 applies only to contracts, hedging relationships and other transactions that reference LIBOR or another reference rate expected to be discontinued. The standard is effective immediately and may be applied prospectively through December 31, 2022. The Company is currently evaluating the impact of reference rate reform and the optional expedients provided by this standard on its contracts.
In May 2021, the FASB issued ASU No. 2021-04, Earnings per Share (Topic 260), Debt - Modifications and Extinguishments (Subtopic 470-50), Compensation-Stock Compensation (Topic 718), and Derivatives and Hedging - Contracts in Entity's Own Entity (Subtopic 815-40), to clarify the accounting for modifications or exchanges of equity-classified warrants. This amendment applies to freestanding stock options, which the Company granted in Fiscal 2021. In accordance with the ASU, if there is a modification and the option is still determined to be classified as equity, the modification should be accounted for as an exchange of the original option for a new option. This guidance will be effective for the Company beginning with the year ended July 31, 2023, with early adoption permitted. The Company is currently evaluating the impact of this update and will monitor for modifications or exchanges of the issued freestanding stock options, but at this time does not anticipate the adoption of ASU 2021-04 to have a material impact on the Condensed Consolidated Financial Statements.
3. Revenue
Disaggregated revenue information
The following table presents the percentages of consolidated net sales disaggregated by sales channels:
Three months ended January 31,
Six months ended January 31,
2022
2021
2022
2021
Wholesale - distributors
67.2
%
60.2
%
67.9
%
66.9
%
Wholesale - California direct to retail(a)
19.8
19.6
18.1
16.9
DTC(b)
13.0
20.2
14.0
16.2
Net sales
100.0
%
100.0
%
100.0
%
100.0
%
________________________________________________
(a) Includes $0.5 million and $2.2 million of sales related to bulk, grape and merchandise sales for the three months and six months ended January 31, 2022, respectively. Sales of a similar nature were immaterial for the three months and six months ended January 31, 2021.
(b) Includes shipping and handling revenue of $0.4 million and $0.6 million for the three months ended January 31, 2022 and 2021, respectively and $0.9 million and $1.1 million for the six months ended January 31, 2022 and 2021, respectively.
Contract liabilities
When the Company receives payment from a customer prior to transferring the product under the terms of a contract, the Company records deferred revenue, which represents a contract liability. The Company’s deferred revenue is primarily comprised of cash collected from DTC members for purchases ahead of the wine shipment date. The Company does not recognize revenue until control of the wine is transferred and the performance obligation is met.
As shown on the Condensed Consolidated Statements of Financial Position, the balance of deferred revenue was $3.1 million at July 31, 2021, the beginning of the period, and was $0.1 million at January 31, 2022, the end of the period. Revenue recognized during the six months ended January 31, 2022, which was included in the opening contract liability balance for the corresponding period totaled $3.0 million.
4.Inventories
Inventories were comprised of the following:
(in thousands)
January 31, 2022
July 31 2021
Finished goods
Bottled wine
$
94,520
$
120,876
Merchandise
458
547
Work in progress
Bulk wine
194,186
130,693
Packaging
3,747
3,541
Overhead
1,671
613
Raw materials
Deferred crop costs
2,949
11,467
Total
$
297,531
$
267,737
The Company capitalizes into inventory depreciation related to property and equipment used in the production of inventory. For the six months ended January 31, 2022 and the year ended July 31, 2021, the amount of depreciation capitalized was $6.6 million and $12.5 million, respectively.
5.Property and equipment
Property and equipment was comprised of the following major components as of:
(in thousands)
January 31, 2022
July 31, 2021
Land
$
131,297
$
120,063
Buildings and improvements
68,646
68,616
Vineyards and improvements
32,511
29,164
Machinery and equipment
51,618
49,607
Barrels
30,844
26,349
Total depreciable property and equipment
314,916
293,799
Less: accumulated depreciation and amortization
(63,177)
(58,542)
Total depreciable property and equipment, net
251,739
235,257
Construction in progress
4,106
5,682
Property and equipment, net
$
255,845
$
240,939
Depreciation expense was $0.3 million and $0.7 million for three months and six months ended January 31, 2022 and $0.3 million and $0.6 million for three months and six months ended January 31, 2021, respectively. See Note 4 (Inventories) for depreciation expense capitalized into inventory.
Vineyard acquisitions
In the second quarter of Fiscal 2022, the Company completed the purchase of three Napa County, California vineyards and related assets for a total of $14.5 million.
Intangible assets were comprised of the following components:
January 31, 2022
(in thousands)
Gross carrying amount
Accumulated amortization
Net
Definite-lived intangible assets
Customer relationships
$
92,720
$
38,054
$
54,666
Leasehold interests
1,572
433
1,139
Total definite-lived intangible assets
94,292
38,487
55,805
Indefinite-lived intangible assets
Trade names
139,600
—
139,600
Lane rights
1,300
—
1,300
Total indefinite-lived intangible assets
140,900
—
140,900
Total other intangible assets
$
235,192
$
38,487
$
196,705
July 31, 2021
(in thousands)
Gross carrying amount
Accumulated amortization
Net
Definite-lived intangible assets
Customer relationships
$
92,720
$
34,274
$
58,446
Leasehold interests
1,572
371
1,201
Total definite-lived intangible assets
94,292
34,645
59,647
Indefinite-lived intangible assets
Trade names
139,600
—
139,600
Lane rights
1,300
—
1,300
Total indefinite-lived intangible assets
140,900
—
140,900
Total other intangible assets
$
235,192
$
34,645
$
200,547
The Company’s amortization expense for both the three months and six months ended January 31, 2022 and 2021 was $1.9 million and $3.8 million, respectively. For the next five years, the Company anticipates the annual amortization of the definite-lived intangible assets that have been recorded as of January 31, 2022 to be $7.7 million per year.
7.Accrued expenses
The Company’s accrued expenses balance consisted of the following amounts:
(in thousands)
January 31, 2022
July 31, 2021
Trade spend(a)
$
16,207
$
10,734
Bulk wine and other received not invoiced
607
1,526
Barrel purchases
—
936
Deferred compensation liability(b)
2,144
2,096
Income tax payable
2,313
—
Accrued invoices and other accrued expenses
5,805
6,265
Total
$
27,076
$
21,557
________________________________________________
(a) Trade spend refers to estimated amounts the Company owes to distributors for depletion-based incentives granted for meeting specific depletion targets.
(b) The Company intends to use the cash surrender value life insurance policies in settling its deferred compensation plan liability. The cash surrender value of the life insurance policies was $1.9 million and $1.7 million at January 31, 2022 and July 31, 2021, respectively.
The Company is subject to the requirements of various financial covenants pursuant to the term loans and revolving line of credit, including a debt to net worth maximum and a fixed charge coverage ratio as defined in the Credit Facility. As of January 31, 2022, the Company was not in violation of any financial covenant.
Included in interest expense in the Condensed Consolidated Statements of Operations, and in depreciation and amortization on the Condensed Consolidated Statements of Cash Flows, is amortization related to debt issuance costs of $0.4 million for both the three months ended January 31, 2022 and 2021 and $0.8 million for both the six months ended January 31, 2022 and 2021.
Revolving line of credit
At January 31, 2022, $290.0 million was available to draw under the revolving line of credit, excluding the incremental seasonal borrowing amount of an additional $30.0 million of capacity. The weighted-average interest rate was 1.8% on the amount outstanding at January 31, 2022. There were no amounts outstanding on the letter of credit sub-facility or the swingline sub-facility at January 31, 2022.
9.Derivative instruments
The Company manages exposure to interest rates and foreign currency movements by entering into derivative contracts from time to time, as movements in such markets could impact the financial results and Condensed Consolidated Statements of Financial Position.
The changes in estimated fair values of derivative instruments result from changes in interest rates and foreign currency exchange rates. Such changes serve to offset exposure in related business assets or liabilities. The Company is exposed to credit loss in the event of nonperformance by a counterparty. Certain of the Company's derivative instruments are subject to master netting agreements. In certain circumstances, this agreement allows the Company to net-settle amounts payable or receivable related to multiple derivative transactions with the same counterparty. The fair values of derivative instruments are presented on a gross basis, even when the derivative instruments are subject to master netting arrangements. Collateral is generally not required of the Company or of the counterparties to the master netting agreements, and no cash collateral was received or pledged under such agreements as of January 31, 2022 or July 31, 2021. The Company does not enter into derivative instruments for trading or speculative purposes. The Company's accounting policies do not apply hedge accounting treatment to derivative instruments.
As of January 31, 2022, the Company held the following interest rate swap agreements, which fixed the interest rate on the applicable notional amount of outstanding variable rate debt:
Notional amount
(in thousands)
Interest rate
Effective date
Expiration date
$100,000
0.487%
March 21, 2020
March 23, 2023
As discussed in Note 11 (Commitments and contingencies), the Company manages annual barrel purchases by engaging domestic and foreign cooperages to provide specified barrel quantities on agreed delivery dates. Some of these invoices are paid in Euros. In order to reduce the foreign exchange risk associated with the Euro to U.S. Dollar conversion rate, the Company enters into foreign currency forward contracts aligning settlement dates with expected barrel delivery and the anticipated payments to various coopers.
The total notional amounts of the Company’s derivative instruments outstanding are as follows:
(in thousands)
January 31, 2022
July 31, 2021
Derivative instruments not designated as hedging instruments
Interest rate swap contracts
$
100,000
$
100,000
Foreign currency forward contracts
—
2,369
Total derivative instruments not designated as hedging instruments
The estimated fair value and classification of derivative instruments on the accompanying Condensed Consolidated Statements of Financial Position are as follows:
(in thousands)
January 31, 2022
July 31, 2021
Derivative instruments not designated as hedging instruments
Classification
Interest rate swap contracts
Swap contract
Other long-term assets
$
482
$
—
Derivative instrument
Other long-term liabilities
—
(480)
Foreign currency forward contracts
Derivative instrument
Other current assets
$
—
$
5
The amounts and classification of the gains and losses in the Condensed Consolidated Statements of Operations related to derivative instruments not designated as hedging instruments are as follows:
Three months ended January 31,
Six months ended January 31,
(in thousands)
Classification
2022
2021
2022
2021
Interest rate swap contracts
Other income, net
$
(515)
$
(1,279)
$
(962)
$
(2,945)
Foreign currency forward contracts
Other income, net
—
—
5
118
Total gains
$
(515)
$
(1,279)
$
(957)
$
(2,827)
10.Fair value measurements
The Company applies a fair value hierarchy pursuant to ASC 820, Fair Value Measurement, which consists of three levels of inputs that may be used to measure fair value:
Level 1 Inputs to fair value are quoted prices in active markets for identical assets or liabilities;
Level 2 Inputs to fair value are based on observable data other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data such as interest rates or yield curves for substantially the full term of the instrument;
Level 3 Inputs to fair value are based on unobservable data for the instrument and are supported by little or no market activity.
Following is a description of the valuation methodologies used for instruments measured at fair value in the Condensed Consolidated Financial Statements, as well as the general classification of such instruments under the valuation hierarchy.
Interest rate swap contracts: The fair value of the Company’s interest rate swap agreement is estimated with the assistance of a third party, using inputs that can be corroborated by observable market data (Level 2 of the fair value hierarchy).
Foreign currency forward contracts: The fair value of the Company’s outstanding foreign currency forward contracts is estimated with the assistance of a third party, using inputs that can be corroborated by observable market data (Level 2 of the fair value hierarchy).
Deferred compensation plan: Contributions to the Company’s deferred compensation plan are managed by a third-party administrative agent. The fair value of the total contributed plan assets and liabilities are based on inputs that can be corroborated by observable market data (Level 2 of the fair value hierarchy).
The Company’s other financial instruments consist mainly of cash, accounts receivable, accounts payable, accrued expenses, and debt. The carrying value of all other financial instruments, except debt, approximates fair value due to the short-term nature of these assets and liabilities. The carrying value of the Company's debt approximates fair value as the interest rates are variable and reflective of market rates. Debt is categorized as a Level 2 liability within the fair value hierarchy.
The Company’s assets and liabilities measured and recorded at fair value on a recurring basis at January 31, 2022, were as follows:
(in thousands)
Fair value measurements using:
Quoted prices in active markets (Level 1)
Significant other observable inputs (Level 2)
Significant unobservable inputs (Level 3)
Total
Assets
Interest rate swap contracts
$
—
$
482
$
—
$
482
Deferred compensation plan asset
—
1,920
$
—
1,920
Liabilities
Deferred compensation liability
$
—
$
2,144
—
$
2,144
The Company’s assets and liabilities measured and recorded at fair value on a recurring basis at July 31, 2021, were as follows:
(in thousands)
Fair value measurements using:
Quoted prices in active markets (Level 1)
Significant other observable inputs (Level 2)
Significant unobservable inputs (Level 3)
Total
Assets
Foreign currency forward contracts
$
—
$
5
$
—
$
5
Deferred compensation plan asset
—
1,719
—
1,719
Liabilities
Interest rate swap contracts
$
—
$
480
$
—
$
480
Deferred compensation liability
—
2,096
—
2,096
11.Commitments and contingencies
Operating leases
The Company leases approximately 150 acres of vineyard property in California under various third-party operating lease agreements, with terms ranging from one to 30 years, expiring in future years through December 2046. The Company also leases office space, office equipment and visitor centers under third-party operating leases. Some lease agreements contain purchase options and many include renewal options at specified dates throughout the lease terms. Rental expense was $1.0 million and $2.0 million for three months and six months ended January 31, 2022, respectively, and $0.9 million and $2.0 million for the three months and six months ended January 31, 2021, respectively, the majority of which is capitalized into inventory.
At January 31, 2022, the future minimum payments under the non-cancelable operating lease agreements by fiscal year are as follows:
(in thousands)
Remaining portion of 2022
$
2,068
2023
4,122
2024
4,106
2025
4,070
2026
2,686
Thereafter (collectively)
10,836
Total
$
27,888
The Company is also party to non-cancelable sublease agreements. Sublease income was immaterial for the three and six months ended January 31, 2022 and is accounted for as other income in the Consolidated Statements of Operations. The terms of the agreements range between three and five years and the total future minimum payments for these subleases is immaterial.
Long-term purchase contracts
The Company has entered into long-term grape purchase contracts with various growers to supply a significant portion of its future grape requirements. The lengths of the contracts typically vary from one to eight years, and prices per ton are either determined at the outset for the contract duration or are negotiated annually. The Company's grape purchase contracts generally include acceptance provisions based on qualitative and quantitative grape quality characteristics. For the 2021 harvest, the Company contracted for approximately 34,000 tons of grapes at a cost of $68.1 million in Fiscal 2022. For the 2020 harvest, the Company purchased approximately 12,000 tons of grapes at a total cost of $26.5 million in Fiscal 2021. The increase was largely attributable to lower quantities available for the 2020 harvest at the Company's contractually defined quality levels due to wildfires compounded with higher demand and production levels in current and future periods.
Purchase commitments
The Company enters into various contracts with third-parties for custom crush, storage and mobile bottling services. The costs related to these contracts are recorded in the period the service is provided. The contracts for custom crush services typically have minimums that the Company is required to pay if certain grape volume thresholds are not delivered. The Company does not record these minimums related to service contracts as contingent liabilities on the Condensed Consolidated Statements of Financial Position given the harvest yield size, resulting volumes and qualities of grape deliveries are not known or estimable until harvest, when all related contingencies would be resolved.
Contingent liabilities
The Company evaluates pending or threatened litigation, operational events which could result in regulatory or civil penalties, environmental risks, and other sources of potential contingent liabilities during the year. In accordance with applicable accounting guidance, the Company establishes an accrued liability when those matters present loss contingencies, which are both probable and reasonably estimable. As of January 31, 2022, there were no material contingent obligations requiring accrual or disclosure.
In the ordinary course of business, the Company enters into agreements containing standard indemnification provisions. The aggregate maximum potential future liability of the Company under such indemnification provisions is uncertain, as these involve potential future claims against the Company that have not occurred. The Company believes the probability of incurring future obligations under these indemnification provisions is sufficiently remote. As of January 31, 2022 and July 31, 2021, no amounts have been accrued related to such indemnification provisions.
The Company recognized equity compensation expense related to the 2016 Plan in selling, general and administrative expenses due to units vesting over their requisite service periods in the aggregate amounts of $0.1 million and $0.2 million for the three months and six months ended January 31, 2022, respectively, and $0.3 million and $0.6 million for the three months and six months ended January 31, 2021, respectively. The total unrecognized compensation expense related to the 2016 Plan was $0.2 million as of January 31, 2022, which is expected to be recognized over a weighted-average period of 0.5 years.
Restricted shares
Performance-based shares
Weighted-average grant-date fair value
Unvested as of July 31, 2021
399,234
$
14.23
Granted
—
—
Vested
(133,076)
14.23
Forfeited
—
—
Unvested as of January 31, 2022
266,158
$
14.23
The total fair value of restricted shares that vested during the six months ended January 31, 2022 was $1.9 million.
2021 Equity incentive plan
The Company recognized in selling, general and administrative expenses equity compensation expense related to the 2021 Plan totaling $1.1 million and $2.2 million for the three months and six months ended January 31, 2022, respectively, due to units vesting over their requisite service period. In addition, the Company capitalized into inventory $0.2 million and $0.4 million for the three months and six months ended January 31, 2022, respectively.
Stock options
Stock option activity and activity regarding shares available for grant under the 2021 Plan is shown below:
Number of options
Weighted-average exercise price
Weighted-average remaining contractual life (in years)
Aggregate intrinsic value (in thousands)
Outstanding at July 31, 2021
1,552,648
$
17.11
Granted
—
—
Vested
—
—
Forfeited
(2,799)
17.00
Outstanding at January 31, 2022
1,549,849
$
17.11
9.1
$
5,888
The total unrecognized compensation expense related to the 2021 Plan stock options was $5.6 million as of January 31, 2022, which is expected to be recognized over a weighted-average period of 3.1 years. No options were vested and exercisable as of January 31, 2022.
RSU grant activity under the 2021 Plan is shown below:
Number of units
Weighted-average grant-date fair value per share
Unvested as of July 31, 2021
555,950
$
16.95
Granted
22,333
20.24
Vested
(18,417)
15.34
Forfeited
(932)
17.00
Unvested as of January 31, 2022
558,934
$
17.13
The total fair value of restricted stock that vested during the six months ended January 31, 2022 was $0.3 million. The total unrecognized compensation expense related to the 2021 Plan RSUs was $7.4 million as of January 31, 2022, which is expected to be recognized over a weighted-average period of 2.9 years.
Employee Stock Purchase Plan
In connection with the IPO, the Company adopted the 2021 Employee Stock Purchase Plan, which allows for the issuance of up to a total of 1,250,509 shares of the Company's common stock. The ESPP, pursuant to Internal Revenue Code Section 423, allows eligible participants to purchase shares using payroll deductions of up to 15% of their total compensation, subject to a $25,000 calendar year limitation on contributions. The purchase price of each share will be 85% of the lesser of the fair market value of the stock as determined on the applicable grant date or the applicable purchase date for each offering period.
Each offering period is six months in duration. The first offering period for the Employee Stock Purchase Plan began on January 3, 2022. Thereafter, offering periods will begin on the first business day of January and July. No purchases have been made under the ESPP as of January 31, 2022.
The fair value of ESPP shares is estimated at the date of grant using the Black-Scholes option-pricing valuation model. The following assumptions were applied in the model to estimate the grant-date fair value of the ESPP for the initial offering period that began on January 3, 2022.
Expected term (in years)(a)
0.5
Expected dividend yield(b)
—
Risk-free interest rate(c)
0.22
%
Expected volatility(d)
47
%
Stock price
$
23.33
________________________________________________
(a) Based on the contractual terms of the 2021 ESPP Agreement and equal to each option period.
(b) The Company has not historically paid and does not expect to pay dividends in the foreseeable future.
(c) The risk-free rate was estimated from the U.S. Constant Maturity Treasury Yield Curve for a period consistent with the expected term in effect at the grant date.
(d) The expected volatility was estimated based on analysis of the Company's historical and implied volatility, and considering a group of guideline public companies deemed to be comparable public peers within the Company’s industry.
The equity-based compensation expense related to the ESPP is generally recognized evenly over the service period unless otherwise stipulated by the award agreement. The service period is the period over which the employee performs the related services, which is normally the same as the six month ESPP offering period.
As of January 31, 2022, total estimated unrecognized compensation expense related to the ESPP was $0.1 million. That cost is expected to be recognized over the remaining term of the offering period of 0.4 years.
Several wildfires occurred in northern California in the first quarter of Fiscal 2021. Other than smoke exposure to unharvested grapes, the Company's owned and leased vineyards did not sustain damage during the fires. Fire and smoke exposure related expenses are reported on the casualty loss line in the Condensed Consolidated Statement of Operations and were immaterial in the current fiscal year. Smoke and fire damage to vineyards in the primary markets where the Company sources fruit rendered some of the available grapes unacceptable for the Company’s production needs. Based on an internal analysis of the impacts of these wildfires, Management believes the potential impact to the Company's operational results to be immaterial and intend to continue to monitor the ongoing effects to the business for any material changes to that conclusion.
Flood
In Fiscal 2021, as discussed in the 2021 Form 10-K, the Company received proceeds from an insurance claim related to losses incurred in February 2019 due to a flood at a winery. Any incremental charges in the fiscal year ended July 31, 2021, offset by insurance proceeds received, which were reported on the casualty gain, net line item in the Consolidated Statements of Operations and did not recur in Fiscal 2022.
14. Earnings per share
Basic earnings per share is calculated by dividing the net income by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share reflects the dilution that would occur if any potentially dilutive instruments were exercised or converted into shares of common stock.
The following is a reconciliation of the Company's basic and diluted income per share calculation:
Three months ended January 31,
Six months ended January 31,
(in thousands, except share and per share amounts)
2022
2021
2022
2021
Numerator - Net income attributable to The Duckhorn Portfolio, Inc.
$
17,932
$
22,003
$
39,205
$
39,526
Denominator:
Weighted average number of shares of common stock outstanding - basic
115,049,395
101,713,460
115,048,094
101,713,460
Dilutive stock options and restricted stock(a)
340,107
—
342,917
—
Weighted average number of shares of common stock outstanding - assuming dilution
115,389,502
101,713,460
115,391,011
101,713,460
Earnings per share attributable to The Duckhorn Portfolio, Inc.
Basic
$
0.16
$
0.22
$
0.34
$
0.39
Diluted
$
0.16
$
0.22
$
0.34
$
0.39
________________________________________________
(a) Calculated using the treasury stock method.
There were no outstanding common stock awards deemed anti-dilutive for the three months and six months ended January 31, 2022 and 2021.
15. Subsequent events
In February 2022, the Company entered into a preliminary purchase and sale agreement to buy a San Luis Obispo County, California vineyard and related assets for a total of $18.2 million. This acquisition is expected to close during the third quarter of Fiscal 2022, subject to customary closing conditions. Accordingly, until closing of the purchase, there can be no assurance that the Company will acquire the vineyard property. The Company has not yet completed its evaluation and determination of final consideration to be paid, certain assets and liabilities acquired or treatment of these transactions as either a business combination or asset acquisition in accordance with Topic 805.
Item 2. Management’s discussion and analysis of financial condition and results of operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and the related notes to those statements included elsewhere in this Quarterly Report on Form 10-Q. In addition to historical financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. See “Cautionary note regarding forward-looking statements” included in this Quarterly Report on Form 10-Q. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed in Part I “Item 1A. Risk factors” included in our Annual Report on Form 10-K for Fiscal 2021.
Overview
The Duckhorn Portfolio is the premier scaled producer of luxury wines in North America. We have delighted millions of consumers with authentic, high-quality, approachable wines for over four decades. We champion a curated and comprehensive portfolio of highly acclaimed luxury wines across multiple varietals, appellations, brands and price points. Our portfolio is focused exclusively on the desirable luxury segment, which we define as wines sold for $15 or higher per 750ml bottle.
We sell our wines in all 50 states and over 50 countries at prices ranging from $20 to $200 per bottle under a world-class luxury portfolio of winery brands, including Duckhorn Vineyards, Decoy, Kosta Browne, Goldeneye, Paraduxx, Calera, Migration, Canvasback, Greenwing and Postmark. Our wines have a strong record of achieving critical acclaim, vintage after vintage. Each winery brand boasts its own winemaking team to create distinct experiences for consumers, to ensure product quality and continuity and to galvanize sustainable farming practices. Beyond our winemaking teams is an organization comprised of passionate, talented employees, including a highly tenured executive team that has approximately 100 years of cumulative experience with Duckhorn.
We sell our wines to distributors outside California and directly to retail accounts in California, which together comprise our wholesale channel. We also sell directly to consumers through our DTC channel, which made up approximately 14% of our net sales for the first six months of Fiscal 2022. Our powerful omni-channel sales model drives strong margins by leveraging long-standing relationships developed over the past forty years. We believe our iconic winery brands together with our scaled, quality-focused production, omni-channel distribution and dedicated employees, set the standard for North American luxury wine.
Key financial metrics
We use net sales, gross profit and adjusted EBITDA to evaluate the performance of our business, identify trends in our business, prepare financial forecasts and make capital allocation decisions. We believe the following metrics are useful in evaluating our performance, but adjusted EBITDA should not be considered in isolation or as a substitute for any other financial information depicting our results prepared in accordance with U.S. GAAP. Certain judgments and estimates are inherent in our processes to calculate these metrics.
Three months ended January 31,
Six months ended January 31,
(in thousands)
2022
2021
2022
2021
Net sales
$
98,736
$
83,657
$
202,917
$
175,295
Gross profit
$
49,477
$
41,757
$
101,887
$
86,032
Net income attributable to The Duckhorn Portfolio, Inc.
The following table represents the reconciliation of adjusted EBITDA to net income attributable to The Duckhorn Portfolio, Inc.:
Three months ended January 31,
Six months ended January 31,
(in thousands)
2022
2021
2022
2021
Net income attributable to The Duckhorn Portfolio, Inc.
$
17,932
$
22,003
$
39,205
$
39,526
Interest expense
1,636
3,612
3,242
7,192
Income tax expense
6,407
7,935
13,784
14,071
Depreciation and amortization expense
6,280
5,765
11,109
10,881
EBITDA
32,255
39,315
67,340
71,670
Purchase accounting adjustments(a)
99
762
292
1,323
Transaction expenses(b)
1,024
—
2,770
—
Change in fair value of derivatives(c)
(515)
(1,279)
(957)
(2,827)
Equity-based compensation(d)
1,416
288
2,875
576
Casualty gain, net(e)
—
(7,832)
—
(7,832)
Loss on debt extinguishment(f)
—
—
—
272
IPO preparation costs(g)
—
210
—
405
Wildfire costs(h)
31
62
80
1,617
COVID-19 costs(i)
—
652
—
696
Adjusted EBITDA
$
34,310
$
32,178
$
72,400
$
65,900
________________________________________________
(a) Purchase accounting adjustments relate to the impacts of prior business combination accounting for our acquisition by TSG in Fiscal 2017, our subsequent acquisitions of Calera and Kosta Browne in Fiscal 2018 and Fiscal 2019, respectively, and certain other transactions consummated prior to our acquisition by TSG, which resulted in fair value adjustments to inventory and long-lived assets.
(b) Transaction expenses include legal and professional fees and change of control payments incurred in connection with our IPO in March 2021. Also included are expenses incurred for abandoned transactions and the secondary offering completed in October 2021. These expenses were directly related to such transactions and were incremental to our normal operating expenses.
(c) See Note 9 (Derivative instruments) to our Condensed Consolidated Financial Statements for additional information.
(d) See Note 12 (Equity-based compensation) to our Condensed Consolidated Financial Statements for additional information.
(e) Casualty gain, net in adjusted EBITDA pertains to the flood event at one of our wineries in Fiscal 2019, and was primarily comprised of insurance proceeds received pursuant to our claim, offset by flood damage and remediation costs. The proceeds received, offset by costs incurred, are reported on the casualty loss (gain), net line in the Condensed Consolidated Statements of Operations. See Note 13 (Casualty loss) to our Condensed Consolidated Financial Statements for additional information.
(f) Loss on debt extinguishment includes charges for unamortized deferred financing fees we recognized in connection with amendments to our Credit Facility.
(g) IPO preparation costs include professional fees incurred for outside consultants to advise us on legal, accounting and tax matters related to our preparation for becoming a public company, which were not directly attributable to an offering.
(h) Wildfire costs include the cost of unharvested fruit that was damaged and rendered useless, charges we incurred to respond to imminent wildfire threat with fire-fighting crews to protect our assets, clean-up and smoke remediation expenses to restore operations at our tasting rooms after the fires, testing fees to evaluate our fruit for possible smoke damage, and washing or other grape processing costs prior to vinification to reduce the risk of smoke in finished wine.These costs are reported on the casualty loss (gain), net line in the Condensed Consolidated Statements of Operations. See Note 13 (Casualty loss) to our Condensed Consolidated Financial Statements for additional information. While we expect the potential for wildfires to be an ongoing risk to running an agricultural business in California, we believe the wildfires and related costs we experienced are not indicative of our core operating performance.
(i) COVID-19 costs include certain incremental expenses incurred during the outbreak of the COVID-19 pandemic and the short-term closure mandates imposed by government officials in the jurisdictions in which we operate. These costs include tasting room expenses incurred during a period of mandatory closure and reduced capacity, salaries and severance expenses for certain employees and other immaterial costs to transfer inventory.
Net sales
Our net sales represent revenues less discounts, promotions and excise taxes.
Gross profit
Gross profit is equal to our net sales less cost of sales. Cost of sales includes all wine production costs, winemaking, bottling, packaging, warehousing and shipping and handling costs. Our gross profit and gross profit margins on net sales are impacted by the mix of winery brands we sell in our portfolio. See “—Components of results of operation and key factors affecting our performance” for additional information.
Adjusted EBITDA
Adjusted EBITDA is a non-GAAP financial measure that we calculate as net income before interest, taxes, depreciation and amortization, non-cash equity-based compensation expense, purchase accounting adjustments,
casualty losses or gains, impairment losses, changes in the fair value of derivatives and certain other items, which are not related to our core operating performance. Adjusted EBITDA is a key metric we use to evaluate business performance in comparison to budgets, forecasts and prior period financial results, providing a measure that Management believes reflects the Company’s core operating performance.
For comparative periods presented, our primary operational drivers of adjusted EBITDA have been sustained sales growth in our wholesale channel and steady growth in our DTC channel, management of our cost of sales through our diversified supply planning strategy, and discipline over selling, general and administrative expenses relative to our sales growth.
Key operating metrics
We monitor the following key metrics to help us evaluate our business, identify trends affecting our business, measure our performance, formulate business plans and make strategic decisions. We believe the following metrics are useful in evaluating our business but should not be considered in isolation or, solely with respect to price / mix contribution, as a substitute for financial information prepared and presented in accordance with U.S. GAAP. Certain judgments and estimates are inherent in our processes to calculate these metrics.
Net sales percentage by channel
We calculate net sales percentage by channel as net sales made through our wholesale channel to distributors, through our wholesale channel directly to retail accounts in California and through our DTC channel, respectively, as a percentage of our total net sales. We monitor net sales percentage across these three routes to market to understand the effectiveness of our omni-channel distribution model and to ensure we are deploying resources effectively to optimize engagement with our customers across our complementary distribution channels.
Three months ended January 31,
Six months ended January 31,
2022
2021
2022
2021
Wholesale - distributors
67.2
%
60.2
%
67.9
%
66.9
%
Wholesale - California direct to retail
19.8
%
19.6
%
18.1
%
16.9
%
DTC
13.0
%
20.2
%
14.0
%
16.2
%
The composition of our net sales, expressed in percentages by channel for the three months and six months ended January 31, 2022 and 2021, continued to move toward historical trends along with the signs of ongoing recovery from COVID-19 disruption across major markets. While notable gains in on-premise activity continued the shift back toward pre-pandemic levels, off-premise activity remained a key strength in our results as we held onto share gains across our broader wholesale channel.
Net sales for the DTC channel were bolstered by higher visitor center sales overall as compared to the prior year period for the three months and six months ended, although comparability to prior year was impacted by earlier member shipment timing pulling a portion of net sales from the second quarter into the first quarter of Fiscal 2022.
We expect sales channel mix to continue to normalize toward historical levels in correlation with the reversion of consumer purchasing patterns and the re-opening of on-premise sales locations in future periods.
Net sales growth contribution
Net sales growth is defined as the percentage increase of net sales in the period compared to the prior period. Contribution to net sales growth is calculated based on the portion of changes in net sales for a given period that is driven by two factors: changes in sales volume and changes in sales price and mix. Volume contribution presents the percentage increase in cases sold in the current period compared to the prior period.
Price / mix contribution presents net sales growth less volume contribution and reflects that, in addition to changes in sales volume, changes in net sales are primarily attributable to changes in sales price and mix.
Three months ended January 31,
Six months ended January 31,
2022
2021
2022
2021
Net sales growth
18.0
%
8.7
%
15.8
%
17.1
%
Volume contribution
24.8
%
11.4
%
15.3
%
25.4
%
Price / mix contribution
(6.8)
%
(2.8)
%
0.5
%
(8.3)
%
For the six months ended January 31, 2022, growth in net sales was mainly attributable to continued strong sales volume growth and a neutral price / mix contribution demonstrating the shift back toward pre-COVID-19 trends with the growth in our on-premise sales. Generally, on-premise growth also drives increased sales in our ultra-luxury brands that sell at higher average sales prices and positively impact price / mix contribution. In the prior year period, we saw immense growth primarily driven by off-premise sales of our luxury winery brands that drove a negative price / mix contribution. Our consistent use of distributor and retail sales discounts and promotions in our wholesale channel to gain market share has historically and may continue to put downward pressure on price / mix contribution given an increase in net sales.
For the three months ended January 31, 2022, negative price mix contribution was impacted by the outsized volume growth of the wholesale channel, aided by continued on-premise resurgence and further pressured by DTC shipment timing moving out of the second quarter of Fiscal 2022 into the first quarter of the same fiscal year.
We expect price / mix contribution will continue to move toward historical levels as consumer purchasing and consumption habits return to normal following the COVID-19 pandemic. We expect that volume contribution will continue to be the primary driver of changes in our net sales in future periods. To the extent our growth is fueled by sales of lower-priced luxury winery brands, we may see lower or negative price / mix contribution in the future, with potential for favorable impacts to price / mix due to brand velocity at varying price points.
Components of results of operation and key factors affecting our performance
Net sales
Our net sales consist primarily of wine sales to distributors and directly to retail accounts in California, which together comprise our wholesale channel, and directly to individual consumers through our DTC channel. Net sales generally represent wine sales and shipping, when applicable. Sales are generally recorded at the point of shipment and are recorded net of returns, consideration provided to customers through various incentive programs, other promotional discounts and excise taxes.
We refer to the volume of wine we sell in terms of cases, each of which represents a standard 12 bottle case of wine (in which each bottle has a volume of 750 milliliters). Cases sold represent wine sales through our wholesale and DTC channels. Depletions, in turn, represent sell-through from our distributors, including our California wholesale sales channel, to retail accounts nationally.
The following factors and trends in our business have driven net sales growth over the past fiscal years and are expected to be key drivers of our net sales growth for the foreseeable future:
•Further leverage brand strength. We believe our comprehensive growth plan will continue to increase brand awareness and grow sales of our winery brands to our existing consumer base and a new generation of consumers. This plan is made possible by our omni-channel platform, which enables us to grow both through increased volume with existing and new customers and accounts as well as through periodic price increases, particularly on our higher end, smaller lot DTC wines.
•Insightful and targeted portfolio evolution. Our curated portfolio and historical growth result from long-term dedication to continuous evolution and alignment with the luxury wine consumer. We believe we can drive additional sales through our wholesale and DTC channels. As we continue to scale, we believe our growth mindset, coupled with our differentiated production and distribution platform, will enable us to adapt and remain at the forefront of our industry.
•Distribution expansion and acceleration. Purchasing by distributors and loyal accounts that continue to feature our wines are key drivers of net sales. We plan to continue broadening distribution of the wines in
our portfolio as well as to increase the volume of wine sold to existing accounts. We believe our long-standing existing commercial relationships coupled with exceptional portfolio strength position us to capture distribution growth opportunities and accelerate sales to existing distributors and retail accounts in California.
•Continued investment in DTC channel. We expect to continue to invest in our DTC channel, leveraging wine clubs and brand-specific tasting rooms to engage with our consumers, create brand evangelists and drive adoption across our portfolio.
•Opportunistic evaluation of strategic acquisitions. Our strategic and opportunistic approach to evaluating acquisitions has led to the successful acquisition of two winery brands in the past five years: Kosta Browne and Calera. While our growth and success are not contingent upon future acquisitions, we believe our team has the capabilities and track record both to execute and to integrate meaningful acquisitions when opportunities arise to create stockholder value.
The primary market for our wines is the United States, which has historically represented approximately 95% of our net sales. Accordingly, our results of operations are primarily dependent on U.S. consumer discretionary spending.
Sales channels
Our sales and distribution platform is based on long-standing relationships with a highly-developed network of distributor accounts in all U.S. states (except California, where we sell directly to retail accounts) and in over 50 countries globally. We also have developed strong relationships with consumers who buy our wines directly from us in the DTC channel. Channel mix can affect our performance and results of operations, particularly gross profit and gross profit margin.
•Wholesale channel. Consistent with sales practices in the wine industry, sales to retailers in California and to distributors in other states occur below suggested retail price. We work closely with our distributors to increase the volume of our wines and number of products that are sold by the retail accounts in their respective territories. In California, where we make sales directly to retail accounts, we benefit from greater control over our sales and higher profit margins by selling directly to retailers in the state. Our wholesale channel comprises a greater proportion of our net sales than our DTC channel.
•DTC channel. Wines sold through our DTC channels are generally sold at suggested retail prices. Our DTC channel continues to grow as a result of a number of factors, including a shift to more consumption and corporate engagement in the home.
Wholesale channel sales made on credit terms generally require payment within 90 days of delivery, and a substantial majority are collected within 60 days. In periods where the net sales channel mix reflects a greater concentration of wholesale sales (which typically occurs in our first and second fiscal quarters), we typically experience an increase in accounts receivable for the period to reflect the change in sales mix, with payment collections in the subsequent period generally reducing accounts receivable and having a positive impact on cash flows in such subsequent period.
While we seek to increase sales in both channels, we expect that our future sales will continue to be substantially comprised of sales in the wholesale channel. We intend to maintain and strengthen our long-standing relationships within our network of distributors, which we believe will be critical to our continued growth and success. In the wholesale channel, we are positioned as a one-stop luxury and ultra-luxury wine shop, offering a diverse mix of high-quality winery brands and varietals at varying luxury and ultra-luxury price points. We believe this strategy will enable us to continue increasing our share of the wholesale luxury and ultra-luxury wine market in the future, as customers will have greater opportunity to engage with and experience wines across our broad portfolio. We continue to innovate with new products at all price points within the portfolio. We strive to enhance customer engagement and increase sales as new customers encounter our wines and existing customers trade up to higher-priced wines.
Our sales mix within our wholesale channel has reflected disproportional benefits to off-premise sales in certain periods, while on-premise sales have experienced variability, directly related to the COVID-19 pandemic, which began impacting our sales in March 2020. Our responses to periods of historical disruption in the wholesale channel have focused on strengthening relationships with our accounts and distributors, introducing new products
and maintaining and strengthening our winery brand engagement. We believe this approach has enabled us to strengthen our portfolio and increase our market share relative to competitors during periods of market disruption.
We routinely offer sales discounts and promotions through various programs to distributors around the country and to retail accounts in California. These programs, where permissible, include volume-based discounts on sales orders, depletion-based incentives we pay distributors and certain other promotional activities. The expense associated with these discounts and promotions is estimated and recorded as a reduction of total sales in order to arrive at reported net sales. While our promotional activities may result in some variance in total net sales from quarter to quarter, historically, the total impact of such activities on annual net sales has been generally stable, and we expect this trend to continue in the future.
In the DTC channel, our holistic approach to consumer engagement both online and offline is supported by an integrated e-commerce platform and portfolio wine shop, seven distinctive tasting room experiences located throughout Northern California and Washington, and several award-winning wine clubs, all of which enable us to cross-sell wines within our portfolio. These strategies are designed to maximize each winery brand and property while driving awareness for the Company’s other world-class wines and properties, resulting in more and deeper customer connections. We strive to evolve our offerings, experiences and communication to match the generational shifts in wine engagement preferences and related purchasing decisions. In addition, we anticipate that our holistic consumer engagement approach will help our DTC sales remain strong through the near-term impact of the COVID-19 pandemic on consumer purchasing behaviors.
Increasing customer engagement is a key driver of our business and results of operations. We continue to invest in our DTC channel and in performance marketing to drive customer engagement. In addition to developing new offerings and cross-selling wines in our portfolio of winery brands, we focus on increasing customer conversion and customer retention. As we continue to invest in enhancing our DTC channel, we expect to continue to increase customer engagement, which we believe will result in greater customer satisfaction and retention.
Seasonality
Our net sales are typically highest in the first half of our fiscal year, mostly due to increased consumer demand around major holidays. Net sales seasonality differs for wholesale and DTC channels, resulting in quarterly seasonality in our net sales that depends on the channel mix for that period. We typically experience a higher concentration of sales through our wholesale channel during our first and second fiscal quarters due to increased purchasing by distributors in anticipation of higher consumer demand during the holiday season, which has the effect of lowering average selling prices as a result of the use of distributor and retail sales discounts and promotions in our wholesale channel. See “—Key operating metrics.” In Fiscal 2021, our net sales in the first, second, third and fourth fiscal quarters represented approximately 27%, 25%, 27% and 21%, respectively, of our total net sales for the year.
Gross profit
Gross profit is equal to our net sales, minus our cost of sales. Cost of sales includes grape and bulk wine purchase costs. For grapes we grow, cost of sales includes amounts incurred to develop and farm the vineyards we own and lease. Cost of sales also includes all winemaking and processing charges, bottling, packaging, warehousing and shipping and handling. Costs associated with storing and maintaining wines that age longer than one year prior to sale continue to be capitalized until the wine is bottled and available for sale.
As we continue to grow our business in the future, we expect gross profit to increase as our sales grow and as we effectively manage our cost of sales, subject to any future unexpected volatility in the grape and bulk wine markets, increased seasonal labor costs and, to a lesser extent inflationary impact from commodity costs such as dry goods. Additionally, we expect gross profit as a percentage of net sales to remain consistent with historical levels or to improve to the extent we observe a return toward normalized consumer spending behavior across the industry and within our business, particularly with respect to on-premise sales in the wholesale channel, which would favorably influence our gross profit margins on net sales.
We have developed a diversified sourcing and production model, supported by our eight wineries and world-class, strategically located Estate vineyards and strong relationships with quality-oriented growers. In addition, our sourcing model includes the purchase of high-quality bulk wine from established suppliers to add a highly flexible element of diversity to our supply model. Generally, over 85% of our total production is sourced from third-party growers and, to a significantly lesser extent, the bulk wine market. Our ability to adjust the composition of a particular vintage among our grape and bulk wine sourcing supply channels allows us to tailor inputs based on varying market or seasonal factors, which we believe enables us to produce the highest possible quality wine while optimizing gross profit.
Consistent with other agriculture enterprises, the cost of our wine fluctuates due to annual harvest yields, which vary due to weather and other events. In addition to agricultural factors, price volatility in the grape and bulk wine markets, competition for supply and seasonal labor costs also impact our cost of sales. We may continue to experience fluctuations in the costs of producing wine, which could impact our gross profit.
Selling, general and administrative expenses
Selling, general and administrative expenses consist of selling expenses, marketing expenses and general and administrative expenses. Selling expenses consist primarily of direct selling expenses in our wholesale and DTC channels, including payroll and related costs, product samples and tasting room operating costs, including processing fees and outside services. Marketing expenses consist primarily of advertising costs to promote winery brand awareness, customer retention costs, payroll and related costs. General and administrative expenses consist primarily of payroll and related costs, administrative expenses to support corporate functions, legal and professional fees, depreciation, accounting and information technology, tenancy expenses and other costs related to management. Although we expect selling, general and administrative expenses to increase as sales and related support needs expand, we expect our sales growth rate to outpace the rate of increased selling, general and administrative expenses as we achieve further efficiencies of scale. We also expect to incur greater selling, general and administrative expenses as a result of operating as a publicly traded company.
Other expenses
Other expenses consist primarily of interest expense we incur on balances outstanding under the terms of our Credit Facility and unrealized gains or losses on our derivative instruments.
Income tax expense
Income tax expense consists of federal and state taxes payable to various federal, state and local tax authorities.
Inventory lifecycle
Grape growing on our estate vineyards
Although generally over 85% of our wine is typically derived from grapes grown by third party growers and, to a significantly lesser extent, bulk wine we purchase, the remainder is sourced from our Estate vineyards that we own or lease. Once a vineyard reaches consistent yield levels, approximately three to five years after planting, it will generally produce a relatively consistent amount of fruit for approximately 15 to 25 years, at which time blocks of the vineyard will gradually be replanted in stages after a period of lying fallow. The length of time between initial investment and ultimate sale of our Estate wines, coupled with the ongoing investment required to produce quality wine, is not typical of most agricultural industries. Over the long-term as our business grows, we expect Estate vineyards to represent a smaller relative share of our overall sourcing model.
Harvest-to-release
Of the total case volume we produce and sell, the majority is comprised of red wines from grape varietals such as Cabernet Sauvignon, Pinot Noir and Merlot, which can have production lifecycles spanning months and years from harvest until the time the wine is released, depending on the aging requirements prescribed by the winemakers responsible for each of our winery brands. Our red wines generally have a harvest-to-release inventory lifecycle that can range from 15 to 48 months. Our white, rosé and sparkling wines generally have a
harvest-to-release inventory lifecycle that can range from five to 35 months. During aging and storage, we continue to capitalize overhead costs into the carrying value of the wine.
Given the long-term nature of our investment, grape purchasing and bulk wine purchasing decisions, our production planning processes are designed to mitigate the risk of over-supply by sourcing a portion of our production needs in the spot markets to the degree appropriate based on winery brand and vintage. This opportunistic approach to grape purchases also helps reduce our exposure to future grape price volatility.
Other factors impacting the comparability of our results of operations
Impacts of COVID-19
In March 2020, the World Health Organization declared a global pandemic due to the spread of COVID-19, the disease caused by a novel strain of coronavirus. As governmental authorities implemented various measures limiting the activities of businesses and individuals to reduce the spread of COVID-19, wine producers in the United States were generally classified as essential businesses, which enabled us to continue producing and selling our wine. For the safety of our employees and the individuals with whom we work, we adapted our policies and protocols to meet applicable federal, state and local requirements, and we continue to monitor and revise our policies as appropriate.
The comparability of our results of operations have been significantly impacted by the effects of the COVID-19 pandemic on our business, industry, customer behavior, key markets where we operate and as a result of macroeconomic factors. Accordingly, certain period-over-period comparisons have been and may continue to be influenced by disruption due to the COVID-19 pandemic.
At the outset of the COVID-19 pandemic in the third quarter of Fiscal 2020, we experienced a significant decrease in sales of ultra-luxury wines sold through our on-premise wholesale sales channel and a significant increase of sales of ultra-luxury and luxury wines sold at off-premise retailers. Historically, our ultra-luxury winery brands have delivered higher gross profit margins, and generally sell in larger volumes on-premise than our luxury winery brands, which typically see higher sales volumes off-premise. This shift in sales channel mix continued through the majority of Fiscal 2021. As we observe continued signs of reopening across the domestic consumer product markets and reversion toward consumer consumption and purchasing habits which we believe to be more in line with trends observable before the COVID-19 pandemic, we expect on-premise sales to continue to increase from their pandemic lows, resulting in higher sales of our ultra-luxury winery brands. At the same time, the significant growth in off-premise sales that we have experienced during the pandemic may be tempered, and the rate of growth may marginally slow at off-premise retailers. Although we have observed strong customer demand during periods impacted by pervasive stay-at-home restrictions, and cannot predict the future impact on consumer spending as these restrictions continue to lessen, we believe that the diverse offerings of The Duckhorn Portfolio, which include a broad spectrum of price points, mitigates some of the risk to our future operations in periods in which the on- and off-premise relative mix fluctuates.
During the pandemic, our tasting rooms have also experienced lower tasting fee revenue due to reduced capacities or mandatory closure in order to comply with applicable regulations despite sustained operating levels of expenses, primarily comprised of tasting room operating expenses during periods of capacity restrictions or mandatory closure. Conversely, e-commerce sales increased substantially in response to lockdowns as customers sought to purchase our wines in a manner that reduced human contact. We believe that our tasting rooms will continue to see significant increases in tasting fee revenue as the pandemic wanes, tourism increases and regulations limiting occupancy are eased. At the same time, we believe that customers who used e-commerce platforms to purchase our wines will continue to enjoy the convenience of those platforms to purchase wines from The Duckhorn Portfolio, Inc.
Impact of wildfires
During the first quarter of Fiscal 2021, several wildfires occurred in Northern California. These fires have adversely affected industry grape supplies, though the full extent is not yet known. Other than smoke exposure to grapes that had not been harvested, our own vineyards did not sustain damage during the fires. However, smoke and fire damage to vineyards in the primary regions and markets where we source fruit rendered some of the available grapes unacceptable for the Company’s production needs. In response, we took steps to obtain alternative sources of supply that we believe substantially mitigates the impact of the fires on our supply. Based
on our internal analysis of the impacts of the wildfires, we believe the potential future impact on our operational results to be immaterial. We intend to continue monitoring the ongoing effects on our business for any material changes to that conclusion. Wildfires and smoke damage to grape yields have resulted in disruption and could continue to disrupt the overall grape supply market, introduce changes to our production plan, impact the quantity or release timing of expected case sales in our sales forecast, or result in changes to future gross profit margins as compared to prior periods.
We continue to enhance our wildfire response plan and to mitigate the supply risk associated with wildfires in the following ways:
•our diversified sourcing strategy, with a mix of our owned or leased Estate properties and high-quality grower contracts, covers a wide geographic footprint across California and Washington; and
•we have assembled a team of winemakers and operational leadership with deep industry experience, enabling us to respond effectively to supply disruption in our active grape sourcing markets or to expand into new sourcing markets if needed.
Impacts of purchase accounting due to prior acquisitions
We were acquired by TSG in Fiscal 2017, and subsequently completed acquisitions of Calera and Kosta Browne in Fiscal 2018 and Fiscal 2019, respectively. In applying business combination accounting pursuant to U.S. GAAP authoritative literature in connection with each of these transactions, we recorded acquired assets and liabilities at their fair values. The impacts of these purchase accounting adjustments primarily resulted in reductions to deferred revenue, increases to inventory, increases to long-lived assets and recognition of indefinite-lived intangible assets and definite-lived intangible assets, which amortize over their assigned useful lives ranging from 9 to 14 years. See Note 6 (Other intangible assets) to our Condensed Consolidated Financial Statements for additional information.
The effects of purchase accounting adjustments on our operational performance caused our pre-tax income from operations to be lower in certain periods than we would otherwise have recognized due to reduced revenue for the fair value adjustment to deferred revenue, increased cost of sales due to step-up on inventory and increased operating expenses due to step-up depreciation on property and equipment and amortization of definite-lived intangible assets. The table below reflects the line items of our Condensed Consolidated Statements of Operations impacted by these purchase accounting adjustments:
Three months ended January 31,
Six months ended January 31,
(in thousands)
2022
2021
2022
2021
Purchase accounting adjustments to cost of sales
$
99
$
762
$
292
$
1,323
Impact of purchase accounting on gross profit
(99)
(762)
(292)
(1,323)
Amortization of customer relationships and other intangible assets
1,921
1,921
3,842
3,842
Impact of purchase accounting on selling, general and administrative expenses
1,921
1,921
3,842
3,842
Impacts of purchase accounting on income before income taxes
$
(2,020)
$
(2,683)
$
(4,134)
$
(5,165)
Results of operations
The following table sets forth our results of operations for the periods presented and expresses the relationship of each line item shown as a percentage of net sales for the periods indicated. The table below should be read in conjunction with the corresponding discussion and our audited annual consolidated financial
statements, our unaudited Condensed Consolidated Financial Statements and related footnotes included elsewhere in this Quarterly Report on Form 10-Q:
Three months ended January 31,
Six months ended January 31,
(in thousands, except percentages)
2022
2021
2022
2021
Net sales
$
98,736
100.0
%
$
83,657
100.0
%
$
202,917
100.0
%
$
175,295
100.0
%
Cost of sales
49,259
49.9
41,900
50.1
101,030
49.8
89,263
50.9
Gross profit
49,477
50.1
41,757
49.9
101,887
50.2
86,032
49.1
Selling, general, and administrative expenses
23,814
24.1
17,471
20.9
46,972
23.1
34,276
19.6
Casualty loss (gain), net
31
—
(7,770)
(9.3)
80
—
(6,215)
(3.5)
Income from operations
25,632
26.0
32,056
38.3
54,835
27.0
57,971
33.1
Interest expense
1,636
1.7
3,612
4.3
3,242
1.6
7,192
4.1
Other income, net
(338)
(0.3)
(1,491)
(1.8)
(1,431)
(0.7)
(2,814)
(1.6)
Total other expenses
1,298
1.3
2,121
2.5
1,811
0.9
4,378
2.5
Income before income taxes
24,334
24.6
29,935
35.8
53,024
26.1
53,593
30.6
Income tax expense
6,407
6.5
7,935
9.5
13,784
6.8
14,071
8.0
Net income
17,927
18.2
22,000
26.3
39,240
19.3
39,522
22.5
Less: Net loss (income) attributable to non-controlling interest
5
—
3
—
(35)
—
4
—
Net income attributable to The Duckhorn Portfolio, Inc.
$
17,932
18.2
%
$
22,003
26.3
%
$
39,205
19.3
%
$
39,526
22.5
%
Comparison of the three and six months ended January 31, 2022 and 2021
Net sales
Three months ended January 31,
Change
Six months ended January 31,
Change
(in thousands, except percentages)
2022
2021
$
%
2022
2021
$
%
Net sales
$
98,736
$
83,657
$
15,079
18.0
%
$
202,917
$
175,295
$
27,622
15.8
%
Net sales for the three months ended January 31, 2022 increased $15.1 million, or 18.0%, to $98.7 million compared to $83.7 million for the three months ended January 31, 2021. The increase in net sales for the three months ended January 31, 2022 is driven by increased volume growth and partially offset by a negative price/mix contribution due to channel mix. Additionally, we saw a significant increase in our Wholesale to Distributor channel.
Net sales for the six months ended January 31, 2022 increased $27.6 million, or 15.8%, to $202.9 million compared to $175.3 million for the six months ended January 31, 2021. The increase in net sales for the six months ended January 31, 2022 is primarily driven by volume growth and a neutral price/mix contribution, driven by both volume and mix improvements in the wholesale channel as well as growth in the DTC channel from higher tasting room sales. There were no material pricing changes for the periods presented.
Cost of sales
Three months ended January 31,
Change
Six months ended January 31,
Change
(in thousands, except percentages)
2022
2021
$
%
2022
2021
$
%
Cost of sales
$
49,259
$
41,900
$
7,359
17.6
%
$
101,030
$
89,263
$
11,767
13.2
%
Cost of sales increased by $7.4 million, or 17.6%, to $49.3 million for the three months ended January 31, 2022 compared to $41.9 million for the three months ended January 31, 2021. Cost of sales increased by $11.8 million, or 13.2%, to $101.0 million for the six months ended January 31, 2022 compared to $89.3 million for the six months ended January 31, 2021.The increases in both periods were mainly driven by higher sales, partially offset by diminishing impacts of step-up cost of wine due to purchase accounting adjustments from prior acquisitions. For additional information see “—Other factors impacting the comparability of our results of operations”.
Gross profit increased $7.7 million, or 18.5%, to $49.5 million for the three months ended January 31, 2022 compared to $41.8 million for the three months ended January 31, 2021. Gross profit increased $15.9 million, or 18.4%, to $101.9 million for the six months ended January 31, 2022 compared to $86.0 million for the six months ended January 31, 2021. The changes in gross profit were primarily the result of:
•higher sales volume;
•brand and channel mix shifts that were net favorable to gross profit margin; and
•a reduction in step-up cost of wine sold for the six months ended January 31, 2022 versus the same period prior year, due to lower balances of remaining inventory with associated step-up from purchase accounting in previous periods.
Gross profit margin was 50.1% for the three months ended January 31, 2022 compared to 49.9% for the three months ended January 31, 2021. Gross profit margin was 50.2% for the six months ended January 31, 2022 compared to 49.1% for the six months ended January 31, 2021. The increases in both periods depict the shift in sales mix in favor of luxury wines sold in the Wholesale to Distributor channel in the current periods, with additional margin lift due to lower step-up from purchase accounting impacting cost of sales than in previous periods. The gross profit margin increases, primarily due to movement towards historical trends in consumer spending patterns with the continued recovery of on-premise sales locations, also depict a shift in sales mix slightly in favor of ultra-luxury wines sold through all sales channels. These shifts are especially prevalent in our Wholesale California and DTC channels in the current period. As our luxury winery brands contribute to outsized volume growth in the future, we may expect downward pressure on gross profit margins in future periods, with brand mix potentially introducing favorable gross profit margin impacts based on brand velocity at different price points.
Operating expenses
Selling, general and administrative expenses
Three months ended January 31,
Change
Six months ended January 31,
Change
(in thousands, except percentages)
2022
2021
$
%
2022
2021
$
%
Selling expenses
$
10,971
$
8,403
$
2,568
30.6
%
$
21,369
$
16,727
$
4,642
27.8
%
Marketing expenses
2,887
2,178
709
32.6
5,059
3,925
1,134
28.9
General and administrative expenses
9,956
6,890
3,066
44.5
20,544
13,624
6,920
50.8
Total selling, general and administrative expenses
$
23,814
$
17,471
$
6,343
36.3
%
$
46,972
$
34,276
$
12,696
37.0
%
Selling, general and administrative expenses increased $6.3 million, or 36.3%, to $23.8 million for the three months ended January 31, 2022, compared to $17.5 million for the three months ended January 31, 2021. Selling, general and administrative expenses increased $12.7 million, or 37.0%, to $47.0 million for the six months ended January 31, 2022 compared to $34.3 million for the six months ended January 31, 2021. The increase for both the three months and six months ended January 31, 2022 was largely attributable to compensation costs due to our expanded workforce, higher equity-based compensation as a public company as compared to the prior year period, transaction expenses incurred for the secondary offering (see Note 1 (Description of business) for additional information related to the offering), higher general and administrative costs related to being a public company and higher selling expenses in support of revenue-generating activities as travel restrictions lessened versus the comparative prior year period.
General and administrative expenses were higher for the three months and six months ended January 31, 2022 compared to the respective prior year periods, primarily due to equity-based compensation costs and public company costs that we had not incurred in the prior year period shown. Selling expenses were higher for the three months and six months ended January 31, 2022 due to equity-based and other compensation costs along with the impacts of increased sales activities to support sales growth, including higher levels of business travel than in
prior periods constrained due to COVID-19 restrictions in key markets where we operate. Marketing expenses increased by $0.7 million and $1.1 million for the three months and six months ended January 31, 2022, respectively, versus the comparative period due primarily to increases in equity-based compensation and other compensation costs, further increased due to the prior year period showing reductions in marketing and promotional events as a result of the ongoing pandemic.
Casualty loss (gain), net
Three months ended January 31,
Change
Six months ended January 31,
Change
(in thousands, except percentages)
2022
2021
$
%
2022
2021
$
%
Casualty loss (gain), net
$
31
$
(7,770)
$
7,801
(100.4)
%
$
80
$
(6,215)
$
6,295
(101.3)
%
Casualty loss (gain), net increased by $7.8 million, or 100.4%, for the three months ended January 31, 2022 compared to the three months ended January 31, 2021. Casualty loss (gain), net increased by $6.3 million, or 101.3%, for the six months ended January 31, 2022 compared to the six months ended January 31, 2021. The change between the current and prior year is primarily due to insurance proceeds received in Fiscal 2021 related to a flood at one of our wineries in a previous fiscal year that did not reoccur in the current fiscal year. See Note 13 (Casualty loss) to our Condensed Consolidated Financial Statements for further information.
Other expenses
Three months ended January 31,
Change
Six months ended January 31,
Change
(in thousands, except percentages)
2022
2021
$
%
2022
2021
$
%
Interest expense
1,636
3,612
$
(1,976)
(54.7)
%
$
3,242
$
7,192
$
(3,950)
(54.9)
%
Other income, net
(338)
(1,491)
1,153
(77.3)
%
(1,431)
(2,814)
1,383
(49.1)
%
Total other expenses
$
1,298
$
2,121
$
(823)
(38.8)
%
$
1,811
$
4,378
$
(2,567)
(58.6)
%
Other expenses decreased by $0.8 million, or 38.8%, to $1.3 million for the three months ended January 31, 2022 compared to $2.1 million for the three months ended January 31, 2021. Other expenses decreased by $2.6 million, or 58.6%, to $1.8 million for the six months ended January 31, 2022 compared to $4.4 million for the six months ended January 31, 2021. Our interest expense was reduced year over year due to lower debt balances outstanding for the period, in conjunction with lower average interest rates on our variable-rate debt. The change in our other income, net was primarily driven by downward pressure on LIBOR and a lower overall swap notional balance. Both of these factors contributed to a net gain for the three months and six months ended January 31, 2022 and a change in overall position to an asset on our Condensed Consolidated Statements of Financial Position. In addition, see “—Liquidity and capital resources” for discussion of our Credit Facility.
Income tax expense
Three months ended January 31,
Change
Six months ended January 31,
Change
(in thousands, except percentages)
2022
2021
$
%
2022
2021
$
%
Income tax expense
$
6,407
$
7,935
$
(1,528)
(19.3)
%
$
13,784
$
14,071
$
(287)
(2.0)
%
Income tax expense decreased $1.5 million, or 19.3%, to $6.4 million for the three months ended January 31, 2022 compared to $7.9 million for the three months ended January 31, 2021. Income tax expense decreased $0.3 million, or 2.0%, to $13.8 million for the six months ended January 31, 2022 compared to $14.1 million for the six months ended January 31, 2021. The change in our income tax expense was primarily due to decreased pre-tax income in the current period, as the effective tax rate remained largely consistent year over year.
Liquidity and capital resources
Sources of liquidity
Our primary cash needs are for working capital purposes, such as producing or purchasing inventory and funding operating and capital expenditures. We fund our operational cash requirements with cash flows from operating activities and borrowings under our Credit Facility. As of January 31, 2022, we had $4.8 million in cash and $290.0 million available in undrawn capacity on our revolving line of credit, subject to the terms of our Credit Facility.
In response to the COVID-19 pandemic, we evaluated risks related to our inventory and liquidity management, which we determined to be sufficiently mitigated, subject to reassessment in the future in response to pandemic-related impacts as they occur. The full impact of COVID-19 on our future operations remains uncertain and will be determined by the length and severity of pandemic-related disruption. Consequently, unforeseen future events could negatively impact our operations, results of operations, cash flows and liquidity.
Due to the seasonal nature of our operations, our cash needs are generally greatest during harvest, a period which can span from August to November based on agricultural conditions and other factors outside our control. We believe that our expected operating cash flows, cash on hand and borrowing capacity on our revolving line of credit, will be adequate to meet our cash needs for the next 12 months. However, changes in our business growth plan, planned capital expenditures or responses to the impacts of the global pandemic or to an ever-changing and highly competitive industry landscape may result in changes to our cash requirements.
If our cash needs change in the future, we may seek alternative or incremental funding sources to respond to changes in our business. To the extent required, we may seek to fund additional liquidity through debt or equity financing, although we can provide no assurance that such forms of capital will be available when needed, if at all, or available on terms that are acceptable.
Cash flows
The following table presents the major components of net cash flows.
Six months ended January 31,
(in thousands)
2022
2021
Cash flows provided by (used in):
Operating activities
$
18,828
$
26,141
Investing activities
(23,336)
(9,748)
Financing activities
5,034
(13,371)
Net increase in cash
$
526
$
3,022
Operating activities
Our cash flows from operating activities consist primarily of net income adjusted for certain non-cash transactions, including depreciation and amortization, amortization of debt issuance costs, changes in the fair values of derivatives, equity-based compensation and deferred income taxes. Operating cash flows also reflect the periodic changes in working capital, primarily inventory, accounts receivable, prepaid expenses, accounts payable and accrued expenses.
For the six months ended January 31, 2022, net cash provided by operating activities was $18.8 million compared to $26.1 million for the six months ended January 31, 2021, a decrease of $7.3 million. The decrease in cash provided by operating activities was driven by the following factors:
•The net income after adjusting for non-cash items increased operating cash flows by $3.7 million;
•Increases in prepaid expenses for the six months ended January 31, 2022 that were less than the higher prepaid expenses in the prior year period due to increased professional fees and insurance, partially offset by timing impacts in bulk and bottled wine supply management to support increases in demand, in aggregate resulted in an increase to operating cash flow of $4.0 million;
•Our wholesale sales channel, generally subject to credit terms, saw an increase in net sales, which drove a corresponding increase in accounts receivable and resulted in a $6.5 million decrease in operating cash flow;
•Changes in accounts payable and accrued expenses increased operating cash flows $1.6 million due primarily to timing of invoice accruals and payments, predominately related to grape grower purchases during the annual harvest period;
•Decreases in accrued compensation of $4.1 million based on the timing of certain compensation-related payments resulted in a corresponding decrease in operating cash flow; and
•Deferred revenues decreased operating cash flows by $6.0 million primarily due to shipment timing for DTC list member sales.
For the six months ended January 31, 2022, net cash used in investing activities was $23.3 million compared to $9.7 million for the six months ended January 31, 2021, an increase of $13.6 million, primarily due to vineyard acquisitions completed during the current fiscal quarter, see Note 5 (Property and equipment). Capital expenditures were $23.4 million for the six months ended January 31, 2022 and $9.8 million for six months ended January 31, 2021. From time to time, we evaluate wineries, vineyards and production facilities for potential opportunities to make strategic acquisitions to support our growth. Any such transactions may require us to make additional investments and capital expenditures in the future.
Financing activities
For the six months ended January 31, 2022, net cash provided by financing activities was $5.0 million as compared to net cash used in financing activities of $13.4 million for the six months ended January 31, 2021, an increase of $18.4 million of net cash provided by financing activities. The increase in cash provided by financing activities was primarily the result of an increase in net borrowings on our revolving line of credit totaling $11.0 million for the six months ended January 31, 2022 in comparison to $6.0 million in net revolving line of credit paydowns for the six months ended January 31, 2021. Additionally, payments made on long-term debt decreased by $1.5 million, thereby increasing cash provided by financing activities.
Capital resources
Credit facility
On October 14, 2016, we entered into the Credit Facility with a syndicated group of lenders. The Credit Facility provides a combination of term and revolving line of credit features. The term and revolving line of credit borrowings have variable interest rates, based primarily on LIBOR plus an applicable margin as defined in the First Lien Loan Agreement. Interest is paid monthly or quarterly based on loan type. Our debt is collateralized by substantially all of our cash, trade accounts receivable, real and personal property. Pursuant to the terms and conditions of the First Lien Loan Agreement, we have issued the instruments discussed below.
As of January 31, 2022, outstanding principal balances on the debt instruments were $135.0 million for the revolving line of credit, $6.9 million for the capital expenditure loan, $100.1 million for the term loan (tranche one) and $13.8 million for term loan (tranche two).
The First Lien Loan Agreement contains customary affirmative covenants, including delivery of audited financial statements and customary negative covenants that, among other things, limit our ability to incur additional indebtedness or to grant certain liens. As of January 31, 2022, we were not in violation of any covenants.
Revolving line of credit
The revolving line of credit allows us to borrow up to a principal amount of $425.0 million (including a letter of credit sub-facility of the revolving loan facility in the aggregate of $15.0 million and a swingline sub-facility of the revolving loan facility in the aggregate of $15.0 million), with an incremental seasonal borrowing amount for harvest costs increasing the total amount to a maximum of $455.0 million. The revolving line of credit matures on August 1, 2023. The interest rate ranges from LIBOR plus 125 basis points to LIBOR plus 175 basis points depending on the average availability of the revolving line of credit.
Capital expenditure loan
The capital expenditure loan has a maximum, non-revolving draw-down limit of $25.0 million with quarterly principal payments and the remaining unpaid principal and interest due upon maturity on August 1, 2023. As of January 31, 2022, the $25.0 million limit was fully drawn. This instrument has an interest rate of LIBOR plus 190 basis points.
Term loans
The first tranche of term loans was issued in 2016 for a principal balance of $135.0 million with quarterly principal payments and the remaining unpaid principal and interest due upon maturity on August 1, 2023. This tranche of the term loans has an interest rate of LIBOR plus 190 basis points.
The second tranche of term loans, issued in August 2018, allowed for a principal balance up to $25.0 million with quarterly principal payments and the remaining unpaid principal and interest due upon maturity on August 1, 2023. We drew $16.4 million of the second tranche of the term loan in November 2018. This tranche of the term loans has an interest rate of LIBOR plus 163 basis points.
Off-balance sheet arrangements
As of January 31, 2022, we did not have any off-balance sheet arrangements that had, or are reasonably likely to have in the future, a material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.
Critical accounting policies and estimates
Our management’s discussion and analysis of our financial condition and results of operations are based on our Condensed Consolidated Financial Statements, which are prepared in accordance with U.S. GAAP. The preparation of these Condensed Consolidated Financial Statements requires the application of appropriate technical accounting rules and guidance, as well as the use of estimates. The application of these policies requires judgments regarding future events. These estimates and judgments could materially impact the Condensed Consolidated Financial Statements and disclosures based on varying assumptions, as future events rarely develop exactly as forecasted, and even the best estimates routinely require adjustment.
There have been no material changes in our critical accounting policies during the six months ended January 31, 2022, as compared to those disclosed in the "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies" in our Annual Report on Form 10-K for Fiscal 2021.
Recent accounting pronouncements
See Note 2 (Basis of presentation and significant accounting policies) to our Condensed Consolidated Financial Statements included in Part I, Item 1 of this Report for additional information regarding recent accounting pronouncements.
Emerging growth company status
We are an emerging growth company, as defined in the JOBS Act. Section 107 of the JOBS Act provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. In other words, an “emerging growth company” can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. Section 107 of the JOBS Act provides that any decision to opt out of the extended transition period for complying with new or revised accounting standards is irrevocable. We have elected to use this extended transition period for complying with new or revised accounting standards that have different effective dates for public and private companies. As a result, our financial statements may not be comparable to companies that comply with the new or revised accounting pronouncements as of public company effective dates. Based on the Company's aggregate worldwide market value of voting and non-voting common equity held by non-affiliates as of January 31, 2022, the Company will become a “large accelerated filer” and lose emerging growth company status beginning with its Annual Report on Form 10-K for the year ending July 31, 2022.
Item 3. Quantitative and qualitative disclosures about market risk.
Our ongoing business operations cause us to be exposed to certain market risks, including fluctuations in interest rates, commodity prices and other costs related to production inputs, foreign currencies and inflation.
Interest rates
We are subject to interest rate risk in connection with changes in interest rates on our credit facilities, which bear interest at variable rates based upon LIBOR plus applicable margins or predetermined alternatives rates, as applicable, pursuant to the terms of our Credit Facility. As of January 31, 2022, our outstanding borrowings at variable interest rates totaled $253.4 million. An increase of 100 basis points in the effective interest rate applied to these borrowings would result in a $2.5 million increase in interest expense on an annualized basis and could
have a material effect on our results of operation or financial condition. We manage our interest rate risk through normal operating and financing activities and through the use of derivative financial instruments. To mitigate exposure to fluctuations in interest rates, we entered into an interest rate swap in March 2020. See Note 9 (Derivative instruments) to our Condensed Consolidated Financial Statements for further information on the interest rate swap.
Inflation
We do not believe that inflation has had a material impact on our business, results of operations or financial condition to date. We continue to track the impact of inflation in an attempt to minimize its effects through pricing strategies and cost reductions. If, however, our operations are impacted by significant inflationary pressures, we may not be able to fully offset such impacts through price increases on our products, supply negotiations or production improvements. A higher than anticipated rate of inflation in the future could harm our operations and financial condition.
Foreign currency
Our revenues and costs are denominated in U.S. dollars and are not subject to significant foreign exchange risk. Fluctuations in foreign currency exchange rates may cause us to recognize transaction gains and losses in our Condensed Consolidated Statements of Operations. The Company uses foreign exchange forward contracts to offset a portion of the foreign currency exchange risks associated with forecasted purchases of barrels from France. The Company had no outstanding foreign exchange forward contracts as of January 31, 2022. See Note 9 (Derivative instruments) to our Condensed Consolidated Financial Statements for further information.
Sensitivity due to fluctuations in foreign currency exchange rates was not material as of January 31, 2022.
Commodity prices
The primary commodity in our product is grapes, and generally more than 85% of our input grapes are sourced from third party suppliers in the form of grapes or bulk wine. For these purchased grapes and bulk wine, prices are subject to many factors beyond our control, such as the yield of different grape varietals in different geographies, the annual demand for these grapes and the vagaries of these farming businesses, including poor harvests due to adverse weather conditions, natural disasters and pestilence. Our grape and bulk wine supply mix varies from year to year between pre-contracted purchases and spot purchases; the variation from year to year is based on market conditions and sales demands. We do not engage in commodity hedging on our forecasted purchases of grapes and bulk wine. We continue to diversify our sources of supply and look to changes annually to our product line to optimize the grapes available each harvest year.
Other raw materials we source include glass, corks and wine additives. We currently source these materials from multiple vendors. We have and will continue to negotiate prices with these suppliers on an annual basis, conducting a competitive bidding process for all raw materials to leverage our volume in lowering the input costs of production. We do not engage in forward, future or other derivative hedging activities to attempt to manage future price volatility of raw materials or other production-related inputs. As a result, some of these prices change over time, and future changes to commodity prices, raw materials or other significant inputs in our wine production could have a material impact to our future results of operations.
Item 4. Controls and procedures.
Disclosure controls and procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required financial disclosure.
As of the end of the period covered by this 10-Q Report, our management, under the supervision and with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures defined in Exchange Act Rule 13a-15(e) and 15d-15(e). Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of January 31, 2022, our
disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in reports we file pursuant to the Exchange Act is communicated to management as appropriate for disclosure consideration, and is accurately and timely recorded, processed, summarized, and reported within the time periods specified by applicable SEC forms and regulations.
Changes in internal control over financial reporting
There were no changes in our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting during the three months ended January 31, 2022.
Limitations on the effectiveness of controls
Our disclosure controls and procedures and internal control over financial reporting are designed to provide reasonable assurance of achieving their objectives as specified above. Management does not expect, however, that our disclosure controls and procedures will prevent or detect all error and fraud. Any control system, no matter how well designed and operated, is based on certain assumptions and can provide only reasonable, not absolute, assurance that its objectives will be met. Further, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected.
From time to time, we are involved in various legal proceedings arising from the normal course of business activities. Legal expenses associated with loss contingencies are accrued if reasonably estimable and the related matter is probable of causing the Company to incur expenses or other losses based on future contingent events in accordance with the Company's policies, otherwise legal expenses are expensed as incurred. We are not presently a party to any litigation the outcome of which, we believe, if determined adversely to us, would individually or taken together have a material adverse effect on our business, operating results, cash flows or financial condition.
Item 1A. Risk factors.
For a discussion of our potential risks and uncertainties, please see the information under the heading "Risk Factors" in our Annual Report on Form 10-K for Fiscal 2021. There have been no material changes since our previous 10-K filing.
XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
Pursuant to the requirements of the Securities Exchange Act of 1934 the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
The Duckhorn Portfolio, Inc.
Date: March 10, 2022
By:
/s/ Alex Ryan
Alex Ryan
President, Chief Executive Officer and Chairman
(Principal Executive Officer)
Date: March 10, 2022
By:
/s/ Lori Beaudoin
Lori Beaudoin
Executive Vice President, Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer)
