THE DUCKHORN PORTFOLIO, INC. 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. OverviewThe Duckhorn Portfolio is the premier scaled producer of luxury wines inNorth 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$200 per bottle under a world-class luxury portfolio of winery brands, includingDuckhorn Vineyards , Decoy,Kosta Browne , Goldeneye, Paraduxx, Calera, Migration, Canvasback, Greenwing and Postmark. Our wines have a strong record of achieving critical acclaim, vintage after vintage. Each winery brand boasts its own winemaking team to create distinct experiences for consumers, ensure product quality and continuity and galvanize sustainable farming practices. Beyond our winemaking teams is an organization comprised of passionate, talented employees, including a highly tenured executive team that has approximately 100 years of cumulative experience with Duckhorn. We sell our wines to distributors and directly to retail accounts inCalifornia , which together comprise our wholesale channel. We also sell directly to consumers through our DTC channel, which comprised approximately 15% of our net sales in the first three months of Fiscal 2022. Our powerful omni-channel sales model drives strong margins by leveraging long-standing relationships developed over the past forty years. We believe our iconic winery brands together with our scaled, quality-focused production, omni-channel distribution and dedicated employees, set the standard for North American luxury wine. Key financial metrics We use net sales, gross profit and adjusted EBITDA to evaluate the performance of our business, identify trends in our business, prepare financial forecasts and make capital allocation decisions. We believe the following metrics are useful in evaluating our performance, but adjusted EBITDA should not be considered in isolation or as a substitute for any other financial information depicting our results prepared in accordance withU.S. GAAP. Certain judgments and estimates are inherent in our processes to calculate these metrics. Three months ended October 31, (in thousands) 2021 2020 Net sales$ 104,181 $ 91,638 Gross profit$ 52,410 $ 44,275 Net income attributable to The Duckhorn Portfolio, Inc.$ 21,273 $ 17,523 Adjusted EBITDA$ 38,089 $ 33,722 22
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Table of Contents
The following table represents the reconciliation of adjusted EBITDA to net
income attributable to
Three months ended
October 31,
(in thousands) 2021 2020
Net income attributable to The Duckhorn Portfolio, Inc. $ 21,273 $ 17,523
Interest expense 1,606 3,580
Income tax expense 7,377 6,136
Depreciation and amortization expense 4,829 5,116
EBITDA 35,085 32,355
Purchase accounting adjustments(a) 193 561
Transaction expenses(b) 1,745 -
Change in fair value of derivatives(c) (442) (1,548)
Equity-based compensation 1,459 288
Loss on debt extinguishment(d) - 272
IPO preparation costs(e) - 196
Wildfire costs(f) 49 1,555
COVID-19 costs(g) - 43
Adjusted EBITDA $ 38,089 $ 33,722 ________________________________________________
(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 andKosta 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 acquisition ofKosta Browne inAugust 2018 and our IPO inMarch 2021 . Also included are expenses incurred for abandoned transactions and the secondary offering completed inOctober 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) Loss on debt extinguishment includes charges for unamortized deferred financing fees we recognized in connection with amendments to our Credit Facility. (e) 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. (f) 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 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 inCalifornia , we believe the wildfires and related costs we experienced are not indicative of our core operating performance. (g) 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. 23 -------------------------------------------------------------------------------- Table of Contents 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 withU.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 inCalifornia 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 October 31, 2021 2020 Wholesale - distributors 68.5 % 73.1 % Wholesale - California direct to retail 16.4 % 14.3 % DTC 15.1 % 12.6 % The variations in the net sales percentages by channel between the three month periods endedOctober 31, 2021 and 2020 were largely driven by the ongoing signs of recovery from COVID-19 disruption across consumer markets and the continued, gradual return toward historical consumer spending norms. The increase in net sales within the DTC channel was bolstered by higher visitor center sales as compared to the prior year period, coupled with timing of member shipments which we do not expect to reoccur. Further impacting our wholesale channel sales, consumer purchasing and consumption patterns appeared to be shifting back toward levels more consistent with pre-pandemic trends. We expect our sales channel mix and consumer purchasing patterns to continue to normalize toward historical levels in conjunction with the gradual lessening of on-premise sales location restrictions related to COVID-19 and with the expansion of certain markets 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 October 31, 2021 2020 Net sales growth 13.7 % 26.0 % Volume contribution 7.5 % 39.8 % Price / mix contribution 6.2 % (13.8) % Growth in net sales was attributable to continued strong sales volume growth and a positive price / mix contribution, demonstrating the shift back toward pre-COVID-19 trends as we saw growth in our on-premise and DTC sales, which drive increased sales in our ultra-luxury brands that sell at higher average sales prices. 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 will continue to put downward 24 -------------------------------------------------------------------------------- Table of Contents pressure on price / mix contribution given an increase in net sales. 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, and to the extent that growth is fueled by sales of our lower-priced luxury winery brands, we may expect lower or negative price / mix contribution in the future. 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 inCalifornia , 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 ourCalifornia 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 inCalifornia . •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 four 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 integrate meaningful acquisitions when opportunities arise to create stockholder value. The primary market for our wines isthe United States , which has historically represented approximately 95% of our net revenue. Accordingly, our results of operations are primarily dependent onU.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 allU.S. states (exceptCalifornia , where we sell directly to retail accounts) and in over 50 25 -------------------------------------------------------------------------------- Table of Contents countries globally. We also have developed strong relationships with consumerswho 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 inCalifornia 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. InCalifornia , 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 shifted in favor of off-premise sales while on-premise sales have experienced variability during the COVID-19 pandemic, which began impacting our sales inMarch 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 inCalifornia . 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 throughoutNorthern California andWashington , 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. 26 -------------------------------------------------------------------------------- Table of Contents 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 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 and increased seasonal labor costs. 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. Agribusiness 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 27 -------------------------------------------------------------------------------- Table of Contents 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. In the future, 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 InMarch 2020 , theWorld 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 inthe 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 comparison have been and may continue to be influenced by disruption due to the COVID-19 pandemic. 28 -------------------------------------------------------------------------------- Table of Contents 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 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 ofThe 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 as customers sought to purchase our wines in a manner that reduced human contact. We believe that our tasting rooms will 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 customerswho used e-commerce platforms to purchase our wines will continue to enjoy the convenience of those platforms to purchase wines fromThe Duckhorn Portfolio, Inc. Impact of wildfires During the first quarter of Fiscal 2021, several wildfires occurred inNorthern 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 acrossCalifornia andWashington ; 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 andKosta Browne in Fiscal 2018 and Fiscal 2019, respectively. In applying business combination accounting pursuant toU.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 29 -------------------------------------------------------------------------------- Table of Contents 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 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 October 31, (in thousands) 2021 2020 Purchase accounting adjustments to cost of sales$ 193 $ 561 Impact of purchase accounting on gross profit (193) (561)
Amortization of customer relationships and other intangible assets
1,921 1,921
Impact of purchase accounting on selling, general and administrative expenses
1,921 1,921
Impacts of purchase accounting on income before income taxes
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 October 31,
(in thousands, except percentages) 2021 2020
Net sales $ 104,181 100.0 % $ 91,638 100.0 %
Cost of sales 51,771 49.7 47,363 51.7
Gross profit 52,410 50.3 44,275 48.3
Selling, general, and administrative expenses 23,158 22.2 16,805 18.3
Casualty loss 49 - 1,555 1.7
Income from operations 29,203 28.0 25,915 28.3
Interest expense 1,606 1.5 3,580 3.9
Other (income) expense, net (1,093) (1.0) (1,323) (1.4)
Total other expenses 513 0.5 2,257 2.5
Income before income taxes 28,690 27.5 23,658 25.8
Income tax expense 7,377 7.1 6,136 6.7
Net income 21,313 20.5 17,522 19.1
Less: Net (income) loss attributable to
non-controlling interest (40) - 1 -
Net income attributable to The Duckhorn
Portfolio, Inc. $ 21,273 20.4 % $ 17,523 19.1 %
Comparison of the three months ended
Three months ended October 31, Change
(in thousands, except percentages) 2021 2020 $ %
Net sales $ 104,181 $ 91,638 $ 12,543 13.7 %
Net sales for the three months ended October 31, 2021 increased $12.5 million ,
or 13.7% to $104.2 million compared to $91.6 million for the three months ended
October 31, 2020 . The increase in the period is driven by volume growth and a
positive price/mix contribution, with increases in the percentage of net sales
seen in both our California Direct to Retail and DTC channels. There were no
material pricing changes for the periods presented.
30
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Cost of sales
Three months ended October 31, Change
(in thousands, except percentages) 2021 2020 $ %
Cost of sales $ 51,771 $ 47,363 $ 4,408 9.3 %
Cost of sales increased by $4.4 million , or 9.3% to $51.8 million for the three
months ended October 31, 2021 compared to $47.4 million for the three months
ended October 31, 2020 . The increase in the period was directly driven by higher
sales and decreased impact of step-up cost of wine due to purchase accounting
adjustments from prior acquisitions.
Gross profit
Three months ended October 31, Change
(in thousands, except percentages) 2021 2020 $ %
Gross profit $ 52,410 $ 44,275 $ 8,135 18.4 %
Gross profit increased $8.1 million , or 18.4% to $52.4 million for the three
months ended October 31, 2021 compared to $44.3 million for the three months
ended October 31, 2020 . The change in gross profit was primarily the result of:
•higher sales volume; and
•a reduction in step-up cost of wine sold for the three months ended October 31,
2021 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 50.3% for the three months ended October 31, 2021
compared to 48.3% for the three months ended October 31, 2020 . The increase, due
to movement towards historical trends in consumer spending patterns with the
continued recovery of on-premise sales locations, depicts a shift in sales mix
in favor of ultra-luxury wines sold throughout all of our 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.
Operating expenses
Selling, general and administrative expenses
Three months
ended October
31, Change
(in thousands, except percentages) 2021 2020 $ %
Selling expenses $ 10,398 $ 8,324 $ 2,074 24.9 %
Marketing expenses 2,172 1,746 426 24.4
General and administrative expenses 10,588 6,735 3,853 57.2
Total selling, general and administrative expenses $ 23,158 $ 16,805 $ 6,353 37.8 %
Selling, general and administrative expenses increased $6.4 million , or 37.8% to
$23.2 million for the three months ended October 31, 2021 compared to $16.8
million for the three months ended October 31, 2020 . The increase 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 ended
October 31, 2021 , 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 ended October 31, 2021 due to
equity-based and other compensation costs along with the impacts of increased
business travel and the related costs of in-person sales activities beginning to
occur again that had previously been constrained due to COVID-19 restrictions in
key markets where we operate. Marketing expenses increased by $0.4 million for
the three months ended October 31, 2021 versus the comparative period due
primarily to increases in equity-based compensation and other
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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
Three months ended October 31, Change
(in thousands, except percentages) 2021 2020 $ %
Casualty loss $ 49 $ 1,555 $ (1,506) (96.8) %
Casualty loss decreased by $1.5 million , or 96.8% for the three months ended
October 31, 2021 compared to the three months ended October 31, 2020 . In the
first quarter of Fiscal 2021, a series of wildfires occurred resulting in
incremental costs to us. These costs, largely occurring in the same quarter as
the fires, included 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. See Note 13 (Casualty loss) to our Condensed Consolidated Financial
Statements for further information.
Other expenses
Three months ended October 31, Change
(in thousands, except percentages) 2021 2020 $ %
Interest expense $ 1,606 $ 3,580 $ (1,974) (55.1) %
Other (income) expense, net (1,093) (1,323) 230 (17.4) %
Total other expenses, net $ 513 $ 2,257 $ (1,744) (77.3) %
Other expenses decreased by $1.7 million , or 77.3% to $0.5 million for the three
months ended October 31, 2021 compared to $2.3 million for the three months
ended October 31, 2020 . Our interest expense was reduced year over year driven
by lower debt balances outstanding for the period, in conjunction with lower
average interest rates on our variable debt. The change in our other (income)
expenses, net, was primarily driven by downward pressure on LIBOR and a lower
overall swap nominal balance, which reduced the liability balance on our
interest rate swap, resulting in a gain for the three months ended October 31,
2021 . In addition, see "-Liquidity and capital resources" for discussion of our
Credit Facility.
Income tax expense
Three months
ended October
31, Change
(in thousands, except percentages) 2021 2020 $ %
Income tax expense $ 7,377 $ 6,136 $ 1,241 20.2 %
Income tax expense increased $1.2 million , or 20.2% to $7.4 million for the
three months ended October 31, 2021 compared to $6.1 million for the three
months ended October 31, 2020 . The change in our income tax expense was
primarily due to increased 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 October 31, 2021 , we had $5.2
million in cash and $314.0 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
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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.
Three months ended October 31,
(in thousands) 2021 2020
Cash flows provided by (used in): Operating activities $ 22,747$ 2,487 Investing activities (5,896) (7,686) Financing activities (15,848) 252 Net increase (decrease) in cash $ 1,003 $
(4,947)
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 three months endedOctober 31, 2021 , net cash provided by operating activities was$22.7 million compared to$2.5 million for the three months endedOctober 31, 2020 , an increase of$20.2 million . The increase in cash provided by operating activities was driven by the following factors: •Operating cash flows increased due to an increase in net income of$5.4 million after adjusting for non-cash items; •The combination of increased prepaid insurance premiums on new and existing policies and bulk and bottled wine supply management to support increases in demand resulted in a decrease to operating cash flow of$8.8 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$0.4 million increase in operating cash flow; •Changes in accounts payable and accrued expenses increased operating cash flows$32.2 million due primarily to timing of invoice payments, predominately related to grape grower purchases during the annual harvest period; •Decreases in accrued compensation of$4.6 million based on the timing of certain compensation-related payments resulted in an increase in operating cash flow; and •Higher list member sales as compared to previous periods, partially due to shipment timing, decreased deferred revenues and operating cash flows by$4.3 million . 33 -------------------------------------------------------------------------------- Table of Contents Investing activities For the three months endedOctober 31, 2021 , net cash used in investing activities was$5.9 million compared to$7.7 million for the three months endedOctober 31, 2020 , a decrease of$1.8 million . Capital expenditures were$5.9 million for the three months endedOctober 31, 2021 and$7.7 million for three months endedOctober 31, 2020 . 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 three months endedOctober 31, 2021 , net cash used in financing activities was$15.8 million as compared to net cash provided by financing activities of$0.3 million for the three months endedOctober 31, 2020 , an increase of$16.1 million of net cash used in financing activities. The increase in cash used in financing activities was primarily the result of an increase in payments and a decrease in borrowing on our revolving line of credit, netting to$13.0 million cash used for the three months endedOctober 31, 2021 in comparison to$4.0 million cash provided by the net revolving line of credit activities for the three months endedOctober 31, 2020 . Capital resources Credit facility OnOctober 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 ofOctober 31, 2021 , outstanding principal balances on the debt instruments were$111.0 million for the revolving line of credit,$7.9 million for the capital expenditure loan,$101.8 million for the term loan (tranche one) and$14.0 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 ofOctober 31, 2021 , 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 onAugust 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 onAugust 1, 2023 . As ofOctober 31, 2021 , 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 onAugust 1, 2023 . This tranche of the term loans has an interest rate of LIBOR plus 190 basis points. The second tranche of term loans was issued inAugust 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 34 -------------------------------------------------------------------------------- Table of ContentsAugust 1, 2023 . We drew$16.4 million of the second tranche of the term loan inNovember 2018 . This tranche of the term loans has an interest rate of LIBOR plus 163 basis points. Off-balance sheet arrangements As ofOctober 31, 2021 , 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 withU.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 three months endedOctober 31, 2021 , 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. 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 ofOctober 31, 2021 , our outstanding borrowings at variable interest rates totaled$231.9 million . An increase of 100 basis points in the effective interest rate applied to these borrowings would result in a$2.3 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 inMarch 2020 . See Note 9 35 -------------------------------------------------------------------------------- Table of Contents (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 inU.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 fromFrance . The Company had no outstanding foreign exchange forward contracts as ofOctober 31, 2021 . 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 ofOctober 31, 2021 . 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 theSEC'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 ofOctober 31, 2021 , 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 36 -------------------------------------------------------------------------------- Table of Contents disclosure consideration, and is accurately and timely recorded, processed, summarized, and reported within the time periods specified by applicableSEC 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 endedOctober 31, 2021 . 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. 37
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