Duckhorn Portfolio, Inc. - Quarter Report: 2023 January (Form 10-Q)
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||
For the quarterly period ended January 31, 2023
OR
☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||
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, CA 94574
(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 115,219,396 shares of common stock, $0.01 par value per share, as of March 1, 2023.
| Table of Contents | ||
| Page | |||||
| PART I | |||||
| PART II | |||||
Glossary
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 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.
•“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 pandemic for the COVID-19 virus.
•“DTC channel” and “DTC” refer 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 our 2021 Employee Stock Purchase Plan.
•“Estate vineyards” refers to vineyards owned or controlled 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 vineyards and facilities.
•“Exchange Act” refers to the Securities Exchange Act of 1934.
•“Fiscal 2021” refers to our fiscal year ended July 31, 2021.
•“Fiscal 2022” refers to our fiscal year ended July 31, 2022.
•“Fiscal 2023” refers to our fiscal year ended July 31, 2023.
•“LIBOR” refers to London Interbank Offered Rate.
•“Luxury wine” refers to wines sold for $15 or higher per 750ml bottle.
•“New Credit Facility” and “New Credit Agreement” refer to the Amended and Restated First Lien Loan and Security Agreement, dated as of November 4, 2022, by and among the Company, the borrowers named therein, the lenders named therein and the Bank of the West, as administrative agent and collateral agent.
•“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.
•“Original Credit Facility” and “Original Credit Agreement” refer to the original 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, as amended by Amendment No. 7 dated February 22, 2021, and as amended by Amendment No. 8 dated August 30, 2022), by and among the Company, the borrowers named therein, the lenders named therein and the Bank of the West, as administrative agent.
3
•“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.
•“Term SOFR” refers to the forward-looking term rate based on the Secured Overnight Financing Rate.
•“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 United States Generally Accepted Accounting Principles.
•“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.
4
Cautionary Note Regarding Forward-Looking Statements
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 and the impact of inflation on 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, war 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 disruption of the delivery of wine to customers;
• the impact of COVID-19 and its variants 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; and
• the future trading prices of our common stock and the impact of securities analysts’ reports on these prices.
5
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 2022 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.
6
PART I
Item 1. Financial Statements
| Index to Condensed Consolidated Financial Statements | |||||
| Page | |||||
7
The Duckhorn Portfolio, Inc. Condensed Consolidated Statements of Financial Position (unaudited) | ||
| (in thousands, except share and per share amounts) | January 31, 2023 | July 31, 2022 | |||||||||
| ASSETS | |||||||||||
| Current assets | |||||||||||
| Cash | $ | 7,292 | $ | 3,167 | |||||||
| Accounts receivable trade, net | 48,324 | 37,026 | |||||||||
| Inventories | 327,024 | 285,430 | |||||||||
| Prepaid expenses and other current assets | 13,125 | 13,898 | |||||||||
| Total current assets | 395,765 | 339,521 | |||||||||
| Long-term assets | |||||||||||
| Property and equipment, net | 271,217 | 269,659 | |||||||||
| Operating lease right-of-use assets | 21,777 | 23,375 | |||||||||
| Intangible assets, net | 188,006 | 191,786 | |||||||||
| Goodwill | 425,209 | 425,209 | |||||||||
| Other long-term assets | 5,487 | 1,963 | |||||||||
| Total long-term assets | 911,696 | 911,992 | |||||||||
| Total assets | $ | 1,307,461 | $ | 1,251,513 | |||||||
| LIABILITIES AND EQUITY | |||||||||||
| Current liabilities | |||||||||||
| Accounts payable | $ | 18,410 | $ | 3,382 | |||||||
| Accrued expenses | 29,071 | 29,475 | |||||||||
| Accrued compensation | 9,224 | 12,893 | |||||||||
| Deferred revenue | 3,285 | 272 | |||||||||
| Current operating lease liabilities | 3,603 | 3,498 | |||||||||
| Current maturities of long-term debt | 9,721 | 9,810 | |||||||||
| Other current liabilities | 3,056 | 672 | |||||||||
| Total current liabilities | 76,370 | 60,002 | |||||||||
| Long-term liabilities | |||||||||||
| Revolving line of credit, net | — | 108,674 | |||||||||
| Long-term debt, net of current maturities and debt issuance costs | 215,633 | 105,074 | |||||||||
| Operating lease liabilities | 18,000 | 19,732 | |||||||||
| Derivative instrument | 1,537 | — | |||||||||
| Deferred income taxes | 90,483 | 90,483 | |||||||||
| Other long-term liabilities | 387 | 387 | |||||||||
| Total long-term liabilities | 326,040 | 324,350 | |||||||||
| Total liabilities | 402,410 | 384,352 | |||||||||
| Commitments and contingencies (Note 10) | |||||||||||
| Equity | |||||||||||
Common stock, $0.01 par value; 500,000,000 shares authorized; 115,219,396 issued and outstanding at January 31, 2023 and 115,184,161 issued and outstanding at July 31, 2022 | 1,152 | 1,152 | |||||||||
| Additional paid-in capital | 734,763 | 731,597 | |||||||||
| Retained earnings | 168,556 | 133,824 | |||||||||
| Total The Duckhorn Portfolio, Inc. equity | 904,471 | 866,573 | |||||||||
| Non-controlling interest | 580 | 588 | |||||||||
| Total equity | 905,051 | 867,161 | |||||||||
| Total liabilities and equity | $ | 1,307,461 | $ | 1,251,513 | |||||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements (unaudited).
8
The Duckhorn Portfolio, Inc. Condensed Consolidated Statements of Operations (unaudited) | ||
| Three months ended January 31, | Six months ended January 31, | ||||||||||||||||||||||
| (in thousands, except share and per share amounts) | 2023 | 2022 | 2023 | 2022 | |||||||||||||||||||
Net sales (net of excise taxes of $1,469, $1,507, $3,052 and $2,983, respectively) | $ | 103,488 | $ | 98,736 | $ | 211,659 | $ | 202,917 | |||||||||||||||
| Cost of sales | 48,302 | 49,259 | 101,763 | 101,030 | |||||||||||||||||||
| Gross profit | 55,186 | 49,477 | 109,896 | 101,887 | |||||||||||||||||||
| Selling, general and administrative expenses | 29,579 | 23,845 | 55,318 | 47,052 | |||||||||||||||||||
| Income from operations | 25,607 | 25,632 | 54,578 | 54,835 | |||||||||||||||||||
| Interest expense | 2,684 | 1,636 | 4,846 | 3,242 | |||||||||||||||||||
| Other expense (income), net | 2,743 | (338) | 2,656 | (1,431) | |||||||||||||||||||
| Total other expenses, net | 5,427 | 1,298 | 7,502 | 1,811 | |||||||||||||||||||
| Income before income taxes | 20,180 | 24,334 | 47,076 | 53,024 | |||||||||||||||||||
| Income tax expense | 5,265 | 6,407 | 12,352 | 13,784 | |||||||||||||||||||
| Net income | 14,915 | 17,927 | 34,724 | 39,240 | |||||||||||||||||||
| Less: Net loss (income) attributable to non-controlling interest | 2 | 5 | 8 | (35) | |||||||||||||||||||
| Net income attributable to The Duckhorn Portfolio, Inc. | $ | 14,917 | $ | 17,932 | $ | 34,732 | $ | 39,205 | |||||||||||||||
| Net income per share of common stock: | |||||||||||||||||||||||
| Basic | $ | 0.13 | $ | 0.16 | $ | 0.30 | $ | 0.34 | |||||||||||||||
| Diluted | $ | 0.13 | $ | 0.16 | $ | 0.30 | $ | 0.34 | |||||||||||||||
| Weighted average shares of common stock outstanding: | |||||||||||||||||||||||
| Basic | 115,191,575 | 115,049,395 | 115,187,868 | 115,048,094 | |||||||||||||||||||
| Diluted | 115,327,660 | 115,389,502 | 115,424,809 | 115,391,011 | |||||||||||||||||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements (unaudited).
9
| The Duckhorn Portfolio, Inc. Condensed Consolidated Statements of Changes in Equity (unaudited) | ||
| Three months ended January 31, | |||||||||||||||||||||||||||||||||||||||||
| (in thousands, except share amounts) | Common stock | Additional paid-in capital | Retained earnings | Total The Duckhorn Portfolio, Inc. equity | Non-controlling interest | Total equity | |||||||||||||||||||||||||||||||||||
| Shares | Amount | ||||||||||||||||||||||||||||||||||||||||
| Balances at October 31, 2022 | 115,184,161 | $ | 1,152 | $ | 732,777 | $ | 153,639 | $ | 887,568 | $ | 582 | $ | 888,150 | ||||||||||||||||||||||||||||
| Net income | — | — | — | 14,917 | 14,917 | (2) | 14,915 | ||||||||||||||||||||||||||||||||||
| Issuance of common stock under equity incentive plans | 22,365 | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||||
| Issuance of employee stock purchase plan | 12,870 | — | 181 | — | 181 | — | 181 | ||||||||||||||||||||||||||||||||||
| Equity-based compensation (Note 11) | — | — | 1,805 | — | 1,805 | — | 1,805 | ||||||||||||||||||||||||||||||||||
| Balances at January 31, 2023 | 115,219,396 | $ | 1,152 | $ | 734,763 | $ | 168,556 | $ | 904,471 | $ | 580 | $ | 905,051 | ||||||||||||||||||||||||||||
| Balances at October 31, 2021 | 115,046,793 | $ | 1,150 | $ | 728,362 | $ | 94,907 | $ | 824,419 | $ | 591 | $ | 825,010 | ||||||||||||||||||||||||||||
| Net income (loss) | — | — | — | 17,932 | 17,932 | (5) | 17,927 | ||||||||||||||||||||||||||||||||||
| Issuance of common stock under equity incentive plans | 18,417 | 1 | — | — | 1 | — | 1 | ||||||||||||||||||||||||||||||||||
| Equity-based compensation (Note 11) | — | — | 1,416 | — | 1,416 | — | 1,416 | ||||||||||||||||||||||||||||||||||
| Initial public offering, net of issuance costs | — | — | (270) | — | (270) | — | (270) | ||||||||||||||||||||||||||||||||||
| Balances at January 31, 2022 | 115,065,210 | $ | 1,151 | $ | 729,508 | $ | 112,839 | $ | 843,498 | $ | 586 | $ | 844,084 | ||||||||||||||||||||||||||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements (unaudited).
10
| The Duckhorn Portfolio, Inc. Condensed Consolidated Statements of Changes in Equity (unaudited) | ||||||||||||||
| Six months ended January 31, | |||||||||||||||||||||||||||||||||||||||||
| (in thousands, except share amounts) | Common stock | Additional paid-in capital | Retained earnings | Total The Duckhorn Portfolio, Inc. equity | Non-controlling interest | Total equity | |||||||||||||||||||||||||||||||||||
| Shares | Amount | ||||||||||||||||||||||||||||||||||||||||
| Balances at July 31, 2022 | 115,184,161 | $ | 1,152 | $ | 731,597 | $ | 133,824 | $ | 866,573 | $ | 588 | $ | 867,161 | ||||||||||||||||||||||||||||
| Net income (loss) | — | — | — | 34,732 | 34,732 | (8) | 34,724 | ||||||||||||||||||||||||||||||||||
| Issuance of common stock under equity incentive plans | 22,365 | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||||
| Issuance of employee stock purchase plan | 12,870 | — | 181 | — | 181 | — | 181 | ||||||||||||||||||||||||||||||||||
| Equity-based compensation (Note 11) | — | — | 2,985 | — | 2,985 | — | 2,985 | ||||||||||||||||||||||||||||||||||
| Balances at January 31, 2023 | 115,219,396 | $ | 1,152 | $ | 734,763 | $ | 168,556 | $ | 904,471 | $ | 580 | $ | 905,051 | ||||||||||||||||||||||||||||
| Balances at July 31, 2021 | 115,046,793 | $ | 1,150 | $ | 726,903 | $ | 73,634 | $ | 801,687 | $ | 551 | $ | 802,238 | ||||||||||||||||||||||||||||
| Net income (loss) | — | — | — | 39,205 | 39,205 | 35 | 39,240 | ||||||||||||||||||||||||||||||||||
| Issuance of common stock under equity incentive plans | 18,417 | 1 | — | — | 1 | — | 1 | ||||||||||||||||||||||||||||||||||
| Equity-based compensation (Note 11) | — | — | 2,875 | — | 2,875 | — | 2,875 | ||||||||||||||||||||||||||||||||||
| Initial public offering, net of issuance costs | — | — | (270) | — | (270) | — | (270) | ||||||||||||||||||||||||||||||||||
| Balances at January 31, 2022 | 115,065,210 | $ | 1,151 | $ | 729,508 | $ | 112,839 | $ | 843,498 | $ | 586 | $ | 844,084 | ||||||||||||||||||||||||||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements (unaudited).
11
| The Duckhorn Portfolio, Inc. Condensed Consolidated Statements of Cash Flows (unaudited) | ||
| Six months ended January 31, | |||||||||||
| (in thousands) | 2023 | 2022 | |||||||||
| Cash flows from operating activities | |||||||||||
| Net income | $ | 34,724 | $ | 39,240 | |||||||
| Adjustments to reconcile net income to net cash from operating activities: | |||||||||||
| Depreciation and amortization | 13,290 | 11,047 | |||||||||
| Loss (gain) on disposal of assets | 93 | (13) | |||||||||
| Change in fair value of derivatives | 2,061 | (957) | |||||||||
| Amortization of debt issuance costs | 593 | 804 | |||||||||
| Equity-based compensation | 2,985 | 2,875 | |||||||||
| Change in operating assets and liabilities: | |||||||||||
| Accounts receivable trade, net | (11,298) | (9,755) | |||||||||
| Inventories | (39,881) | (28,187) | |||||||||
| Prepaid expenses and other current assets | 26 | (361) | |||||||||
| Other long-term assets | (555) | (217) | |||||||||
| Accounts payable | 15,020 | 6,377 | |||||||||
| Accrued expenses | 830 | 6,621 | |||||||||
| Accrued compensation | (3,669) | (4,129) | |||||||||
| Deferred revenue | 3,013 | (2,960) | |||||||||
| Other current and long-term liabilities | 865 | (1,557) | |||||||||
| Net cash provided by operating activities | 18,097 | 18,828 | |||||||||
| Cash flows from investing activities | |||||||||||
| Purchases of property and equipment, net of sales proceeds | (12,388) | (23,336) | |||||||||
| Net cash used in investing activities | (12,388) | (23,336) | |||||||||
| Cash flows from financing activities | |||||||||||
| Payments under line of credit | (119,000) | (52,000) | |||||||||
| Borrowings under line of credit | 9,000 | 63,000 | |||||||||
| Issuance of long-term debt | 225,833 | — | |||||||||
| Payments of long-term debt | (115,166) | (5,696) | |||||||||
| Proceeds from employee stock purchase plan | 181 | — | |||||||||
| Payments for debt issuance costs | (2,432) | — | |||||||||
| Payments of deferred offering costs | — | (270) | |||||||||
| Net cash (used in) provided by financing activities | (1,584) | 5,034 | |||||||||
| Net increase in cash | 4,125 | 526 | |||||||||
| Cash - Beginning of period | 3,167 | 4,244 | |||||||||
| Cash - End of period | $ | 7,292 | $ | 4,770 | |||||||
| Supplemental cash-flow information | |||||||||||
| Interest paid, net of amount capitalized | $ | 1,649 | $ | 2,479 | |||||||
| Income taxes paid | $ | 10,621 | $ | 8,014 | |||||||
| Non-cash investing activities | |||||||||||
| Property and equipment additions in accounts payable and accrued expenses | $ | 467 | $ | 193 | |||||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements (unaudited).
12
The Duckhorn Portfolio, Inc.
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, Decoy, Goldeneye, Paraduxx, Migration, 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; San Luis Obispo, 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 stockholders 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 $0.6 million during the six months ended January 31, 2022, which 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. 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, 2023, for any other interim period or for any future year.
The Condensed Consolidated Statement of Financial Position as of July 31, 2022 was derived from the Company's audited financial statements for the fiscal year ended July 31, 2022, previously filed with the SEC. The Condensed Consolidated Financial Statements do not include all of the information and note disclosures required by U.S. GAAP and should be read in conjunction with the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended July 31, 2022.
13
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 credit losses, calculation of accrued liabilities, customer incentive reserves, uncertain tax positions, contingent liabilities, 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 Topic 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, 2023 and July 31, 2022, the Company's ownership percentage of the sole identified VIE was 76.2%. The total net assets of the VIE included on the Condensed Consolidated Statement of Financial Position were $2.3 million and $2.4 million at January 31, 2023 and July 31, 2022, 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.
Recently adopted accounting pronouncements
In March 2020, the Financial Accounting Standards Board 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. The Company adopted the standard effective August 1, 2022, the first day of Fiscal 2023. The adoption of the standard did not have a material impact on the Condensed Consolidated Financial Statements or the related disclosures.
As previously disclosed in the Annual Report on Form 10-K for the year ended July 31, 2022, the Company adopted ASU No. 2016-02, Leases (Topic 842) using the modified retrospective transition method as of the first day of Fiscal 2022. The impact of the adoption of ASC 842 on previously reported interim financial statements during the year ended July 31, 2022, included the recognition of right-of-use ("ROU") assets and lease liabilities for operating leases. The adoption of ASC 842 also resulted in reclassifying certain lines within operating activities in the Condensed Consolidated Statement of Cash Flows due to changes in operating assets and liabilities for the related accounts. These changes to previously disclosed amounts conform to the current period presentation.
No other new accounting pronouncements issued or effective as of January 31, 2023 have had, or are expected to have, a material impact on the Condensed Consolidated Financial Statements or the related disclosures.
14
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, | ||||||||||||||||||||||
| 2023 | 2022 | 2023 | 2022 | ||||||||||||||||||||
| Wholesale - Distributors | 61.3 | % | 67.2 | % | 69.0 | % | 67.9 | % | |||||||||||||||
Wholesale - California direct to trade(a) | 19.1 | 19.8 | 17.4 | 18.1 | |||||||||||||||||||
DTC(b) | 19.6 | 13.0 | 13.6 | 14.0 | |||||||||||||||||||
| Net sales | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | |||||||||||||||
________________________________________________
(a) Includes $0.6 million of sales related to bulk and grape sales for the six months ended January 31, 2023, and $0.5 million and $2.8 million for the three and six months ended January 31, 2022, respectively.
(b) Includes shipping and handling revenue of $0.9 million and $1.0 million for the three and six months ended January 31, 2023, respectively, and $0.4 million and $0.9 million for the three and six months ended January 31, 2022, respectively.
Charges related to credit loss on accounts receivable were immaterial for the three and six months ended January 31, 2023. Recoveries and reductions in the allowance for credit loss were immaterial for the three and six months ended January 31, 2023. As of January 31, 2023 and July 31, 2022, the allowance for credit losses was $0.4 million for both periods.
Contract balances
When the Company receives payment from a customer, prior to meeting the performance obligation 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 wines sold through our DTC channels, 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.
Deferred revenue in the Condensed Consolidated Statements of Financial Position was $3.3 million and $0.3 million at January 31, 2023 and July 31, 2022, respectively. In the three and six months ended January 31, 2023, the Company recognized revenue of $12.1 million and $0.3 million, respectively, which was included in the opening contract liability balance for the corresponding period.
4. Inventories
Inventories were comprised of the following:
| (in thousands) | January 31, 2023 | July 31, 2022 | |||||||||
| Finished goods | $ | 91,142 | $ | 108,989 | |||||||
| Work in progress | 232,227 | 162,337 | |||||||||
| Raw materials | 3,655 | 14,104 | |||||||||
| Inventories | $ | 327,024 | $ | 285,430 | |||||||
Inventories are stated at the lower of cost or net realizable value, and are primarily measured on a first-in-first-out basis. The Company records valuation adjustments to the carrying value of its inventories based on periodic reviews of slow-moving, obsolete and excess inventory to determine the need for reserves by comparing inventory carrying values with their net realizable values upon ultimate sale or disposal. The Company's estimates of net realizable value are based on historical experience as well as Management's judgments with respect to future market conditions. In the period the Company determines a reserve is required, the Company recognizes a charge to cost of sales for the excess of the carrying value over net realizable value. The inventory reserve was $0.4 million and $5.1 million at January 31, 2023 and July 31, 2022, respectively.
15
The Company capitalizes into inventory depreciation related to property and equipment used in the production of inventory. For the three months ended January 31, 2023 and 2022, the amount capitalized was $5.2 million and $4.0 million, respectively, and $8.6 million and $6.6 million for the six months ended January 31, 2023 and 2022, respectively. The Company also capitalizes total lease costs related to leases used in the production of inventory. For the three months ended January 31, 2023 and 2022, the amount capitalized was $1.1 million and $1.1 million, respectively. For the six months ended January 31, 2023 and 2022, the amount capitalized was $2.2 million and $2.1 million, respectively.
5. Property and equipment, net
Property and equipment, net was comprised of the following:
| (in thousands) | January 31, 2023 | July 31, 2022 | |||||||||
| Land | $ | 136,328 | $ | 136,328 | |||||||
| Buildings and improvements | 70,847 | 70,813 | |||||||||
| Machinery and equipment | 53,160 | 52,619 | |||||||||
| Vineyards and improvements | 44,866 | 44,759 | |||||||||
| Barrels | 37,185 | 30,067 | |||||||||
| Total depreciable property and equipment | 342,386 | 334,586 | |||||||||
| Less: accumulated depreciation and amortization | (77,898) | (70,591) | |||||||||
| Total depreciable property and equipment, net | 264,488 | 263,995 | |||||||||
| Construction in progress | 6,729 | 5,664 | |||||||||
| Property and equipment, net | $ | 271,217 | $ | 269,659 | |||||||
Depreciation expense recognized in selling, general and administrative expenses was $0.5 million and $0.3 million for the three months ended January 31, 2023 and 2022, respectively, and $0.9 million and $0.7 million for the six months ended January 31, 2023 and 2022, 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.
16
6. Accrued expenses
Accrued expenses were comprised of the following:
| (in thousands) | January 31, 2023 | July 31, 2022 | |||||||||
Trade spend(a) | $ | 17,477 | $ | 15,319 | |||||||
| Accrued professional fees | 3,903 | 3,191 | |||||||||
Deferred compensation liability(b) | 2,879 | 2,142 | |||||||||
| Income taxes payable | 1,730 | 387 | |||||||||
| Bulk wine and other received not invoiced | 882 | 143 | |||||||||
| Barrel purchases | — | 988 | |||||||||
| Accrued invoices and other accrued expenses | 2,200 | 7,305 | |||||||||
| Accrued expenses | $ | 29,071 | $ | 29,475 | |||||||
(a) Trade spend refers to estimated amounts the Company owes to distributors for depletion-based incentives for meeting specific depletion targets.
(b) The Company intends to use the cash surrender value life insurance policies to partially settle its deferred compensation plan liability. The cash surrender value of the life insurance policies was $2.3 million and $1.8 million at January 31, 2023 and July 31, 2022, respectively, and is included in other long-term assets on the Condensed Consolidated Statements of Financial Position.
7. Debt
At January 31, 2023, the Company had unused capacity of $425.0 million under the new revolving line of credit, excluding the incremental seasonal borrowing amount of an additional $30.0 million of capacity. There were no amounts outstanding on the letter of credit sub-facility or the swingline sub-facility at January 31, 2023.
Included in interest expense in the Condensed Consolidated Statements of Operations is amortization related to debt issuance costs of $0.2 million and $0.4 million for the three months ended January 31, 2023 and 2022, respectively, and of $0.6 million and $0.8 million for the six months ended January 31, 2023 and 2022, 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 capitalization ratio and a fixed charge coverage ratio as defined in the New Credit Facility. As of January 31, 2023, the Company is in compliance with all covenants.
Amendment to the Original Credit Agreement
Effective August 30, 2022, Mallard Buyer Corp., Selway Wine Company and certain other subsidiaries of The Duckhorn Portfolio, Inc. (collectively, the “Borrowers”) entered into an eighth amendment to the Original Credit Agreement, to extend the maturity date of all facilities to November 1, 2023 and to transition from a LIBOR based interest rate to a Term SOFR based interest rate plus applicable margins defined by the terms of the Original Credit Facility. The transaction did not result in any additional cash proceeds.
New Credit Agreement
Effective November 4, 2022, the Borrowers entered into the New Credit Agreement which amends and restates, in its entirety, the Original Credit Agreement. The New Credit Agreement provides for $675.8 million in first lien senior secured credit facilities consisting of (i) a $425.0 million revolving credit facility, (ii) a $225.8 million term loan facility and (iii) a $25.0 million delayed draw term loan facility. The maturity date for loans borrowed under the New Credit Agreement is November 4, 2027.
The term loan facility in the New Credit Agreement replaces the $135.0 million term loan tranche one facility, $25.0 million term loan tranche two facility and $25.0 million capital expenditure facility under the Original Credit Agreement.
17
The New Credit Agreement allows the Borrowers, at any time, to request additional term loans, revolver commitments and delayed draw term loan commitments in an aggregate amount of up to $400.0 million (the “Incremental Facility”). The lenders are not under any obligation to provide the Incremental Facility, and the Incremental Facility is subject to certain customary conditions precedent and other limitations.
Borrowings under the revolver portion of the New Credit Agreement generally bear interest based on the sum of Term SOFR plus a loan margin based on average availability as follows: (a) less than or equal to 33% of average availability, a loan margin of 1.50%, (b) greater than 33% and less than or equal to 66% of average availability, a loan margin of 1.25%, and (c) greater than 66% of average availability, a loan margin of 1.00%. Borrowings under the term loan and delayed draw portions of the New Credit Agreement generally bear interest based on the sum of (i) Term SOFR plus (ii) a credit spread adjustment of 10 basis points for 1-month and 3-month interest periods and 15 basis points for a six-month interest period plus (iii) a loan margin of 1.625%.
The New Credit Agreement also includes an unused line fee and contains customary representations and warranties and affirmative and negative covenants for agreements of this type. In addition, the New Credit Agreement requires compliance with the following financial covenants, in each case commencing from fiscal quarter ending January 31, 2023: (i) a debt to capitalization ratio not to exceed 0.55:1.00, measured at the end of each fiscal quarter and (ii) a fixed charge coverage ratio not to be less than 1.15:1.00, measured at the end of each fiscal quarter.
The Company incurred approximately $3.3 million in debt issuance costs, including bank financing fees and third party legal and other professional fees in closing the New Credit Agreement, of which approximately $2.4 million were capitalized in accordance with ASC Topic 470, Debt. The fees associated with the revolving and delayed draw term facilities were capitalized to other long-term assets and the fees associated with the term loan facility were capitalized to long-term debt, net of current maturities and debt issuance costs on the Condensed Consolidated Statement of Position. The capitalized debt issuance costs will be amortized as interest expense over the term of the New Credit Agreement. Other related charges incurred of $0.9 million that were not capitalized during the period are reflected in other (income) expense in the Condensed Consolidated Statement of Operations.
Long-term debt, net was comprised of the following:
| (in thousands) | January 31, 2023 | July 31, 2022 | |||||||||
| Revolving line of credit | $ | — | $ | 110,000 | |||||||
| Term loan, first lien | 225,832 | 110,117 | |||||||||
Capital expenditure loan(a) | — | 5,049 | |||||||||
| Total debt | 225,832 | 225,166 | |||||||||
| Less: Current maturities of long-term debt | (9,721) | (9,810) | |||||||||
| Total long-term debt | 216,111 | 215,356 | |||||||||
Debt issuance costs(b) | (478) | (1,608) | |||||||||
| Total long-term debt, net of current maturities and debt issuance costs | $ | 215,633 | $ | 213,748 | |||||||
(a) The capital expenditure loan under the Original Credit Agreement was replaced as part of the refinancing and execution of the New Credit Agreement. Under the New Credit Facility, the intent of the delayed draw term loan is similar to that of the capital expenditure loan under the Original Credit Agreement. The delayed draw term loan is secured by certain capital expenditures. As of January 31, 2023, the Company has not drawn on the delayed draw term loan.
(b) At January 31, 2023, debt issuance costs are the costs associated with the term loan facility. Debt issuance costs of $3.0 million associated with the revolving credit and delayed draw term loan facilities are recorded in other long-term assets on the Condensed Consolidated Statements of Financial Position. Under the Original Credit Facility, the revolving credit facility debt issuance costs were treated consistently with those of the term debt facilities as the Company did not intend to repay the revolving credit facility in full prior to its maturity.
18
8. 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, 2023 or July 31, 2022. 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, 2023, 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 | 0.315% | September 30, 2022 | March 23, 2023 | |||||||||||||||||
| $100,000 | 3.735% | January 4, 2023 | November 4, 2027 | |||||||||||||||||
The total notional amounts of the Company’s derivative instruments outstanding are as follows:
| (in thousands) | January 31, 2023 | July 31, 2022 | |||||||||
| Derivative instruments not designated as hedging instruments | |||||||||||
| Interest rate swap contracts | $ | 200,000 | $ | 100,000 | |||||||
| Foreign currency forward contracts | 1,010 | 2,793 | |||||||||
| Total derivative instruments not designated as hedging instruments | $ | 201,010 | $ | 102,793 | |||||||
Effective September 30, 2022, the Company amended its interest rate swap initially entered into in March 2020 to transition from a LIBOR-based floating rate to a Term SOFR based floating rate. On January 4, 2023, the Company entered into an interest rate swap that partially mitigates the risk to the Company due to potential future Term SOFR movements by trading floating rate payments for fixed rate payments on an applicable notional amount of outstanding variable rate debt.
As discussed in Note 10 (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, generally aligning settlement dates with expected barrel deliveries and the anticipated timing of payments to various coopers.
19
Results of period derivative activity
The estimated fair value and classification of derivative instruments on the accompanying Condensed Consolidated Statements of Financial Position for January 31, 2023 were as follows:
| (in thousands) | Derivative Assets | Derivative Liabilities | |||||||||||||||||||||
| Balance Sheet Classification | Fair Value | Balance Sheet Classification | Fair Value | ||||||||||||||||||||
| Interest rate swap contracts | Prepaid expenses and other current assets | $ | 607 | Derivative instrument | $ | 1,537 | |||||||||||||||||
| Foreign currency forward contracts | Prepaid expenses and other current assets | 89 | Other current liabilities | — | |||||||||||||||||||
| Total derivatives not designated as hedging instruments | $ | 696 | $ | 1,537 | |||||||||||||||||||
The estimated fair value and classification of derivative instruments on the accompanying Condensed Consolidated Statements of Financial Position for July 31, 2022 were as follows:
| (in thousands) | Derivative Assets | Derivative Liabilities | |||||||||||||||||||||
| Balance Sheet Classification | Fair Value | Balance Sheet Classification | Fair Value | ||||||||||||||||||||
| Interest rate swap contracts | Prepaid expenses and other current assets | $ | 1,443 | Derivative instrument | $ | — | |||||||||||||||||
| Foreign currency forward contracts | Prepaid expenses and other current assets | — | Other current liabilities | 223 | |||||||||||||||||||
| Total derivatives not designated as hedging instruments | $ | 1,443 | $ | 223 | |||||||||||||||||||
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 | 2023 | 2022 | 2023 | 2022 | |||||||||||||||||||||
| Interest rate swap contracts | Other expense (income), net | $ | 2,518 | $ | (515) | $ | 2,373 | $ | (962) | |||||||||||||||||
| Foreign currency forward contracts | Other expense (income), net | (89) | — | (312) | 5 | |||||||||||||||||||||
| Total loss (gain) | $ | 2,429 | $ | (515) | $ | 2,061 | $ | (957) | ||||||||||||||||||
9. Fair value measurements
The Company applies a fair value hierarchy pursuant to ASC Topic 820, Fair Value Measurement, which consists of three levels of inputs 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; and
20
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 agreements are 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 (Level 2 of the fair value hierarchy).
The Company’s assets and liabilities measured and recorded at fair value on a recurring basis at January 31, 2023, 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 contract | $ | — | $ | 607 | $ | — | $ | 607 | ||||||||||||||||||
| Deferred compensation plan asset | — | 2,308 | — | 2,308 | ||||||||||||||||||||||
| Liabilities | ||||||||||||||||||||||||||
| Interest rate swap contract | $ | — | $ | 1,537 | $ | — | $ | 1,537 | ||||||||||||||||||
| Deferred compensation liability | — | 2,879 | — | 2,879 | ||||||||||||||||||||||
The Company’s assets and liabilities measured and recorded at fair value on a recurring basis at July 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 | $ | — | $ | 1,443 | $ | — | $ | 1,443 | ||||||||||||||||||
| Deferred compensation plan asset | — | 1,753 | — | 1,753 | ||||||||||||||||||||||
| Liabilities | ||||||||||||||||||||||||||
| Foreign currency forward contracts | $ | — | $ | 223 | $ | — | $ | 223 | ||||||||||||||||||
| Deferred compensation liability | — | 2,142 | — | 2,142 | ||||||||||||||||||||||
21
10. Commitments and contingencies
Long-term purchase contracts
The Company has entered certain grape purchase contracts with various growers to supply a significant portion of its future grape requirements for wine production. The lengths of the contracts vary from to eight years, and prices 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 2022 harvest, the Company purchased grapes for a total cost of approximately $71.0 million in Fiscal 2023. For the 2021 harvest, the Company purchased grapes for a total cost of $68.1 million in Fiscal 2022. The Company also increases the scope of its grape contracts when necessitated by supply needs to meet production levels in future periods.
Purchase commitments
The Company enters into commitments to purchase barrels for each harvest, a significant portion of which are settled in Euros. As of July 31, 2022, the Company had $8.8 million in barrel purchase commitments. During the six months ended January 31, 2023, the Company paid the remaining commitments and liabilities associated with the barrel purchases for the 2022 harvest. As of January 31, 2023, the Company does not yet have any commitments for the 2023 harvest. 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, generally aligning settlement dates with expected barrel deliveries and the anticipated timing of payments to various coopers. The Company does not enter into these contracts for speculative purposes. Gains and losses on these contracts are recorded in the Condensed Consolidated Statements of Operations. See Note 8 (Derivative instruments) for the total notional value and impact on the Condensed Consolidated Financial Statements due to foreign currency forward contracts.
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, 2023, 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 expects the risk of any future obligations under these indemnification provisions to be remote. As of January 31, 2023 and July 31, 2022, no amounts have been accrued related to such indemnification provisions.
22
11. Equity-based compensation
2016 Equity Plan
In 2016, the Company adopted the 2016 Equity Plan, which provided profit interest units to certain employees of the Company. In connection with the adoption of the Company's 2021 Plan, the Company will no longer grant additional awards under the 2016 Plan. However, the terms and conditions of the 2016 Plan will continue to govern the previously granted awards, to the extent applicable. The remaining awards vested on August 1, 2022 and were fully expensed as of July 31, 2022. The total fair value of restricted shares that vested during the six months ended January 31, 2023 was $4.9 million.
Restricted shares
The following table represents restricted share activity:
| Performance-based shares | Weighted-average grant-date fair value | ||||||||||
Unvested as of July 31, 2022 | 266,158 | $ | 14.23 | ||||||||
| Granted | — | — | |||||||||
| Vested | (266,158) | 14.23 | |||||||||
| Forfeited | — | — | |||||||||
Unvested as of January 31, 2023 | — | $ | — | ||||||||
2021 Equity Incentive Plan
In March 2021, the Company's Board of Directors approved the 2021 Plan, which provides for granting up to 14,003,560 shares of the Company's common stock to employees, officers, and founders. Restricted stock units and stock options are granted to certain employees of the Company, advisors and directors (collectively “grants”). The grants are considered equity awards for purposes of calculating compensation expense and are equity-classified in the Condensed Consolidated Statements of Financial Position.
Stock options
The following table represents the stock option activity:
| Number of options | Weighted-average exercise price | Weighted-average remaining contractual life (in years) | Aggregate intrinsic value (in thousands) | ||||||||||||||||||||
Outstanding at July 31, 2022 | 1,555,610 | $ | 17.15 | 8.7 | $ | 3,847 | |||||||||||||||||
| Granted | 1,067,979 | 14.43 | |||||||||||||||||||||
| Exercised | (2,586) | 15.00 | |||||||||||||||||||||
| Forfeited | (118,237) | 16.94 | |||||||||||||||||||||
| Expired | (39,599) | 17.25 | |||||||||||||||||||||
Outstanding at January 31, 2023 | 2,463,167 | $ | 15.99 | 8.8 | $ | 3,079 | |||||||||||||||||
Exercisable as of January 31, 2023 | 336,673 | $ | 17.13 | 8.2 | |||||||||||||||||||
The Company recognized equity compensation expense related to the 2021 Plan stock options in selling, general and administrative expenses and capitalized a portion into inventories on the Condensed Consolidated Statements of Financial Position, as applicable, due to units vesting over their requisite service periods. Total recognized equity compensation expense related to the 2021 Plan stock options was $0.8 million and $0.5 million for the
23
three months ended January 31, 2023 and 2022, respectively, and $1.3 million and $1.0 million for the six months ended January 31, 2023 and 2022, respectively.
The total unrecognized compensation expense related to the 2021 Plan stock options was $9.5 million as of January 31, 2023, which is expected to be recognized over a weighted-average period of 3.1 years.
The following assumptions were applied in the Black-Scholes option pricing model to estimate the grant-date fair value of the stock options granted in the six months ended January 31, 2023:
| Six months ended January 31, 2023 | |||||
Expected term (in years)(a) | 6.23 | ||||
Expected dividend yield(b) | — | % | |||
Risk-free interest rate(c) | 3.96 | % | |||
Expected volatility(d) | 33.9 | % | |||
| Stock price | $ | 14.43 | |||
________________________________________________
(a) Calculated as the midpoint between the weighted-average time to vest and the time to expiration.
(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. Treasury Constant Maturity Rates 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 historical and implied volatility of a group of guideline public companies deemed to be comparable public peers within the Company’s industry.
Restricted stock units
The following table represents the RSU grant activity under the 2021 Plan:
| Number of units | Weighted-average grant-date fair value per share | ||||||||||
Unvested as of July 31, 2022 | 414,609 | $ | 17.32 | ||||||||
| Granted | 382,985 | 14.56 | |||||||||
| Vested | (22,333) | 20.24 | |||||||||
| Forfeited | (39,414) | 16.94 | |||||||||
Unvested as of January 31, 2023 | 735,847 | $ | 15.81 | ||||||||
The Company recognized equity compensation expense related to the 2021 Plan RSUs in selling, general and administrative expenses and capitalized a portion into inventories on the Condensed Consolidated Statements of Financial Position, as applicable, due to units vesting over their requisite service periods, of $0.9 million and $0.8 million, respectively, for the three months ended January 31, 2023 and 2022 and $1.6 million and $1.6 million for the six months ended January 31, 2023 and 2022, respectively. The total unrecognized compensation expense related to the 2021 Plan RSUs was $9.4 million as of January 31, 2023, which is expected to be recognized over a weighted-average period of 2.8 years.
Employee Stock Purchase Plan
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. An offering period under the Plan began on September 1, 2022 and ended on December 30, 2022. The Company recognized equity compensation expense related to the ESPP in selling, general and administrative expenses and capitalized a portion into inventory, as applicable. For the three and six months ended January 31, 2023, total recognized compensation expense was immaterial and $0.1 million, respectively. There was no unrecognized compensation expense related to the ESPP as of January 31, 2023.
24
12. 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) | 2023 | 2022 | 2023 | 2022 | |||||||||||||||||||
| Numerator: Net income attributable to The Duckhorn Portfolio, Inc. | $ | 14,917 | $ | 17,932 | $ | 34,732 | $ | 39,205 | |||||||||||||||
| Denominator: | |||||||||||||||||||||||
| Weighted average number of shares outstanding for basic per share calculation | 115,191,575 | 115,049,395 | 115,187,868 | 115,048,094 | |||||||||||||||||||
Effect of dilutive potential shares(a): | |||||||||||||||||||||||
| Stock options | — | 145,990 | — | 158,261 | |||||||||||||||||||
| Restricted stock awards | 136,085 | 194,117 | 236,941 | 184,656 | |||||||||||||||||||
| Adjusted weighted average shares outstanding for diluted per share calculation | 115,327,660 | 115,389,502 | 115,424,809 | 115,391,011 | |||||||||||||||||||
| Earnings per share attributable to The Duckhorn Portfolio, Inc. | |||||||||||||||||||||||
| Basic | $ | 0.13 | $ | 0.16 | $ | 0.30 | $ | 0.34 | |||||||||||||||
| Diluted | $ | 0.13 | $ | 0.16 | $ | 0.30 | $ | 0.34 | |||||||||||||||
(a) Calculated using the treasury stock method.
For the three months ended January 31, 2023 and 2022, there were 0.6 million and 0.1 million incremental common shares issuable upon the exercise of certain stock options, respectively, that were not included in the calculation of diluted EPS because the effect of their inclusion would have been antidilutive under the treasury stock method. For the six months ended January 31, 2023 and 2022, there were 0.5 million and 0.1 million incremental common shares issuable upon the exercise of certain stock options, respectively, that were not included in the calculation of diluted EPS because the effect of their inclusion would have been antidilutive under the treasury stock method. Refer to Note 11 (Equity-based compensation) for the terms of the awards.
13. Income taxes
Income tax expense was $5.3 million and $12.4 million, with an effective tax rate of 26.1% and 26.2% for the three and six months ended January 31, 2023, respectively, compared to $6.4 million and $13.8 million, with an effective tax rate of 26.3% and 26.0% for the three and six months ended January 31, 2022, respectively. The effective tax rates for both periods presented were higher than the federal statutory rate of 21% primarily due to the impact of state income taxes.
14. Subsequent events
Effective February 6, 2023, the Company entered into the First Amendment to the Amended and Restated First Lien Loan and Security Agreement. The changes in the amendment are administrative in nature and do not have a material impact on the Company's outstanding debt or related debt covenants. The amendment did not result in any additional cash proceeds or changes in commitment amounts.
25
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 2022.
Overview
The Duckhorn Portfolio is the premier scaled producer of luxury wines in North America. We offer a curated and comprehensive portfolio of luxury wines with suggested retail prices ranging from $20 to $200 per bottle. Our wines are available in all 50 states and over 50 countries under a world-class luxury portfolio of winery brands, including Duckhorn Vineyards, Decoy, Goldeneye, Paraduxx, Migration, Canvasback, Calera, Kosta Browne, Greenwing and Postmark.
We sell our wines to distributors outside California and directly to trade accounts in California, which together comprise our wholesale channel. We also sell directly to consumers through our DTC channel, which includes eight tasting rooms, wine clubs and our multi-winery e-commerce website. Our powerful omni-channel sales model continues to drive strong margins by leveraging long-standing relationships.
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. 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 key financial metrics. See “—Limitations of non-GAAP financial measures and adjusted EBITDA reconciliation” for additional information.
| Three months ended January 31, | Six months ended January 31, | ||||||||||||||||||||||
| (in thousands) | 2023 | 2022 | 2023 | 2022 | |||||||||||||||||||
| Net sales | $ | 103,488 | $ | 98,736 | $ | 211,659 | $ | 202,917 | |||||||||||||||
| Gross profit | $ | 55,186 | $ | 49,477 | $ | 109,896 | $ | 101,887 | |||||||||||||||
| Net income attributable to The Duckhorn Portfolio, Inc. | $ | 14,917 | $ | 17,932 | $ | 34,732 | $ | 39,205 | |||||||||||||||
| Adjusted EBITDA | $ | 38,813 | $ | 34,310 | $ | 74,478 | $ | 72,400 | |||||||||||||||
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, purchase accounting adjustments, transaction expenses, changes in the fair value of
26
derivatives, equity-based compensation and certain other items which are not related to our core operating performance. Adjusted EBITDA is a key performance measure we use in evaluating our operational results. We believe adjusted EBITDA is a helpful measure to provide investors an understanding of how management regularly monitors our core operating performance, as well as how management makes operational and strategic decisions in allocating resources. We believe adjusted EBITDA also provides management and investors consistency and comparability with our past financial performance and facilitates period to period comparison of operations, as it eliminates the effects of certain variations unrelated to our overall performance. See “—Limitations of non-GAAP financial measures and adjusted EBITDA reconciliation” for additional information.
Key operating metrics
We monitor the following key operating 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 trade accounts in California and through our DTC channel, respectively, as a percentage of our total net sales. We monitor net sales percentage across all 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, | ||||||||||||||||||||||
| 2023 | 2022 | 2023 | 2022 | ||||||||||||||||||||
| Wholesale - Distributors | 61.3 | % | 67.2 | % | 69.0 | % | 67.9 | % | |||||||||||||||
| Wholesale - California direct to trade | 19.1 | % | 19.8 | % | 17.4 | % | 18.1 | % | |||||||||||||||
| DTC | 19.6 | % | 13.0 | % | 13.6 | % | 14.0 | % | |||||||||||||||
| Total net sales | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | |||||||||||||||
The composition of our net sales, expressed in percentages by channel for the three months ended January 31, 2023, was impacted by a DTC offering shift into the second quarter of Fiscal 2023 compared to the first quarter of Fiscal 2022. In our wholesale business, we strengthened our market position and delivered volume growth during the six months ended January 31, 2023.
Net sales growth contribution
Net sales growth is defined as the percentage increase of net sales in the period compared to the prior year 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 year 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, | ||||||||||||||||||||||
| 2023 | 2022 | 2023 | 2022 | ||||||||||||||||||||
| Net sales growth | 4.8 | % | 18.0 | % | 4.3 | % | 15.8 | % | |||||||||||||||
| Volume contribution | (0.4) | % | 24.8 | % | 4.5 | % | 15.3 | % | |||||||||||||||
| Price / mix contribution | 5.2 | % | (6.8) | % | (0.2) | % | 0.5 | % | |||||||||||||||
27
Price / mix contribution for the three months ended January 31, 2023 was bolstered by a DTC offering shift into the second quarter of Fiscal 2023 compared to the first quarter of Fiscal 2022, as well as pricing increases in our wholesale channel that supported net sales growth for the quarter versus the prior year period.
For the six months ended January 31, 2023, a relatively neutral price / mix contribution was impacted by the outsized volume growth of the wholesale channel and flat DTC channel performance, while benefiting from pricing increases that supported net sales growth. Despite lapping high growth rates we achieved in the prior year period, our focus on trade account growth was a primary driver of increased volume for the six months ended January 31, 2023. Wholesale performance was largely balanced in the channels, with on-premise slightly outpacing off-premise growth. Generally, on-premise expansion also drives increased sales in our ultra-luxury brands that sell at higher average sales prices and positively impact price / mix contribution.
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.
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 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 channel, to trade accounts nationally.
The following factors and trends in our business are expected to be key drivers of our net sales growth for the foreseeable future:
•Further leverage brand strength. Leverage sales and marketing strengths and increasing brand awareness and grow sales of our winery brands to our existing consumer base and a new generation of consumers in a consolidating marketplace.
•Insightful and targeted portfolio evolution. Launch winery brand extensions and continue evolving and strategically broadening our portfolio.
•Distribution expansion and acceleration. Capture distribution growth opportunities and accelerate sales to existing distributors and retail accounts in California.
•Continued investment in DTC channel. Engage with our consumers, create brand evangelists and drive adoption across our portfolio through brand-specific tasting rooms, multiple wine clubs and our multi-winery e-commerce website, all of which enable us to cross-sell wines within our portfolio.
•Opportunistic evaluation of strategic acquisitions. Disciplined evaluation of strategic acquisitions when opportunities arise to create stockholder value.
The primary market for our wines is the United States, which represented approximately 94% of our net sales during the six months ended January 31, 2023. Accordingly, our results of operations are primarily dependent on U.S. consumer spending.
28
Sales channels
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 trade accounts 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 in their respective territories. In California, where we make sales directly to trade accounts, we benefit from greater control over our sales and higher profit margins by selling directly to retailers in the state. Our wholesale channel constitutes a greater proportion of our net sales than our DTC channel.
•DTC channel. Wines sold through our DTC channel are generally sold at suggested retail prices. DTC channel sales represent important direct connections with our customers. DTC channel sales growth will generally be favorable to price/mix contribution and gross profit margin in periods where that channel constitutes a greater proportion of net sales than in a comparative period.
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.
We routinely offer sales discounts and promotions through various programs to distributors around the country and to trade 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 to total sales in calculating net sales. While our promotional activities may result in some variability in net sales from quarter to quarter, historically, the impact of these activities on our results has generally been proportional to changes in total net sales.
Seasonality
Our net sales are typically highest in the first half of our fiscal year, predominantly 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. This dynamic generally results in lower average selling prices due to distributor and retail sales discounts and promotions in our wholesale channel. See “—Key operating metrics.” In Fiscal 2022, our net sales in the first, second, third and fourth fiscal quarters represented approximately 28%, 26%, 25% and 21%, respectively, of our total net sales for the year.
Gross profit
Gross profit is equal to net sales minus 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, including dry goods and packaging materials.
29
Agribusiness
We have developed a diversified sourcing and production model, supported by our eight wineries, world-class, and 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.
Other expenses
Other expenses consist primarily of interest expense we incur on balances outstanding under the terms of our Original Credit Facility and our New Credit Facility, amortization related to debt issuance costs and realized 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 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.
30
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 48 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.
31
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) | 2023 | 2022 | 2023 | 2022 | |||||||||||||||||||||||||||||||||||||||||||
| Net sales | $ | 103,488 | 100.0 | % | $ | 98,736 | 100.0 | % | $ | 211,659 | 100.0 | % | $ | 202,917 | 100.0 | % | |||||||||||||||||||||||||||||||
| Cost of sales | 48,302 | 46.7 | 49,259 | 49.9 | 101,763 | 48.1 | 101,030 | 49.8 | |||||||||||||||||||||||||||||||||||||||
| Gross profit | 55,186 | 53.3 | 49,477 | 50.1 | 109,896 | 51.9 | 101,887 | 50.2 | |||||||||||||||||||||||||||||||||||||||
| Selling, general and administrative expenses | 29,579 | 28.6 | 23,845 | 24.1 | 55,318 | 26.1 | 47,052 | 23.1 | |||||||||||||||||||||||||||||||||||||||
| Income from operations | 25,607 | 24.7 | 25,632 | 26.0 | 54,578 | 25.8 | 54,835 | 27.0 | |||||||||||||||||||||||||||||||||||||||
| Interest expense | 2,684 | 2.6 | 1,636 | 1.7 | 4,846 | 2.3 | 3,242 | 1.6 | |||||||||||||||||||||||||||||||||||||||
| Other expense (income), net | 2,743 | 2.6 | (338) | (0.3) | 2,656 | 1.3 | (1,431) | (0.7) | |||||||||||||||||||||||||||||||||||||||
| Total other expenses, net | 5,427 | 5.2 | 1,298 | 1.3 | 7,502 | 3.5 | 1,811 | 0.9 | |||||||||||||||||||||||||||||||||||||||
| Income before income taxes | 20,180 | 19.5 | 24,334 | 24.6 | 47,076 | 22.2 | 53,024 | 26.1 | |||||||||||||||||||||||||||||||||||||||
| Income tax expense | 5,265 | 5.1 | 6,407 | 6.5 | 12,352 | 5.8 | 13,784 | 6.8 | |||||||||||||||||||||||||||||||||||||||
| Net income | 14,915 | 14.4 | 17,927 | 18.2 | 34,724 | 16.4 | 39,240 | 19.3 | |||||||||||||||||||||||||||||||||||||||
| Less: Net loss (income) attributable to non-controlling interest | 2 | — | 5 | — | 8 | — | (35) | — | |||||||||||||||||||||||||||||||||||||||
| Net income attributable to The Duckhorn Portfolio, Inc. | $ | 14,917 | 14.4 | % | $ | 17,932 | 18.2 | % | $ | 34,732 | 16.4 | % | $ | 39,205 | 19.3 | % | |||||||||||||||||||||||||||||||
Comparison of the three and six months ended January 31, 2023 and 2022
| Net sales | |||||||||||||||||||||||||||||||||||||||||||||||
| Three months ended January 31, | Change | Six months ended January 31, | Change | ||||||||||||||||||||||||||||||||||||||||||||
| (in thousands, except percentages) | 2023 | 2022 | $ | % | 2023 | 2022 | $ | % | |||||||||||||||||||||||||||||||||||||||
| Net sales | $ | 103,488 | $ | 98,736 | $ | 4,752 | 4.8 | % | $ | 211,659 | $ | 202,917 | $ | 8,742 | 4.3 | % | |||||||||||||||||||||||||||||||
Net sales for the three months ended January 31, 2023 increased $4.8 million, or 4.8%, to $103.5 million compared to $98.7 million for the three months ended January 31, 2022. The increase in net sales for the three months ended January 31, 2023 was driven by positive price / mix contribution in our DTC channel sales related to a DTC offering shift to the second quarter of Fiscal 2023 compared to the first quarter of Fiscal 2022, as well as planned pricing increases.
Net sales for the six months ended January 31, 2023 increased $8.7 million, or 4.3%, to $211.7 million compared to $202.9 million for the six months ended January 31, 2022. The increase in net sales for the six months ended January 31, 2023 is primarily driven by volume growth and a neutral price/mix contribution, driven by both volume and mix improvements in the wholesale channel and planned pricing increases.
32
| Cost of sales | |||||||||||||||||||||||||||||||||||||||||||||||
| Three months ended January 31, | Change | Six months ended January 31, | Change | ||||||||||||||||||||||||||||||||||||||||||||
| (in thousands, except percentages) | 2023 | 2022 | $ | % | 2023 | 2022 | $ | % | |||||||||||||||||||||||||||||||||||||||
| Cost of sales | $ | 48,302 | $ | 49,259 | $ | (957) | (1.9) | % | $ | 101,763 | $ | 101,030 | $ | 733 | 0.7 | % | |||||||||||||||||||||||||||||||
Cost of sales decreased by $1.0 million, or 1.9%, to $48.3 million for the three months ended January 31, 2023 compared to $49.3 million for the three months ended January 31, 2022. The decrease in cost of sales for the three months ended January 31, 2023 was primarily driven by favorable brand mix.
Cost of sales increased by $0.7 million, or 0.7%, to $101.8 million for the six months ended January 31, 2023 compared to $101.0 million for the six months ended January 31, 2022. The increase in cost of sales for the six months ended January 31, 2023 was primarily driven by higher sales, partially offset by favorable brand mix.
| Gross profit | |||||||||||||||||||||||||||||||||||||||||||||||
| Three months ended January 31, | Change | Six months ended January 31, | Change | ||||||||||||||||||||||||||||||||||||||||||||
| (in thousands, except percentages) | 2023 | 2022 | $ | % | 2023 | 2022 | $ | % | |||||||||||||||||||||||||||||||||||||||
| Gross profit | $ | 55,186 | $ | 49,477 | $ | 5,709 | 11.5 | % | $109,896 | $101,887 | $ | 8,009 | 7.9 | % | |||||||||||||||||||||||||||||||||
| Gross margin | 53.3 | % | 50.1 | % | 51.9 | % | 50.2 | % | |||||||||||||||||||||||||||||||||||||||
Gross profit increased $5.7 million, or 11.5%, to $55.2 million for the three months ended January 31, 2023 compared to $49.5 million for the three months ended January 31, 2022. Gross profit increased $8.0 million, or 7.9%, to $109.9 million for the six months ended January 31, 2023 compared to $101.9 million for the six months ended January 31, 2022. The increases in gross profit and gross margin for the three and six months ended January 31, 2023 were primarily the result of brand and channel mix shifts and pricing increases that were net favorable to gross profit margin.
| Operating expenses | |||||||||||||||||||||||||||||||||||||||||||||||
| Selling, general and administrative expenses | |||||||||||||||||||||||||||||||||||||||||||||||
| Three months ended January 31, | Change | Six months ended January 31, | Change | ||||||||||||||||||||||||||||||||||||||||||||
| (in thousands, except percentages) | 2023 | 2022 | $ | % | 2023 | 2022 | $ | % | |||||||||||||||||||||||||||||||||||||||
| Selling expenses | $ | 12,355 | $ | 10,971 | $ | 1,384 | 12.6 | % | $ | 25,882 | $ | 21,369 | $ | 4,513 | 21.1 | % | |||||||||||||||||||||||||||||||
| Marketing expenses | 2,601 | 2,887 | (286) | (9.9) | 4,891 | 5,059 | (168) | (3.3) | |||||||||||||||||||||||||||||||||||||||
| General and administrative expenses | 14,623 | 9,987 | 4,636 | 46.4 | 24,545 | 20,624 | 3,921 | 19.0 | |||||||||||||||||||||||||||||||||||||||
| Total selling, general and administrative expenses | $ | 29,579 | $ | 23,845 | $ | 5,734 | 24.0 | % | $ | 55,318 | $ | 47,052 | $ | 8,266 | 17.6 | % | |||||||||||||||||||||||||||||||
Selling, general and administrative expenses increased $5.7 million, or 24.0%, to $29.6 million for the three months ended January 31, 2023, compared to $23.8 million for the three months ended January 31, 2022. Selling, general and administrative expenses increased $8.3 million, or 17.6%, to $55.3 million for the six months ended January 31, 2023, compared to $47.1 million for the six months ended January 31, 2022. The increases in selling, general and administrative expenses for the three and six months ended January 31, 2023 were largely attributable to higher professional fees, most of which we incurred in the second quarter. See “—Limitations of non-GAAP financial measures and adjusted EBITDA reconciliation” for additional information on transaction expenses
33
reflected in operating expenses during the period. Selling, general and administrative expenses also reflect higher compensation costs, driven by strategic investments in our workforce to support future sales growth.
| Other expenses, net | |||||||||||||||||||||||||||||||||||||||||||||||
| Three months ended January 31, | Change | Six months ended January 31, | Change | ||||||||||||||||||||||||||||||||||||||||||||
| (in thousands, except percentages) | 2023 | 2022 | $ | % | 2023 | 2022 | $ | % | |||||||||||||||||||||||||||||||||||||||
| Interest expense | 2,684 | 1,636 | $ | 1,048 | 64.1 | % | $ | 4,846 | $ | 3,242 | $ | 1,604 | 49.5 | % | |||||||||||||||||||||||||||||||||
| Other expense (income), net | 2,743 | (338) | 3,081 | 911.5 | % | 2,656 | (1,431) | 4,087 | 285.6 | % | |||||||||||||||||||||||||||||||||||||
| Total other expenses, net | $ | 5,427 | $ | 1,298 | $ | 4,129 | 318.1 | % | $ | 7,502 | $ | 1,811 | $ | 5,691 | 314.2 | % | |||||||||||||||||||||||||||||||
Total other expenses, net increased by $4.1 million, to $5.4 million for the three months ended January 31, 2023, compared to $1.3 million for the three months ended January 31, 2022. Total other expenses, net increased by $5.7 million to $7.5 million for the six months ended January 31, 2023 compared to $1.8 million for the six months ended January 31, 2022. The increases in total other expenses, net, for the three and six months ended January 31, 2023 compared to the prior year periods were driven by higher interest expense as a result of unfavorable interest rate movements on our variable-rate debt, greater unfavorable fair value adjustments on our interest rate swap agreements and debt issuance costs incurred in connection with our New Credit Facility. See Note 7 (Debt) and Note 8 (Derivative instruments) to our Condensed Consolidated Financial Statements for additional information.
Limitations of non-GAAP financial measures and adjusted EBITDA reconciliation
Adjusted EBITDA has certain limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of the Company’s results as reported under GAAP. Some of these limitations include:
•although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements;
•adjusted EBITDA does not reflect changes in, or cash requirements for, the Company’s working capital needs;
•adjusted EBITDA does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on the Company’s debt;
•adjusted EBITDA does not reflect income tax payments that may represent a reduction in cash available to the Company; and
•other companies, including companies in the Company’s industry, may calculate adjusted EBITDA differently, which reduce their usefulness as comparative measures.
In evaluating adjusted EBITDA, we may incur expenses that are the same as or similar to some of the adjustments in this presentation. Our presentation of adjusted EBITDA should not be construed as an inference that the Company’s future results will be unaffected by the types of items excluded from the calculation of adjusted EBITDA.
For comparative periods presented, our primary operational drivers of adjusted EBITDA have been strong, sustained sales growth in our wholesale channel and stable, modestly higher DTC channel performance, 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.
34
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) | 2023 | 2022 | 2023 | 2022 | |||||||||||||||||||
| Net income attributable to The Duckhorn Portfolio, Inc. | $ | 14,917 | $ | 17,932 | $ | 34,732 | $ | 39,205 | |||||||||||||||
| Interest expense | 2,684 | 1,636 | 4,846 | 3,242 | |||||||||||||||||||
| Income tax expense | 5,265 | 6,407 | 12,352 | 13,784 | |||||||||||||||||||
Depreciation and amortization expense(a) | 7,533 | 6,280 | 13,290 | 11,109 | |||||||||||||||||||
| EBITDA | 30,399 | 32,255 | 65,220 | 67,340 | |||||||||||||||||||
Purchase accounting adjustments(a) | 65 | 99 | 107 | 292 | |||||||||||||||||||
Transaction expenses(b) | 3,596 | 1,024 | 3,653 | 2,770 | |||||||||||||||||||
Change in fair value of derivatives(c) | 2,429 | (515) | 2,061 | (957) | |||||||||||||||||||
Equity-based compensation(d) | 1,564 | 1,416 | 2,572 | 2,875 | |||||||||||||||||||
Debt refinancing costs(e) | 760 | — | 865 | — | |||||||||||||||||||
| Wildfire costs | — | 31 | — | 80 | |||||||||||||||||||
| Adjusted EBITDA | $ | 38,813 | $ | 34,310 | $ | 74,478 | $ | 72,400 | |||||||||||||||
(a) Purchase accounting adjustments relate to the impacts of business combination accounting for our acquisition by TSG, and certain other transactions consummated prior to Fiscal 2021, which resulted in fair value adjustments to inventory and long-lived assets. Purchase accounting adjustments in depreciation and amortization expense include amortization of intangible assets of $1.9 million for the three months ended January 31, 2023 and 2022, and $3.8 million for the six months ended January 31, 2023 and 2022.
(b) Transaction expenses include legal services, professional fees and other due diligence expenses for all periods presented. Transaction expenses for the three and six months ended January 31, 2022 also include the secondary offering completed in October 2021.
(c) See Note 8 (Derivative instruments) to our Condensed Consolidated Financial Statements for additional information.
(d) See Note 11 (Equity-based compensation) to our Condensed Consolidated Financial Statements for additional information.
(e) See Note 7 (Debt) to our Condensed Consolidated Financial Statements for additional information.
35
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 New Credit Facility. As of January 31, 2023, we had $7.3 million in cash and $425.0 million in undrawn capacity on our revolving line of credit, subject to the terms of our New Credit Facility.
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 to an ever-changing and highly competitive industry landscape may result in changes to our cash requirements.
Material Cash Requirements
Beyond the next 12 months, we expect cash flows generated from operations, in addition to our New Credit Facility, will be our primary sources of liquidity. Based on our current operating performance, we believe these sources will be adequate to meet the cash requirements necessary to meet our future business growth plans and contractual obligations. Our liquidity needs generally include expected working capital requirements, planned capital expenditures, operating lease payments, estimated tax liabilities and principal and interest payments contractually due pursuant to the terms of our New Credit Facility.
For the 2022 harvest, we contracted for grapes at a total cost of approximately $71.0 million in Fiscal 2023. Additionally, we have purchase obligations, including for inventory and various contracts with third parties for custom crush, storage and mobile bottling services. See Note 10 (Commitments and contingencies) to our Condensed Consolidated Financial Statements for further information on other commitments.
We have approximately $23.7 million in scheduled principal payments and related interest payments due over the next 12 months and approximately $263.2 million of principal payments and related interest payments due thereafter until our New Credit Facility matures on November 4, 2027. The calculated interest payment amounts use actual rates available as of January 2023 and assume these rates for all future interest payments on the outstanding New Credit Facility, exclusive of any future impact from our interest rate swap agreements. See “—Capital resources”, where our New Credit Facility is described in greater detail. Our future minimum operating lease payments due within the next 12 months total approximately $4.2 million with $20.4 million due in the following years. See our Condensed Consolidated Financial Statements for further information on our operating leases.
We expect to be able to satisfy our liquidity needs for the next 12 months and beyond using cash generated from operations. 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.
36
Cash flows
The following table presents the major components of net cash flows.
| Six months ended January 31, | |||||||||||
| (in thousands) | 2023 | 2022 | |||||||||
| Cash flows provided by (used in): | |||||||||||
| Operating activities | $ | 18,097 | $ | 18,828 | |||||||
| Investing activities | (12,388) | (23,336) | |||||||||
| Financing activities | (1,584) | 5,034 | |||||||||
| Net increase in cash | $ | 4,125 | $ | 526 | |||||||
Comparison of the six months ended January 31, 2023 and 2022
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, 2023, net cash provided by operating activities was $18.1 million compared to $18.8 million for the six months ended January 31, 2022, a decrease of $0.7 million. The decrease in cash provided by operating activities was primarily driven by the following factors:
•Increases in inventory for the six months ended January 31, 2023 due to timing impacts in bulk and bottled wine supply management to support increases in demand resulted in a decrease to operating cash flow of $11.3 million;
•Changes in accounts payable and accrued expenses increased operating cash flows $2.9 million due primarily to timing of invoice accruals and payments, predominately related to grape grower purchases during the annual harvest period;
•Deferred revenues increased operating cash flows by $6.0 million primarily due to an offering shift for wines sold through our DTC channel; and
•Other current and long-term liabilities increased operating cash flows by $2.4 million primarily related to an increase in accrued interest.
Investing activities
For the six months ended January 31, 2023, net cash used in investing activities related to capital expenditures of $12.4 million compared to $23.3 million for the six months ended January 31, 2022. For the six months ended January 31, 2022, we completed the purchase of three Napa County, California vineyards and related assets for a total of $14.5 million. 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.
37
Financing activities
For the six months ended January 31, 2023, net cash used in financing activities was $1.6 million as compared to cash provided by financing activities of $5.0 million for the six months ended January 31, 2022. For the six months ended January 31, 2023, net cash used in financing activities primarily resulted from our New Credit Facility, including the issuance of new long-term debt of $225.8 million and borrowings under our line of credit of $9.0 million, partially offset by the payments under our line of credit of $119.0 million, payments of long-term debt of $115.2 million and payments of debt issuance costs of $2.4 million. For the six months ended January 31, 2022, net cash used in financing activities primarily included payments under our line of credit of $52.0 million and payments of long-term debt of $5.7 million, partially offset by borrowings under our line of credit of $63.0 million.
Capital resources
Original Credit Facility
On October 14, 2016, Mallard Buyer Corp, Selway Wine Company and certain other subsidiaries of The Duckhorn Portfolio, Inc. (collectively, the “Borrowers”) entered into the Original Credit Facility with a syndicated group of lenders. The Original Credit Facility provided 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 Term SOFR based rate plus an applicable margin as defined in the Original Credit Agreement. Interest was paid monthly or quarterly based on loan type. Our debt was collateralized by substantially all of our cash, trade accounts receivable, real and personal property. Pursuant to the terms and conditions of the Original Credit Agreement, we issued the instruments discussed below.
Eighth Amendment to the First Lien Loan and Security Agreement
On August 30, 2022, the Borrowers entered into an eighth amendment to the First Lien Loan and Security Agreement to extend the maturity date of all facilities to November 1, 2023 and to transition from a LIBOR-based interest rate to a Term SOFR-based interest rate. The transaction did not result in any additional cash proceeds.
New Credit Agreement
Effective November 4, 2022, the Borrowers entered into the New Credit Agreement which amends and restates, in its entirety, the Original Credit Agreement. The New Credit Agreement provides for $675.8 million in first lien senior secured credit facilities consisting of (i) a $425.0 million revolving credit facility, (ii) a $225.8 million term loan facility and (iii) a $25.0 million delayed draw term loan facility. The maturity date for loans borrowed under the New Credit Agreement is November 4, 2027. See Note 7 (Debt) to our Condensed Consolidated Financial Statements for additional information.
We incurred approximately $3.3 million in debt issuance costs, including bank financing fees and third party legal and other professional fees in closing the New Credit Agreement, of which approximately $2.4 million was capitalized in accordance with ASC Topic 470, Debt. The capitalized debt issuance costs will be amortized as interest expense over the term of the New Credit Agreement. Remaining debt issuance costs incurred of $0.9 million were expensed and recorded to other (income) expense in the Condensed Consolidated Statement of Operations.
The instruments described below include the impacts of the New Credit Facility.
Revolving Line of Credit — The revolving line of credit allows the Borrowers to draw amounts up to $425.0 million, excluding the incremental seasonal borrowing amount of an additional $30.0 million of capacity. The revolving line of credit matures on November 4, 2027. The interest rate ranged from Term SOFR plus 100 basis points to Term SOFR plus 150 basis points depending on the average availability of the revolving line of credit. The amount available to borrow on the revolving line of credit is subject to a monthly borrowing base calculation, based primarily on the Company’s inventory and accounts receivable balances.
38
Term Loans — The term loan facility in the New Credit Agreement replaces the $135.0 million term loan tranche one facility, $25.0 million term loan tranche two facility and $25.0 million capital expenditure facility under the Original Credit Agreement. The term loan facility provides an aggregate principle amount equal to $225.8 million, with quarterly principal payments and the remaining unpaid principal and interest due upon maturity on November 4, 2027. The term loan has an interest rate of Term SOFR plus a 10 to 15 basis points credit spread adjustment and a 1.625% loan margin.
Delayed Draw Term Loan — The delayed draw term 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 November 4, 2027. The $25.0 million is fully available and undrawn, and has an interest rate of Term SOFR plus a 10 to 15 basis points credit spread adjustment and a 1.625% loan margin.
As of January 31, 2023, there were no outstanding draws on the revolving line of credit, nor on the delayed draw term loan. The outstanding principal balance was $225.8 million for the term loan as of January 31, 2023.
The New Credit 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, 2023, we are in compliance with all covenants. See Note 7 (Debt) to our Condensed Consolidated Financial Statements for additional information.
First Amendment to the Amended and Restated First Lien Loan and Security Agreement
Effective February 6, 2023, the Company entered into the First Amendment to the Amended and Restated First Lien Loan and Security Agreement. The changes in the amendment are administrative in nature and do not have a material impact on the Company's outstanding debt or related debt covenants. The amendment did not result in any additional cash proceeds or changes in commitment amounts.
Off-balance sheet arrangements
As of January 31, 2023, 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, 2023, 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 2022.
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.
39
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 a Term SOFR based rate plus applicable margins or predetermined alternative rates, as applicable, pursuant to the terms of our New Credit Facility. As of January 31, 2023, our outstanding borrowings at variable interest rates totaled $225.8 million. An increase of 100 basis points in the effective interest rate applied to these borrowings would result in a $2.2 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 interest rate swaps in March 2020 (subsequently amended in September 2022) and January 2023. See Note 8 (Derivative instruments) to our Condensed Consolidated Financial Statements for further information on our interest rate swap agreements.
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 monitor 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 maximum term for the Company's outstanding foreign exchange forward contracts was twelve months as of January 31, 2023. See Note 8 (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, 2023.
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 yields of various 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 lines to optimize the grapes available each harvest year.
40
Other raw materials we source include glass, corks and wine additives. We currently source these materials from multiple vendors. We 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 provide reasonable assurance 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 Quarterly Report on Form 10-Q, our management, under the supervision of and with the participation of our Chief Executive Officer and Chief 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, 2023, 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, 2023.
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.
41
PART II
Item 1. Legal proceedings
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 with other matters, 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 2022. There have been no material changes since our previous 10-K filing.
42
Item 6. Exhibits
| Exhibit no. | Exhibit description | Incorporated by reference | ||||||||||||||||||||||||||||||
| Form | Date | Number | File no. | |||||||||||||||||||||||||||||
| 3.1 | 8-K | March 22, 2021 | 3.1 | 001-40240 | ||||||||||||||||||||||||||||
| 3.2 | 8-K | March 22, 2021 | 3.2 | 001-40240 | ||||||||||||||||||||||||||||
| 4.1 | S-1/A | March 10, 2021 | 4.1 | 333-253412 | ||||||||||||||||||||||||||||
| 4.2 | 10-K | October 4, 2021 | 4.2 | 001-40240 | ||||||||||||||||||||||||||||
| 10.1 | 8-K | November 4, 2022 | 10.1 | 001-40240 | ||||||||||||||||||||||||||||
| 10.2* | ||||||||||||||||||||||||||||||||
| 31.1* | ||||||||||||||||||||||||||||||||
| 31.2* | ||||||||||||||||||||||||||||||||
| 32.1* | ||||||||||||||||||||||||||||||||
| 101.INS* | 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). | |||||||||||||||||||||||||||||||
| 101.SCH* | XBRL Taxonomy Extension Schema Document. | |||||||||||||||||||||||||||||||
| 101.CAL* | XBRL Taxonomy Extension Calculation Linkbase Document. | |||||||||||||||||||||||||||||||
| 101.DEF* | XBRL Taxonomy Extension Definition Linkbase Document. | |||||||||||||||||||||||||||||||
| 101.LAB* | XBRL Taxonomy Extension Label Linkbase Document. | |||||||||||||||||||||||||||||||
| 101.PRE* | XBRL Taxonomy Extension Presentation Linkbase Document. | |||||||||||||||||||||||||||||||
| 104* | Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101) | |||||||||||||||||||||||||||||||
* Filed herewith
43
SIGNATURES
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 8, 2023 | By: | /s/ Alex Ryan | ||||||
| Alex Ryan | ||||||||
| President, Chief Executive Officer and Chairman | ||||||||
| (Principal Executive Officer) | ||||||||
Date: March 8, 2023 | By: | /s/ Lori Beaudoin | ||||||
| Lori Beaudoin | ||||||||
| Executive Vice President, Chief Financial Officer | ||||||||
| (Principal Financial Officer and Principal Accounting Officer) | ||||||||
44