THE DUCKHORN PORTFOLIO, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and the related notes to those statements included elsewhere in this Annual Report on Form 10-K. Refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations located in our Annual Report on Form 10-K for the fiscal year endedJuly 31, 2021 , filed onOctober 4, 2021 , for discussion of the fiscal year endedJuly 31, 2020 , the earliest of the three fiscal years presented, and incorporated by reference herein. 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 Annual Report on Form 10-K. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those set forth in Part I "Item 1A. Risk factors" included in this Annual Report on Form 10-K.
Overview
The Duckhorn Portfolio is the premier scaled producer of luxury wines inNorth America . We sell our wines in all 50 states and in over 50 countries at prices ranging from$20 to$200 per bottle under a world-class luxury portfolio of winery brands, includingDuckhorn Vineyards , Decoy, Goldeneye, Paraduxx, Migration, Canvasback, Calera,Kosta Browne , Greenwing and Postmark. We sell our wines to distributors outsideCalifornia and directly to trade accounts inCalifornia , which together comprise our wholesale channel. We also sell directly to consumers through our DTC channel. Our powerful omni-channel sales model drives strong margins by leveraging long-standing relationships. We believe our iconic winery brands together with our scaled, quality-focused production, omni-channel distribution and dedicated employees, set the standard for North American luxury wine.
Key financial metrics
We use net sales, gross profit and adjusted EBITDA to evaluate the performance of our business, identify trends in our business, prepare financial forecasts and make capital allocation decisions. We believe the following metrics are useful in evaluating our performance, but adjusted EBITDA should not be considered in isolation or as a substitute for any other financial information depicting our results prepared in accordance withU.S. GAAP. Certain judgments and estimates are inherent in our processes to calculate these key financial metrics. Fiscal years ended July 31, (in thousands) 2022 2021 Net sales$ 372,510 $ 336,613 Gross profit 185,180 167,348 Net income attributable to The Duckhorn Portfolio, Inc. 60,190 55,976 Adjusted EBITDA (a)$ 127,556 $ 117,208
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(a) See "Limitations of Non-GAAP Financial Measures and Adjusted EBITDA Reconciliation" for additional information on this non-GAAP metric.
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
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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, impairment losses, inventory write-downs, changes in the fair value of derivatives, equity-based compensation, casualty losses or gains, losses on debt extinguishment, IPO preparation costs, wildfire costs and COVID-19 costs. 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 comparisons 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 withU.S. GAAP. Certain judgments and estimates are inherent in our processes to calculate these metrics.
Net sales percentage by channel
We calculate net sales percentage by channel as net sales made through our wholesale channel to distributors, through our wholesale channel directly to trade accounts inCalifornia and through our DTC channel, respectively, as a percentage of our total net sales. We now refer to our sales directly to retail accounts inCalifornia , a point of distinction among largeCalifornia wine producers, as the "Direct toTrade Channel ". 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. Fiscal years ended July 31, 2022 2021 Wholesale - Distributors 66.3 % 65.3 % Wholesale - California direct to trade 17.9 % 16.9 % DTC 15.8 % 17.8 % We saw modest variations in net sales percentage by channel between Fiscal 2022 and Fiscal 2021, performing generally in line with our expectation of a reversion toward pre-pandemic historical trends. Reflected in our full year Fiscal 2022 net sales percentages by channel are continued signs of recovery from COVID-19 disruption across major markets. In our wholesale business, we strengthened our market position and delivered growth despite comparing against significant prior year expansion catalyzed by COVID-19 volatility which was more favorable to off-premise in the prior year. For Fiscal 2022, the sustained recovery of on-premise activity due to greater customer mobility and resurgence of travel and dining across the country delivered outsized growth in the wholesale channel, even surpassing pre-pandemic levels. Off-premise also remained a strong growth driver in our net sales performance.
We believe sales channel mix in the future will be more consistent with performance prior to the COVID-19 pandemic than those periods most prominently impacted by COVID-19 disruption, depending on changing
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consumer purchasing patterns and future market conditions. For further discussion of intra-period seasonality, see "-Components of our results of operation and key factors affecting our performance-Seasonality".
Net sales percentage by brand
We calculate net sales percentage by brand as net sales for ourDuckhorn Vineyards and Decoy winery brands and net sales for our other winery brands, respectively, as a percentage of our total net sales. We consider net sales percentage by brand as an important measure of the sales mix contributed by our winery brands,Duckhorn Vineyards and Decoy, and our eight other complementary winery brands. We monitor net sales percentage by brand on an annual basis to normalize the impact of seasonal fluctuations in demand and sale cycles across our brands from quarter to quarter that we do not believe are reflective of the overall performance of our brands or our business. See "-Components of results of operation and key factors affecting our performance-Seasonality." Fiscal years ended July 31, 2022 2021 Duckhorn Vineyards & Decoy 78.5 % 76.3 % Other winery brands 21.5 % 23.7 % Net sales percentage by brand attributable toDuckhorn Vineyards and Decoy increased in Fiscal 2022 from Fiscal 2021, primarily as a result of continued growth in consumer demand for those brands. We expectDuckhorn Vineyards and Decoy to continue to drive the substantial majority of our net sales in future periods.
Net sales growth contribution
We define net sales growth as the percentage increase for net sales in the period compared to the prior period. Contribution to net sales growth is calculated based on the portion of change in net sales for a period that is driven by two factors: changes in sales volume and changes in sales price and mix.
Volume contribution presents the percentage increase in cases sold in the
current period compared to the prior period. Price / mix contribution presents
net sales growth less volume contribution and indicates whether, separate from
changes in sales volume, changes in net sales are primarily attributable to
changes in sales price and mix.
Fiscal years ended July 31,
2022 2021
Net sales growth 10.7 % 24.4 %
Volume contribution 9.4 % 32.4 %
Price / mix contribution 1.3 % (8.0) %
For Fiscal 2022, growth in net sales versus Fiscal 2021 was mainly attributable
to strong sales volume growth and a modestly positive price / mix contribution.
Collectively, these dynamics illustrate the continued shift toward pre-COVID-19
performance trends, led by strength in on-premise within wholesale and augmented
by DTC growth. Generally, both on-premise and DTC growth correlate to increased
sales of our ultra-luxury brands that sell at higher average sales prices and
positively impact price / mix contribution. Our Fiscal 2022 results are in
contrast with the prior year comparative period, which was a volume-based growth
story primarily driven by substantial off-premise sales expansion for our luxury
winery brands, and resulting in a negative price / mix contribution.
We expect price / mix contribution will continue to trend more in line with
historical levels than with pandemic-disrupted levels, provided consumer
discretionary spending patterns also trend similarly with pre-pandemic levels.
We expect that volume contribution will continue to be a primary driver of
changes in our net sales in future periods. To the extent our growth is fueled
by sales of lower-priced luxury winery brands, we may see lower or negative
price / mix contribution in the future.
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Components of results of operation and key factors affecting our performance
Net sales
Our net sales consist primarily of wine sales to distributors and directly to retail accounts inCalifornia , which together comprise our wholesale channel, and directly to individual consumers through our DTC channel. Net sales generally represent wine sales and shipping, when applicable. Sales are generally recorded at the point of shipment and are recorded net of consideration provided to customers through various incentive programs, other promotional discounts and excise taxes. We refer to the volume of wine we sell in terms of cases, each of which represents a standard 12 bottle case of wine (in which each bottle has a volume of 750 milliliters). Cases sold represent wine sales through our wholesale and DTC channels. Depletions, in turn, represent sell-through from our distributors, including ourCalifornia wholesale channel, to trade accounts nationally. The following factors and trends in our business have driven net sales growth over the past fiscal years and are expected to be key drivers of our net sales growth for the foreseeable future: •Further leverage brand strength. We believe our comprehensive growth plan will continue to increase brand awareness and grow sales of our winery brands to our existing consumer base and a new generation of consumers. This plan is made possible by our omni-channel platform, which enables us to grow, both through increased volume with existing and new customers and accounts as well as through periodic price increases, particularly on our higher end, smaller lot DTC wines. •Insightful and targeted portfolio evolution. Our curated portfolio and historical growth result from long-term dedication to continuous evolution and alignment with the luxury wine consumer. We believe we can drive additional sales through our wholesale and DTC channels. As we continue to scale, we believe our growth mindset, coupled with our differentiated production and distribution platform, will enable us to adapt and remain at the forefront of our industry. •Distribution expansion and acceleration. Purchasing by distributors and loyal accounts that continue to feature our wines are key drivers of net sales. We plan to continue broadening distribution of the wines in our portfolio as well as to increase the volume of wine sold to existing accounts. We believe our long-standing existing commercial relationships coupled with exceptional portfolio strength position us to capture distribution growth opportunities and accelerate sales to existing distributors and retail accounts inCalifornia . •Continued investment in DTC channel. We expect to continue to invest in our DTC channel, leveraging wine clubs and brand-specific tasting rooms to engage with our consumers, create brand evangelists and drive adoption across our portfolio. •Opportunistic evaluation of strategic acquisitions. While our growth and success are not contingent upon future acquisitions, we believe our team has the capabilities and track record both to execute and to integrate meaningful acquisitions when opportunities arise to create stockholder value. In Fiscal 2022, the Company completed the purchase of fourCalifornia vineyards of approximately 340 acres and related assets for a total of$32.7 million .
The primary market for our wines is
Sales channels Our sales and distribution platform is based on long-standing relationships with a highly-developed network of distributor accounts in allU.S. states (exceptCalifornia , where we sell directly to trade accounts) and in over 50 58
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countries globally. We also have developed strong relationships with consumerswho buy our wines directly from us in the DTC channel. Channel mix can affect our performance and results of operations, particularly gross profit and gross profit margin. •Wholesale channel. Consistent with sales practices in the wine industry, sales to trade accounts inCalifornia and to distributors in other states occur below suggested retail price. We work closely with our distributors to increase the volume of our wines and number of products that are sold in their respective territories. InCalifornia , 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 comprises a greater proportion of our net sales than our DTC channel.
•DTC channel. Wines sold through our DTC channels are generally sold at suggested retail price. Our DTC channel continues to grow as a result of a number of factors, including a continued shift to more consumption in the home.
Wholesale channel sales made on credit terms generally require payment within 90 days of delivery, and a substantial majority are collected within 60 days. In periods where the net sales channel mix reflects a greater concentration of wholesale sales (which typically occurs in our first and second fiscal quarters), we typically experience an increase in accounts receivable for the period to reflect the change in sales mix, with payment collections in the subsequent period generally reducing accounts receivable and having a positive impact on cash flows in such subsequent period. While we seek to increase sales in both channels, we expect that our future sales will continue to be substantially comprised of sales in the wholesale channel. We intend to maintain and strengthen our long-standing relationships within our network of distributors, which we believe will be critical to our continued growth and success. In the wholesale channel, we are positioned as a one-stop luxury and ultra-luxury wine shop, offering a diverse mix of high-quality winery brands and varietals at varying luxury and ultra-luxury price points. We believe this strategy will enable us to continue increasing our share of the wholesale luxury and ultra-luxury wine market in the future, as customers will have greater opportunity to engage with and experience wines across our broad portfolio. We continue to innovate with new products at all price points within the portfolio. We strive to enhance customer engagement and increase sales as new customers encounter our wines and existing customers trade up to higher-priced wines. As COVID-19 restrictions eased throughout Fiscal 2022, our sales mix within our wholesale channel reflects improvement of our on-premise sales while we continue to benefit from off-premise sales. Our responses to periods of historical disruption in the wholesale channel have focused on strengthening relationships with our trade accounts and distributors, introducing new products and maintaining and strengthening our winery brand engagement. We believe this approach has enabled us to strengthen our portfolio and increase our market share relative to competitors during periods of market disruption. We routinely offer sales discounts and promotions through various programs to distributors around the country and to trade accounts inCalifornia . These programs, where permissible, include volume-based discounts on sales orders, depletion-based incentives we pay to 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. In the DTC channel, our holistic approach to consumer engagement both online and offline is supported by an integrated e-commerce platform and portfolio wine shop, seven distinctive tasting room experiences located throughoutNorthern California andWashington , and several award-winning wine clubs, all of which enable us to cross-sell wines within our portfolio. These strategies are designed to maximize each winery brand and property while driving awareness for the Company's other world-class wines and properties, resulting in more and deeper 59
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customer connections. We strive to evolve our offerings, experiences and communication to match the generational shifts in wine engagement preferences and related purchasing decisions.
Increasing customer engagement is a key driver of our business and results of operations. We continue to invest in our DTC channel and in performance marketing to drive customer engagement. In addition to developing new offerings and cross-selling wines in our portfolio of winery brands, we focus on increasing customer conversion and customer retention. As we continue to invest in enhancing our DTC channel, we expect to continue to increase customer engagement, which we believe will result in greater customer satisfaction and retention.
Seasonality
Our net sales are typically highest in the first half of our fiscal year, 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. In Fiscal 2021, our net sales in the first, second, third and fourth fiscal quarters represented approximately 27%, 25%, 27% and 21%, respectively, of our total net sales for the year. We expect our net sales seasonality will generally continue to follow historical patterns, though with a somewhat more even quarterly split in the future, to the extent our sales channel mix continues to normalize from pandemic-impacted levels.
Gross profit
Gross profit is equal to our net sales minus our cost of sales. Cost of sales
includes grape and bulk wine purchase costs. For grapes we grow, cost of sales
includes amounts incurred to develop and farm the vineyards we own and lease.
Cost of sales also includes all winemaking and processing charges, bottling,
packaging, warehousing and shipping and handling. Costs associated with storing
and maintaining wines that age longer than one year prior to sale continue to be
capitalized until the wine is bottled and available for sale.
As we continue to grow our business in the future, we expect gross profit to
increase as our sales grow and as we effectively manage our cost of sales,
subject to any future unexpected volatility in the grape and bulk wine market,
increased seasonal labor costs and, to a lesser extent, inflationary impacts on
commodity costs, including dry goods and packaging materials. Additionally, we
expect gross profit as a percentage of net sales to remain generally consistent
with historical levels.
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.
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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 Credit Facility and unrealized gains or losses on our derivative instruments.
Income tax expense
Income tax expense consists of federal and state taxes payable to various federal, state and local tax authorities.
Inventory lifecycle
Grape growing on our estate vineyards
Although generally over 85% of our wine is typically derived from grapes grown by third party growers and, to a significantly lesser extent, bulk wine we purchase, the remainder is sourced from our Estate vineyards that we own or lease. Once a vineyard reaches consistent yield levels, approximately three to five years after planting, it will generally produce a relatively consistent amount of fruit for approximately 15 to 25 years, at which time blocks of the vineyard will gradually be replanted in stages after a period of lying fallow. The length of time between initial investment and ultimate sale of our Estate wines, coupled with the ongoing investment required to produce quality wine, is not typical of most agricultural industries. Over the long-term, as our business grows, Estate vineyards could represent a smaller relative share of our overall sourcing model. Harvest-to-release Of the total case volume we produce and sell, the majority is comprised of red wines from grape varietals such as Cabernet Sauvignon, Pinot Noir and Merlot, which can have production lifecycles spanning months and years from harvest until the time the wine is released, depending on the aging requirements prescribed by the winemakers responsible for each of our winery brands. Our red wines generally have a harvest-to-release inventory lifecycle that can range from 15 to 48 months. Our white, rosé and sparkling wines generally have a harvest-to-release inventory lifecycle that can range from five to 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.
Other factors impacting the comparability of our results of operations
Impacts of COVID-19
InMarch 2020 , theWorld Health Organization declared a global pandemic due to the spread of COVID-19, the disease caused by a strain of virus. As governmental authorities implemented various measures limiting the activities of businesses and individuals to reduce the spread of COVID-19, wine producers inthe United States were generally classified as essential businesses, which enabled us to continue producing and selling our wine. 61
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For the safety of our employees and the individuals with whom we work, we adapted our policies and protocols to meet applicable federal, state and local requirements, and we continue to monitor and revise our policies as appropriate.
The comparability of our results of operations has been significantly impacted by the effects of the COVID-19 pandemic on our business, industry, customer behavior, key markets where we operate and as a result of macroeconomic factors. Accordingly, certain period-over-period comparisons have been and may continue to be influenced by disruption due to the COVID-19 pandemic. During Fiscal 2022, we observed continued signs of reopening across the domestic consumer product markets and reversion toward consumer purchasing habits which we believe to be more in line with trends observable before the COVID-19 pandemic. On-premise sales have continued to increase from their pandemic lows, resulting in higher sales of our ultra-luxury winery brands throughout Fiscal 2022. Off-premise activity remained a key strength in our results as we strengthened share gains across our broader wholesale channel. We expect sales channel mix within wholesale to continue to move toward historical levels and to reflect consumer purchasing patterns more consistent with performance prior to the COVID-19 pandemic. At the same time, the significant off-premise sales growth that we experienced during the pandemic may be tempered compared to the outsized growth rates in pandemic-impacted comparative periods. Although we have observed strong customer demand during periods impacted by pervasive stay-at-home restrictions, and cannot predict the future impact on consumer spending as these restrictions continue to vary by market, we believe that the diverse offerings ofThe Duckhorn Portfolio , which include a broad spectrum of price points, mitigates some of the risk to our future operations in periods in which the on- and off-premise relative mix fluctuates. During the pandemic, our tasting rooms experienced lower tasting fee revenue due to reduced capacities or mandatory closure in order to comply with applicable regulations despite sustained operating levels of expenses, primarily comprised of tasting room operating expenses during periods of capacity restrictions or mandatory closure. The Company incurred incremental costs during periods of capacity restrictions or mandatory closure totaling$0.7 million for the fiscal year endedJuly 31, 2021 which included tasting room expenses and other immaterial costs. No similar incremental costs were incurred for the fiscal year endedJuly 31, 2022 . Conversely, e-commerce sales increased substantially in response to lockdowns as customers sought to purchase our wines in a manner that reduced human contact. We believe that our tasting rooms will continue to see strong visitation and sales results as the pandemic wanes and tourism increases. At the same time, we believe that many customerswho used e-commerce platforms to purchase our wines will continue to enjoy the convenience of those platforms to purchase wines fromThe Duckhorn Portfolio, Inc. The COVID-19 pandemic is an ongoing global pandemic which continues to evolve. At this time, the Company is unable to fully estimate the long-term impacts to the business, financial condition, operational results or future cash flows, as the pandemic is ongoing in all markets in which the Company operates.
Impacts of purchase accounting due to prior acquisitions
We were acquired by TSG in Fiscal 2017, and subsequently completed acquisitions of Calera andKosta Browne in Fiscal 2018 and Fiscal 2019, respectively. In applying business combination accounting pursuant toU.S. GAAP authoritative literature in connection with each of these transactions, we recorded acquired assets and liabilities at their fair values. The impacts of these purchase accounting adjustments primarily resulted in reductions to deferred revenue, increases to inventory, increases to long-lived assets and recognition of indefinite-lived intangible assets and definite-lived intangible assets which amortize over their assigned useful lives ranging from 9 to 14 years. See Note 7 (Goodwill and other intangible assets) to our Consolidated Financial Statements for additional information. The effects of purchase accounting adjustments on our operational performance caused our pre-tax income from operations to be lower in certain periods than we would otherwise have recognized due to increased cost of sales 62
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from step-up to fair value of inventory and increased operating expenses due to step-up depreciation on property and equipment and amortization of definite-lived intangible assets.
Purchase accounting adjustments are as follows:
Fiscal years ended July 31,
(in thousands) 2022 2021
Purchase accounting adjustments to cost of sales $ 467 $ 1,690
Impact of purchase accounting on gross profit (467) (1,690)
Amortization of customer relationships and other intangible assets 7,560
7,683
Impact of purchase accounting on selling, general and administrative expenses
7,560 7,683
Impacts of purchase accounting on income before income taxes
Casualty gain In Fiscal 2020, the Company entered into an agreement with its insurer to resolve an open Fiscal 2019 flood insurance claim. The Company received$8.1 million and$4.3 million in the fiscal years endedJuly 31, 2021 and 2020, respectively, fully resolving the flood insurance claim. The Company incurred incremental charges in the fiscal years endedJuly 31, 2021 and 2020, offset by insurance proceeds received, which were reported on the casualty loss (gain), net line item in the Consolidated Statements of Operations.
Equity-based compensation
We recognize equity-based compensation expense related to stock and stock-based awards granted under the 2021 Plan as approved by the Board of Directors. See Note 15 (Equity-based compensation) to our Consolidated Financial Statements for further information. Previously, under our 2016 Equity Incentive Plan, certain employees were issued profit interest units (Class M Common Units). The vesting of certain of the outstanding Class M Common Units accelerated upon the occurrence of our IPO. Equity-based compensation expense related to the legacy 2016 Equity Incentive Plan awards was$0.5 million and$9.4 million for the years endedJuly 31, 2022 and 2021, respectively,$8.5 million of which for Fiscal 2021 was incremental due to the vesting of certain outstanding Class M Common Units that were converted to common shares ofThe Duckhorn Portfolio, Inc. in Fiscal 2021. There was no such acceleration of equity-based compensation expense in the fiscal year endedJuly 31, 2022 . Any related equity-based compensation expense was included in cost of sales or selling, general and administrative expenses for the period or capitalized into inventory, as applicable. 63
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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 and related footnotes included elsewhere in
this Annual Report on Form 10-K:
Fiscal years ended July 31,
(in thousands, except percentages) 2022 2021
Net sales $ 372,510 100.0 % $ 336,613 100.0 %
Cost of sales 187,330 50.3 169,265 50.3
Gross profit 185,180 49.7 167,348 49.7
Selling, general and administrative expenses 97,743 26.3 89,816 26.7
Casualty loss (gain), net 123 - (6,559) (1.9)
Income from operations 87,314 23.4 84,091 25.0
Interest expense 6,777 1.8 13,618 4.0
Other income, net (2,214) (0.6) (6,505) (1.9)
Total other expenses 4,563 1.2 7,113 2.1
Income before income taxes 82,751 22.2 76,978 22.9
Income tax expense 22,524 6.0 21,008 6.2
Net income 60,227 16.2 55,970 16.6
Less: Net (income) loss attributable to
non-controlling interest (37) - 6 -
Net income attributable to
$ 60,190 16.2 %$ 55,976 16.6 %
Comparison of the fiscal years ended
Net sales
Fiscal years ended July 31, Change
(in thousands) 2022 2021 $ %
Net sales $ 372,510 $ 336,613 $ 35,897 10.7 %
Net sales for the fiscal year ended July 31, 2022 increased $35.9 million , or
10.7%, compared to the fiscal year ended July 31, 2021 . The increase was
primarily driven by strong sales volume growth and a modestly positive price /
mix contribution led by strength in on-premise within wholesale. There were no
material pricing changes for the periods presented. For further discussion of
changes in sales volume and changes in sales price and mix, see "-Key Operating
Metrics-Net sales growth contribution".
Cost of sales
Fiscal years ended July 31, Change
(in thousands) 2022 2021 $ %
Cost of sales $ 187,330 $ 169,265 $ 18,065 10.7 %
Cost of sales increased by $18.1 million , or 10.7%, for the fiscal year ended
July 31, 2022 compared to the fiscal year ended July 31, 2021 . The increase is
primarily driven by higher sales as well as inventory reserves for seltzer
products of $4.3 million for the fiscal year ended July 31, 2022 . See Note 4
(Inventories) to our Consolidated Financial Statements for further information.
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Gross profit
Fiscal years ended July 31, Change
(in thousands) 2022 2021 $ %
Gross profit $ 185,180 $ 167,348 $ 17,832 10.7 %
Gross profit increased $17.8 million , or 10.7%, for the fiscal year ended July
31, 2022 compared to the fiscal year ended July 31, 2021 . Gross profit margin
was 49.7% for the fiscal year ended July 31, 2022 compared to 49.7% for the
fiscal year ended July 31, 2021 . While gross profit margins were consistent over
the comparative periods, the increase in gross profit for the fiscal year ended
July 31, 2022 was primarily the result of higher sales volume, brand and channel
mix shifts that were net favorable to gross profit margin, lower impact to gross
profit due to the impacts of purchase accounting from prior acquisitions,
partially offset by an increase in our inventory reserves. See Note 4
(Inventories) to our Consolidated Financial Statements for additional
information.
Operating expenses
Selling, general and administrative expenses
Fiscal years ended July 31, Change
(in thousands) 2022 2021 $ %
Selling expenses $ 44,379 $ 36,780 $ 7,599 20.7 %
Marketing expenses 10,111 9,117 994 10.9
General and administrative expenses 43,253 43,919 (666) (1.5)
Total selling, general and administrative
expenses $ 97,743 $ 89,816 $ 7,927 8.8 %
Selling, general and administrative expenses increased $7.9 million , or 8.8%,
for the fiscal year ended July 31, 2022 compared to fiscal year ended July 31,
2021 . The increase was largely attributable to higher compensation costs due to
investments in our workforce to support our long-term growth strategy, higher
transaction expenses, higher professional services fees to maintain compliance
with regulatory and reporting requirements specific to being a public company
and higher selling expenses incurred to generate sales activity as business
travel increased, partially offset by lower equity-based compensation versus the
prior year.
Selling expenses increased in Fiscal 2022 versus Fiscal 2021 predominately due
to compensation costs, including equity-based compensation, as well as greater
business travel costs in supporting sales activity versus the prior year which
was influenced by greater travel restrictions. Marketing expenses increased by
$1.0 million for the fiscal year ended July 31, 2022 versus the comparative
period due to increased marketing and promotional events. General and
administrative expenses remained largely flat for the fiscal year ended July 31,
2022 , primarily impacted by lower equity-based compensation costs of
$6.8 million , increased work force related expenses and transaction expenses we
incurred for transactions costs, including secondary offering costs, of
approximately $5.7 million during Fiscal 2022. See Note 15 (Equity-based
compensation) to our Consolidated Financial Statements for further information.
Casualty loss (gain), net
Fiscal years ended July 31, Change
(in thousands) 2022 2021 $ %
Casualty loss (gain), net $ 123 $ (6,559) $ 6,682 (101.9) %
Fiscal 2021 reflects the receipt of insurance proceeds of $8.6 million in excess
of recognized losses. The primary driver of the insurance proceeds related to
flood damages, which originally occurred in Fiscal 2019, the proceeds from which
we received over both Fiscal 2021 and 2020. Additionally, we received insurance
proceeds related to the losses incurred from the impacts of wildfires, which
resulted in fruit damage in Fiscal 2021. See Note 17 (Casualty loss (gain)) to
our Consolidated Financial Statements for further information.
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Other expenses, net
Fiscal years ended July 31, Change
(in thousands) 2022 2021 $ %
Interest expense $ 6,777 $ 13,618 $ (6,841) (50.2) %
Other (income) expense, net (2,214) (6,505) 4,291 (66.0)
Total other expenses, net $ 4,563 $ 7,113 $ (2,550) (35.8) %
Other expenses, net, decreased by $2.6 million , or 35.8%, for the fiscal year
ended July 31, 2022 compared to fiscal year ended July 31, 2021 . The decrease in
interest expense for the fiscal year ended July 31, 2022 was primarily due to
lower debt balances outstanding for the period, which more than offset the
impacts of upward interest rate pressure on our floating-rate debt over the
course of the year. Also favorable to interest expense was the impact of the
Company's interest rate swap contract, which was reclassified to an asset
position on our Consolidated Statements of Financial Position during Fiscal
2022. The change in other (income) expense, net was primarily driven by the
change in the interest rate swap value versus the prior year. See "-Liquidity
and capital resources" for discussion of our Credit Facility.
Income tax expense
Fiscal years ended July 31, Change
(in thousands) 2022 2021 $ %
Income tax expense $ 22,524 $ 21,008 $ 1,516 7.2 %
Income tax expense increased $1.5 million , or 7.2%, for the fiscal year ended
July 31, 2022 compared to fiscal year ended July 31, 2021 . The increase in
income tax expense for the fiscal year ended July 31, 2022 is primarily due to
an increase in income before taxes and an expanded state income tax base.
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 sustained sales growth in our wholesale channel and steady performance in our DTC channel, management of our cost of
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sales through our diversified supply planning strategy and discipline over selling, general and administrative expenses relative to our sales growth.
The following table represents the reconciliation of adjusted EBITDA to net
income attributable to The
Fiscal years ended July 31,
(in thousands) 2022 2021
Net income attributable to The Duckhorn Portfolio, Inc. $ 60,190 $ 55,976
Interest expense 6,777 13,618
Income tax expense 22,524 21,008
Depreciation and amortization expense 23,427 21,343
EBITDA 112,918 111,945
Purchase accounting adjustments(a) 467 1,690
Transaction expenses(b) 5,694 3,984
Inventory write-down(c) 4,715 -
Change in fair value of derivatives(d) (1,695) (5,848)
Equity-based compensation(e) 5,334 10,602
Casualty gain, net(f) - (7,832)
Loss on debt extinguishment(g) - 272
IPO preparation costs(h) - 405
Wildfire costs, net(i) 123 1,273
COVID-19 costs(j) - 717
Adjusted EBITDA $ 127,556 $ 117,208 ________________________________________________
(a) Purchase accounting adjustments relate to the impacts of prior business combination accounting for our acquisition by TSG in Fiscal 2017, our subsequent acquisitions of Calera andKosta Browne in Fiscal 2018 and Fiscal 2019, respectively, and certain other transactions consummated prior to our acquisition by TSG, which resulted in fair value adjustments to inventory and long-lived assets. (b) Transaction expenses include legal and professional fees and change of control payments incurred in connection with our IPO inMarch 2021 . Also included are expenses incurred for a secondary offering inOctober 2021 and a secondary offering inJuly 2022 of our common stock, as well as costs for abandoned transactions. These expenses were directly related to such transactions and were incremental to our normal operating expenses. (c) Inventory write-down pertains to the Company's increase in inventory obsolescence reserves for excess inventory levels of certain seltzer products and related transportation and destruction costs. See Note 4 (Inventories) to our Consolidated Financial Statements for additional information. (d) See Note 10 (Derivative instruments) to our Consolidated Financial Statements for additional information. (e) See Note 15 (Equity-based compensation) to our Consolidated Financial Statements for additional information. (f) Casualty gain, net, pertains to the flood event at one of our wineries in Fiscal 2019, and was primarily comprised of insurance proceeds received pursuant to our claim, net of flood damage and remediation costs. The proceeds received, offset by costs incurred, are reported on the casualty gain, net line in our Consolidated Statements of Operations. See Note 17 (Casualty loss (gain)) to our Consolidated Financial Statements for additional information. (g) Loss on debt extinguishment includes charges for unamortized deferred financing fees we recognized in the period in connection with amending our Credit Facility. See Note 9 (Debt) to our Consolidated Financial Statements for further information. (h) IPO preparation costs include professional fees incurred for outside consultants to advise us on legal, accounting and tax matters related to our preparation for becoming a public company, which were not directly attributable to an offering. (i) Wildfire costs, net, include the cost of unharvested fruit that was damaged and rendered useless, charges we incurred to respond to imminent wildfire threat with fire-fighting crews to protect our assets, clean-up and smoke remediation expenses to restore operations at our tasting rooms after the fires, testing fees to evaluate our fruit for possible smoke damage, and washing or other grape processing costs prior to vinification to reduce the risk of smoke in finished wine. These costs, shown net of crop insurance proceeds received, are reported on the casualty loss (gain), net line in the Consolidated Statements of Operations. See Note 17 (Casualty loss (gain)) to our Consolidated Financial Statements for additional information. While we expect the potential for wildfires to be an ongoing risk to running an agricultural business inCalifornia , we believe the wildfires and related costs we experienced are not indicative of our core operating performance. 67 -------------------------------------------------------------------------------- Table of Contents (j) COVID-19 costs arising from the pandemic from the third quarter of 2020 to the fourth quarter of 2021, include certain incremental expenses incurred during the outbreak of the COVID-19 pandemic and the short-term closure mandates imposed by government officials in the jurisdictions in which we operate. These costs include tasting room expenses incurred during a period of mandatory closure and reduced capacity, salaries and severance expenses for certain employees and other immaterial costs to transfer inventory.
Liquidity and capital resources
Sources of liquidity
Our primary cash needs are for working capital purposes, such as producing or purchasing inventory and funding operating and capital expenditures. We fund our operational cash requirements with cash flows from operating activities and borrowings under our Credit Facility. As ofJuly 31, 2022 , we had$3.2 million in cash and$315.0 million available in undrawn capacity on our revolving line of credit, subject to the terms of our 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 responses to the impacts of the global pandemic or to an ever-changing and highly competitive industry landscape may result in changes to our cash requirements. Material Cash Requirements Beyond the next 12 months, we expect cash flows generated from operations, in addition to our 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 Credit Facility. For the 2022 harvest, we contracted for approximately 32,000 tons of grapes at an estimated cost of approximately$68.7 million , subject to the final determination of yield quantities and our quality acceptance provisions being met. Additionally, we have purchase obligations, including for inventory and various contracts with third-parties for custom crush, storage and mobile bottling services. See Note 14 (Commitments and contingencies) to our Consolidated Financial Statements for further information on other commitments. We have approximately$18.3 million in scheduled principal payments plus associated interest payments due over the next 12 months and approximately$217.4 million of principal payments plus associated interest payments due thereafter until our Credit Facility matures. The calculated interest payment amounts use actual rates available as ofJuly 2022 and assume these rates for all future interest payments on the outstanding Credit Facility. See Note 9 (Debt) to our Consolidated Financial Statements, where our 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$22.6 million due in the following years. See Note 6 (Leases) to our 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. 68
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Cash flows
The following table presents the major components of net cash flows.
Fiscal years ended July 31,
(in thousands) 2022 2021
Cash flows provided by (used in):
Operating activities $ 68,832 $ 64,272
Investing activities (43,734) (13,567)
Financing activities (26,175) (52,713)
Net decrease $ (1,077) $ (2,008) Comparison of the fiscal years ended
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 Fiscal 2022, net cash provided by operating activities was$68.8 million , compared to$64.3 million for Fiscal 2021, an increase of$4.6 million . This increase in cash provided by operating activities was driven primarily by the following factors:
•The net income after adjusting for non-cash items increased operating cash
flows by
•Increases in cash provided by changes in prepaid expenses for Fiscal 2022 were driven by timing of deposits and increased insurance in fiscal year 2021, and an increase in inventory to support increases in demand versus the prior year, resulted in an increase to operating cash flow of$8.0 million ; and •Decreases in accrued compensation of$12.1 million based on the timing of certain compensation-related payments resulted in a corresponding decrease in operating cash flow. Investing activities For Fiscal 2022, net cash used in investing activities was$43.7 million , compared to$13.6 million for Fiscal 2021, an increase of$30.2 million . Capital expenditures were$44.6 million for Fiscal 2022 and$13.7 million for Fiscal 2021 primarily due to vineyard acquisitions completed in Fiscal 2022, see Note 5 (Property and equipment, net). 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 additional investments and capital expenditures in the future.
Financing activities
For Fiscal 2022, net cash used in financing activities was
Our IPO in Fiscal 2021 resulted in several largely offsetting financing activities. In February, prior to the IPO, we paid a dividend of$100.0 million to our owner, funded with borrowings from our revolving line of credit. At the completion of our IPO, we received proceeds of$187.5 million (net of underwriting discounts and commissions of$12.5 million ), partially offset by payments of deferred offering costs of$6.7 million . IPO net proceeds of$180.0 million were used to pay down our line of credit, including the$100.0 million drawn to fund the dividend. 69
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Additionally, in Fiscal 2021, net cash used in financing activities included payments under our line of credit of$263 million , payments of long term debt of$13.8 million , partially offset by additional borrowings under our long term debt of$43.5 million . Capital resources Credit facility OnOctober 14, 2016 , we entered into the Credit Facility with a syndicated group of lenders. The Credit Facility provides a combination of term and revolving line of credit features. The term and revolving line of credit borrowings have variable interest rates, based primarily on LIBOR plus an applicable margin as defined in the First Lien Loan Agreement. Interest is paid monthly or quarterly based on loan type. Our debt is collateralized by substantially all of our cash, trade accounts receivable, real and personal property. Pursuant to the terms and conditions of the First Lien Loan Agreement, we have issued the instruments discussed below. OnAugust 30, 2022 , subsequent to fiscal year end, the Company entered into an eighth amendment to the FirstLien Loan and Security Agreement to extend the maturity date of all facilities toNovember 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. See Note 19 (Subsequent events) for additional information. As ofJuly 31, 2022 , outstanding principal balances on the debt instruments were$110.0 million for the revolving line of credit,$5.0 million for the capital expenditure loan,$96.8 million for the term loan (tranche one) and$13.3 million for term loan (tranche two). See Note 9 (Debt) to our Consolidated Financial Statements for additional information.
The First Lien Loan Agreement contains customary affirmative covenants,
including delivery of audited financial statements and customary negative
covenants that, among other things, limit our ability to incur additional
indebtedness or to grant certain liens. As of
Revolving line of credit
The revolving line of credit allows us to borrow up to a principal amount of$425.0 million (including a letter of credit sub-facility of the revolving loan facility in the aggregate of$15.0 million and a swingline sub-facility of the revolving loan facility in the aggregate of$15.0 million ), with an incremental seasonal borrowing amount for harvest costs increasing the total amount to a maximum of$455.0 million . The revolving line of credit matures onNovember 1, 2023 . As ofJuly 31, 2022 , the interest rate ranged from LIBOR plus 125 basis points to LIBOR plus 175 basis points depending on the average availability of the revolving line of credit.
Capital expenditure loan
The capital expenditure loan has a maximum, non-revolving draw-down limit of$25.0 million with quarterly principal payments and the remaining unpaid principal and interest due upon maturity onNovember 1, 2023 . The interest rate was LIBOR plus 190 basis points as ofJuly 31, 2022 . As ofJuly 31, 2022 , the$25.0 million limit was fully drawn.
Term loans
The first tranche of term loans was issued in 2016 for a principal balance of$135.0 million with quarterly principal payments and the remaining unpaid principal and interest due upon maturity onNovember 1, 2023 . This tranche of the term loans had an interest rate of LIBOR plus 190 basis points as ofJuly 31, 2022 . The second tranche of term loans, issued inAugust 2018 , allowed for a principal balance up to$25.0 million with quarterly principal payments and the remaining unpaid principal and interest due upon maturity onNovember 1, 2023 . We drew$16.4 million of the second tranche of the term loan inNovember 2018 . This tranche of the term loans had an interest rate of LIBOR plus 163 basis points as ofJuly 31, 2022 . 70
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Critical accounting policies and estimates
Our management's discussion and analysis of our financial condition and results of operations are based on our Consolidated Financial Statements, which are prepared in accordance withU.S. GAAP. The preparation of these 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 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. While all significant accounting policies are more fully described in Note 2 (Basis of presentation and significant accounting policies) to our Consolidated Financial Statements, we believe that the following accounting policies and estimates are critical to our business operations and understanding of our financial results.
Revenue recognition
We recognize revenue from the sale of wine to customers when that performance obligation is fulfilled and control transfers to the customer, either at the point of shipment or delivery as dictated by the shipping terms. Payment terms vary by location and customer. However, the duration between when revenue is recognized and when payment is due is less than one year, indicating we do not have any significant financing components to recognize. We have elected to account for shipping and handling costs that we bill our customers as a fulfillment activity rather than as separate performance obligations. Shipping and handling costs are included within net sales. When we receive payment from a customer prior to transferring the product under the terms of a contract, we record deferred revenue, which represents a contract liability. Our deferred revenue is primarily comprised of cash collected during DTC club sales or list member offering periods throughout the year, as the period that elapses from a customer's payment for their allocated purchase to the shipment date may cross reporting periods. Deferred revenue is reported separately on the Consolidated Statements of Financial Position until all revenue recognition criteria have been met (generally when the goods are shipped), at which time revenue is recognized. Revenue subject to variability is constrained to an amount which will not result in a significant reversal in future periods when the contingency that creates variability in revenue is resolved. Revenue is recorded net of excise taxes, and net of consideration given to customers through various incentive programs, including depletion-based incentives paid to distributors, volume discounts and pricing discounts on single transactions. The consideration to customers is deemed variable consideration under ASC 606, Revenue Recognition, and is estimated and recognized as a reduction of the transaction price based on the expected amounts at the time of revenue recognition for the related sale.
Income taxes
Income taxes are recognized using enacted tax rates and are accounted for based on the asset and liability approach, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the consolidated financial statement and tax bases of assets and liabilities at the applicable statutory tax rates. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Other significant temporary differences that impact the Company's deferred taxes primarily relate to the tax basis of assets that were acquired in business combinations that remain at historical bases although the assets were recorded at fair value for financial reporting purposes. The differences primarily relate to inventory, property and equipment and intangible assets. Other temporary differences include differing depreciation and inventory costing methods.Goodwill associated with a prior period acquisition of the Company created a permanent difference. A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized. We evaluate the realizability of our deferred tax assets by assessing our valuation allowance and by adjusting the amount of such allowance, if necessary. The factors 71
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used to assess the likelihood of realization include our forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets. Failure to achieve forecasted taxable income in applicable tax jurisdictions could affect the ultimate realization of deferred tax assets and could result in an increase in our effective tax rate on future earnings.
We recognize goodwill in accounting for business combinations based on the
amount by which the total consideration transferred, plus the fair value of any
non-controlling interest in an acquiree, exceeds the fair value of identifiable
net assets acquired and liabilities assumed as of the acquisition date.
Identifiable intangible assets other than goodwill are primarily comprised of
indefinite-lived trade names, indefinite-lived lane rights, and customer
relationships which amortize on a straight-line basis over an estimated useful
life based on management's estimate of the period the asset is expected to
contribute to future cash flows.
We assess our goodwill and indefinite-lived intangible assets for impairment at
least annually, or more frequently if events and circumstances indicate that the
carrying value may not be recoverable. Our quantitative goodwill impairment test
consists of comparing the reporting unit carrying value to its fair value, which
is estimated as the amount for which it could be sold in a current transaction
between willing parties. If the carrying value exceeds fair value, an impairment
charge is recognized in an amount equal to that excess, not to exceed the
carrying amount of goodwill. While we are permitted to consider qualitative
factors to determine whether it is more likely than not that the fair value of a
reporting unit is less than its carrying amount, we relied on quantitative tests
for our Fiscal 2022 and Fiscal 2021 periods. We determine fair value estimated
based on quantitative fair value methods, generally the comparative market
valuation approach. Based on our quantitative test results, the Company
determined that the reporting unit fair value substantially exceeded its
carrying value in each testing period, and the reporting unit was therefore not
at risk of failing the quantitative impairment tests in either fiscal year.
Our trade name intangible asset impairment testing consists of a comparison of
the fair value of each trade name with its carrying value, with any excess of
carrying value over fair value being recognized as an impairment loss. In
estimating the fair value of our trade names, we use the Relief-from-Royalty
("RFR") method, a form of income approach, as the most appropriate for analyzing
the trade names. The RFR method estimates the cost we avoid by owning rather
than licensing the trade names and includes an estimate of the royalty income
that would be negotiated in an arm's-length transaction if the subject
intangible assets were licensed from a third party. The primary variables we
apply in the RFR method are estimation of future revenues, selection of
appropriate royalty rates and selection of discount rates to calculate present
value. We consider the following in determining the significant assumptions used
in evaluating the fair value of trade names:
•Net sales growth-our estimates include judgments and assumptions regarding
future net sales growth rates based on internally-developed forecasts as well as
terminal growth rates in order to quantify the net sales we expect to be
attributable to the trade names;
•Royalty rates-selected royalty rates are based on industry benchmarking and
market data for companies with similar trade names and activities, giving
consideration to the historical and projected profitability of operations and
trade name market strength; and
•Discount rates-royalty savings are discounted to their present value equivalent
using an appropriate discount rate, adjusted for risk premiums appropriate for
the trade names and the Company's risk profile.
Our use of assumptions requires us to apply judgment in selecting appropriate
inputs for trade name valuation, and these assumptions are subject to change
over time.
We also evaluate the remaining useful lives of our trade name intangible assets
to determine whether current events and circumstances continue to support an
indefinite useful life. See Note 7 (Goodwill and other intangible assets) to our
Consolidated Financial Statements.
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We assess the impairment of definite-lived intangible assets whenever events or changing circumstances indicate that the carrying amount may not be recoverable or that the remaining useful life may no longer be supportable.
Inventories
Inventory primarily includes bulk and bottled wine and is carried at the lower of cost (calculated using the first-in-first-out method) or net realizable value. The cost basis for inventory includes the costs related to winemaking. Consistent with industry practices, the Company classifies inventory as a current asset, although a substantial portion of inventory may be aged for periods longer than one year prior to being sold due to the specific aging requirements for a given wine varietal and vintage. The Company reduces the carrying value of inventories that are obsolete or for which market conditions indicate cost will not be recovered to estimated net realizable value. The Company's estimates of net realizable value are based on analysis and assumptions including, but not limited to, historical experience, as well as Management's judgment with respect to future demand and market requirements. Reductions to the carrying value of inventories are recorded in cost of sales. See Note 2 (Basis of presentation and significant accounting policies) for additional description of our inventories.
Recent accounting pronouncements
See Note 2 (Basis of presentation and significant accounting policies) to our Consolidated Financial Statements included in Part II, Item 8 of this report for additional information regarding recent accounting pronouncements.
Emerging growth company status
Based on the Company's aggregate worldwide market value of voting and non-voting common equity held by non-affiliates as ofJanuary 31, 2022 , the Company became a "large accelerated filer" and lost emerging growth company status onJuly 31, 2022 . Prior toJuly 31, 2022 we were an emerging growth company, as defined in the JOBS Act. Section 107 of the JOBS Act provides that an "emerging growth company" can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. In other words, an "emerging growth company" can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. Section 107 of the JOBS Act provides that any decision to opt out of the extended transition period for complying with new or revised accounting standards is irrevocable. We elected to use this extended transition period for complying with new or revised accounting standards that had different effective dates for public and private companies. As a result, our prior financial statements may not be comparable to companies that comply with the new or revised accounting pronouncements as of public company effective dates.
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