THE DUCKHORN PORTFOLIO, INC.
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our financial statements and the
related notes to those statements included elsewhere in this Quarterly Report on
Form 10-Q. In addition to historical financial information, the following
discussion and analysis contains forward-looking statements that involve risks,
uncertainties and assumptions. See "Cautionary note regarding forward-looking
statements" included below. 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 II "Item 1A. Risk factors" included in this
Quarterly Report on Form 10-Q.
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;
• general competitive conditions, including actions our competitors may take to
grow their businesses;
• overall decline in the health of the economy and consumer discretionary
spending;
• the occurrence of severe weather events (including fires, floods and
earthquakes), catastrophic health events, natural or man-made disasters, social
and political conditions or civil unrest;
• risks associated with disruptions in our supply chain for grapes and raw and
processed materials, including corks, glass bottles, barrels, winemaking
additives and agents, water and other supplies;
• the impact of COVID-19 on our customers, suppliers, business operations and
financial results;
• disrupted or delayed service by the distributors and government agencies we
rely on for the distribution of our wines outside of California ;
• our ability to successfully execute our growth strategy;
• decreases in our wine score ratings by wine rating organizations;
• quarterly and seasonal fluctuations in our operating results;
• our success in retaining or recruiting, or changes required in, our officers,
key employees or directors;
• our ability to protect our trademarks and other intellectual property rights,
including our brand and reputation;
• our ability to comply with laws and regulations affecting our business,
including those relating to the manufacture, sale and distribution of wine;
• the risks associated with the legislative, judicial, accounting, regulatory,
political and economic risks and conditions specific to both domestic and to
international markets;
• claims, demands and lawsuits to which we are, and may in the future, be
subject and the risk that our insurance or indemnities coverage may not be
sufficient;
• our ability to operate, update or implement our IT systems;
• our ability to successfully pursue strategic acquisitions and integrate
acquired businesses;
• our potential ability to obtain additional financing when and if needed;
• our substantial indebtedness and our ability to maintain compliance with
restrictive covenants in the documents governing such indebtedness;
• TSG's significant influence over us and our status as a "controlled company"
under the rules of the New York Stock Exchange ;
• the potential liquidity and trading of our securities; and
• the future trading prices of our common stock and the impact of securities
analysts' reports on these prices.
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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" and elsewhere in this Quarterly
Report 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 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.
Overview
The Duckhorn Portfolio is the premier scaled producer of luxury wines in North
America . We have delighted millions of consumers with authentic, high-quality,
approachable wines for over four decades. Founded by our namesake Dan and
Margaret Duckhorn in 1976, we began by pioneering Merlot wines in Napa Valley
and now champion a curated and comprehensive portfolio of highly acclaimed
luxury wines across multiple varietals, appellations, brands and price points.
Our portfolio is focused exclusively on the desirable luxury segment, which we
define as wines sold for $15 or higher per 750ml bottle.
We sell our wines in all 50 states and over 50 countries at prices ranging from
$20 to $200 per bottle under a world-class luxury portfolio of winery brands,
including Duckhorn Vineyards , Decoy, Kosta Browne , Goldeneye, Paraduxx, Calera,
Migration, Canvasback, Greenwing and Postmark. Our wines have a strong record of
achieving critical acclaim, vintage after vintage. Each winery brand boasts its
own winemaking team to create distinct experiences for consumers, ensure product
quality and continuity and galvanize sustainable farming practices. Beyond our
winemaking teams is an organization comprised of passionate, talented employees,
including a highly tenured executive team that has approximately 100 years of
cumulative experience with Duckhorn.
We sell our wines to distributors and directly to retail accounts in California ,
which together comprise our wholesale channel, and directly to consumers through
our DTC channel, which comprised over 19% of our sales in the first nine months
of Fiscal 2021. Our powerful omni-channel sales model drives strong margins by
leveraging long-standing relationships developed over the past forty years. We
believe our iconic winery brands together with our scaled, quality-focused
production, omni-channel distribution and dedicated employees, set the standard
for North American luxury wine.
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Key Financial Metrics
We use net sales, gross profit and adjusted EBITDA to evaluate the performance
of our business, identify trends in our business, prepare financial forecasts
and make capital allocation decisions. We believe the following metrics are
useful in evaluating our performance, but adjusted EBITDA should not be
considered in isolation or as a substitute for any other financial information
depicting our results prepared in accordance with U.S. GAAP. Certain judgments
and estimates are inherent in our processes to calculate these metrics.
Three months ended April 30, Nine months ended April 30,
(in thousands) 2021 2020 2021 2020
Net sales $ 90,425 $ 68,720 $ 265,720 $ 218,417
Gross profit $ 46,929 $ 36,342 $ 132,961 $ 110,959
Net income attributable to The Duckhorn
Portfolio, Inc. $ 9,022 $ 11,619 $ 48,548 $ 35,100
Adjusted EBITDA(a) $ 32,946 $ 31,236 $ 98,845 $ 87,249 ________________________________________________
(a) See "-Adjusted EBITDA" for additional information and below for the reconciliation to net income attributable tothe Duckhorn Portfolio, Inc. , the most directly comparableU.S. GAAP measure. The following table represents the reconciliation of adjusted EBITDA to net income attributable toThe Duckhorn Portfolio, Inc. : Three months ended April 30, Nine months ended April 30, (in thousands) 2021 2020 2021 2020 Net income attributable to The Duckhorn Portfolio, Inc. $ 9,022$ 11,619 $ 48,548 $ 35,100 Interest expense 3,755 4,221 10,947 13,905 Income tax expense 5,623 4,189 19,694 12,588 Depreciation and amortization expense 5,554 6,116 16,434 17,421 EBITDA 23,954 26,145 95,623 79,014 Purchase accounting adjustments(a) 126 241 1,449 4,836 Transaction expenses(b) 2,304 - 2,304 193 Change in fair value of derivatives (1,991) 3,036 (4,818) 3,427 Equity-based compensation 8,962 288 9,538 866 Casualty gain, net(c) - (24) (7,832) (4,047) Bulk wine loss, net(d) - 1,243 - 2,322 Loss on debt extinguishment(e) - - 272 - IPO preparation costs(f) - 31 405 362 Wildfire costs, net(g) (421) - 1,196 - COVID-19 costs(h) 12 276 708 276 Adjusted EBITDA$ 32,946 $ 31,236 $ 98,845 $ 87,249
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(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 deferred revenue, inventory and long-lived assets. (b) Transaction expenses include legal and professional fees and change of control payments incurred in connection with our acquisition ofKosta Browne inAugust 2018 and our IPO inMarch 2021 . These expenses were incremental to our normal operating expenses and were directly related to the transactions. (c) Casualty gain, net in Adjusted EBITDA pertains to the flood event at one of our wineries in Fiscal 2019, and was primarily comprised of insurance proceeds received pursuant to our claim, offset by flood damage and remediation costs. The proceeds received, offset by costs incurred, are reported on the casualty gain, net line in the Condensed Consolidated Statements of Operations. See Note 14 (Casualty Gain) to our condensed consolidated financial statements for additional information. (d) Bulk wine loss, net, primarily relates to net losses on bulk wine sold in the spot bulk markets at quantities and price points which were unusual and infrequent for our business. During Fiscal 2020 (during which the 2019 harvest occurred), we observed significant and unprecedented oversupply and price volatility in the bulk wine markets that resulted in premium tiers of bulk wine spot prices reaching historic lows. We have not historically sold a significant quantity of bulk wine into the spot bulk markets. However, during Fiscal 2020, we obtained alternative supply that we believe is of higher quality than certain bulk wine that we held at that time, and we responded by selling certain bulk quantities at a net loss. We do not to expect to engage in sales of significant amounts of bulk quantities to the bulk wine market, and therefore have excluded the loss from these sales from adjusted EBITDA as they are not indicative of our core operational performance. (e) Loss on debt extinguishment includes charges for unamortized deferred financing fees we recognized in connection with amendments to our Credit Facility. See Note 8 (Debt) to our condensed consolidated financial statements for further information. (f) 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 are not directly attributable to an offering. 24 -------------------------------------------------------------------------------- (g) Wildfire costs, offset by crop insurance proceeds received, 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, offset by proceeds received, are reported on the casualty gain, net line in the Condensed Consolidated Statements of Operations. See Note 14 (Casualty Gain) to our condensed consolidated financial statements for additional information. While we expect the potential for wildfires to be an ongoing risk to running an agricultural business inCalifornia , we believe the wildfires and related costs we experienced are not indicative of our core operating performance. (h) COVID-19 costs include certain incremental expenses incurred during the outbreak of the COVID-19 pandemic and the short-term closure mandates imposed by government officials in the jurisdictions in which we operate. These costs include tasting room expenses incurred during a period of mandatory closure and reduced capacity, salaries and severance expenses for certain employees and other immaterial costs to transfer inventory.Net Sales Our net sales represent revenues less discounts, promotions and excise taxes. Gross Profit Gross profit is equal to our net sales less cost of sales. Cost of sales includes all wine production costs, winemaking, bottling, packaging, warehousing and shipping and handling costs. Our gross profit and gross profit margins on net sales are impacted by the mix of winery brands we sell in our portfolio. See "-Components of results of operation and key factors affecting our performance" for additional information. Adjusted EBITDA Adjusted EBITDA is a non-GAAP financial measure that we calculate as net income before interest, taxes, depreciation and amortization, non-cash equity-based compensation expense, purchase accounting adjustments, casualty losses or gains, impairment losses, changes in the fair value of derivatives and certain other items which are not related to our core operating performance. Adjusted EBITDA is a key metric we use to evaluate business performance in comparison to budgets, forecasts and prior year financial results, providing a measure that Management believes reflects the Company's core operating performance. For comparative periods presented, our primary operational drivers of adjusted EBITDA have been sustained sales growth in our wholesale channel and steady growth in our DTC channel, management of our cost of sales through our diversified supply planning strategy, and discipline over selling, general and administrative expenses relative to our sales growth. Key Operating Metrics We monitor the following key metrics to help us evaluate our business, identify trends affecting our business, measure our performance, formulate business plans and make strategic decisions. We believe the following metrics are useful in evaluating our business but should not be considered in isolation or, solely with respect to price / mix contribution, as a substitute for financial information prepared and presented in accordance with GAAP. Certain judgments and estimates are inherent in our processes to calculate these metrics. Net Sales Percentage by Channel We calculate net sales percentage by channel as net sales made through our wholesale channel to distributors, through our wholesale channel directly to retail accounts inCalifornia and through our DTC channel, respectively, as a percentage of our total net sales. We monitor net sales percentage across these three routes to market to understand the effectiveness of our omni-channel distribution model and to ensure we are deploying resources effectively to optimize engagement with our customers across our complementary distribution channels. Three months ended April 30, Nine months ended April 30, 2021 2020 2021 2020 Wholesale - Distributors 59.5 % 52.7 % 64.4 % 59.4 % Wholesale - California direct to retail 15.7 % 17.1 % 16.5 % 18.1 % DTC 24.8 % 30.2 % 19.1 % 22.5 % 25
-------------------------------------------------------------------------------- We typically experience an increase in net sales percentage for our wholesale-distributors channel in the first fiscal quarter of each fiscal year due to increased purchasing by distributors in anticipation of higher consumer demand during the holiday season. See "-Components of results of operation and key factors affecting our performance-Seasonality." The variations in net sales percentage by channel between the three and nine months endedApril 30, 2021 and 2020 were largely driven by the impact of COVID-19. In particular, the increase in net sales percentage attributable to our wholesale-distributors channel and the decrease in net sales percentage attributable to our DTC channel for the nine month comparison periods was primarily driven by (i) shifts in consumer purchasing and consumption patterns away from on-premise sales toward off-premise sales primarily serviced by our wholesale-distributors channel, (ii) a decrease in wholesale-California direct to retail due to a higher concentration of on-premise accounts experiencing sales declines of our higher-priced ultra luxury wines and (iii) increased purchasing by our distributors in anticipation of increased off-premise demand during the holiday season in anticipation of ongoing COVID-19 related health and safety restrictions at on-premise sale locations. We expect that our channel mix will begin to normalize in future periods as consumer purchasing and consumption patterns return to normal following the COVID-19 pandemic. Net Sales Growth Contribution Net sales growth is defined as the percentage increase of net sales in the period compared to the prior period. Net sales growth contribution is calculated based on the portion of changes in net sales for a given period that is driven by two factors: changes in sales volume and changes in sales price and mix. Volume contribution presents the percentage increase in cases sold in the current period compared to the prior period. Price / mix contribution presents net sales growth less volume contribution and reflects that, in addition to changes in sales volume, changes in net sales are primarily attributable to changes in sales price and mix. Three months ended April 30, Nine months ended April 30, 2021 2020 2021 2020 Net sales growth 31.6 % 9.2 % 21.7 % 12.8 % Volume contribution 41.0 % 23.0 % 30.2 % 21.4 % Price / mix contribution (9.4) % (13.7) % (8.5) % (8.6) % For the three and the nine months endedApril 30, 2021 , growth in net sales was attributable to strong volume contribution and partially offset by negative price / mix contribution, demonstrating that increased sales volumes continues to be the primary driver of our net sales growth. The negative price / mix contribution was primarily attributable to (i) increases in sales of our luxury winery brands, which sell at lower average sales prices than our ultra-luxury winery brands, (ii) decreases in average selling prices as a result of the COVID-19 pandemic driven shift away from on-premise sales, which have historically accounted for a larger portion of sales of our higher priced ultra-luxury wines and (iii) our consistent use of distributor and retail sales discounts and promotions in our wholesale channel to maintain and to capture market share, which presented downward pressure on price / mix contribution given the increase in net sales from our wholesale channel relative to total net sales during the periods. We expect that price / mix contribution will begin to revert toward historical levels as consumption and purchasing habits return to normal following the COVID-19 pandemic, but we expect that volume contribution will continue to be the primary driver of changes in our net sales in future periods. Components of Results of Operation and Key Factors Affecting our PerformanceNet Sales Our net sales consist primarily of wine sales to distributors and directly to retail accounts inCalifornia , which together comprise our wholesale channel, and directly to individual consumers through our DTC channel. Net sales generally represent wine sales and shipping, when applicable. Sales are generally recorded at the point of shipment and are recorded net of returns, consideration provided to customers through various incentive programs, other promotional discounts and excise taxes. We refer to the volume of wine we sell in terms of cases, each of which represents a standard 12 bottle case of wine (in which each bottle has a volume of 750 milliliters). Cases sold represent wine sales through our wholesale and DTC channels. Depletions, in turn, represent sell-through from our distributors, including ourCalifornia wholesale sales channel, to retail accounts nationally. 26 -------------------------------------------------------------------------------- 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. For example, we launched a line of premium Decoy-branded wine-based seltzers inFebruary 2021 , which we believe will have broad appeal to current Decoy wine drinkers and capture an incremental drinking occasion in this dynamic category. •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 increase the volume of wine sold to existing accounts. We believe our long-standing existing commercial relationships coupled with exceptional portfolio strength position us to capture distribution growth opportunities and accelerate sales to existing distributors and retail accounts inCalifornia . •Continued investment in DTC channel. We expect to continue to invest in our DTC channel, leveraging wine clubs and brand-specific tasting rooms to engage with our consumers, create brand evangelists and drive adoption across our portfolio. •Opportunistic evaluation of strategic acquisitions. Our strategic and opportunistic approach to evaluating acquisitions has led to the successful acquisition of two winery brands in the past three years:Kosta Browne and Calera. While our growth and success are not contingent upon future acquisitions, we believe our team has the capabilities and track record both to execute and integrate meaningful acquisitions when opportunities arise to create stockholder value. Our net sales growth has outpaced luxury wine growth rates in theU.S. wine industry every year since 2012, and because of these growth drivers, we expect that trend to continue for the foreseeable future. The primary market for our wines isthe United States , which represented approximately 95% of our net revenue in the first nine months of Fiscal 2021. Accordingly, our results of operations are primarily dependent onU.S. consumer discretionary spending. Sales Channels Our sales and distribution platform is based on long-standing relationships with a highly-developed network of distributor accounts in allU.S. states (exceptCalifornia , where we sell directly to retail accounts) and in over 50 countries globally. We also have developed strong relationships with consumerswho buy our wines directly from us in the DTC channel. Channel mix can affect our performance and results of operations, particularly gross profit and gross profit margin. •Wholesale channel. Consistent with sales practices in the wine industry, sales to retailers inCalifornia and to distributors in other states occur below suggested retail price ("SRP"). We work closely with our distributors to increase the volume of our wines and number of products that are sold by the retail accounts in their respective territories. InCalifornia , where we make sales directly to retail accounts, we benefit from greater control over our sales and higher profit margins by selling directly to retailers in the state. Our wholesale channel comprises a greater proportion of our net sales than our DTC channel. •DTC channel. Wines sold through our DTC channels are generally sold at SRP. Our DTC channel continues to grow as a result of a number of factors, including a shift to more consumption and corporate engagement in the home. 27 -------------------------------------------------------------------------------- Wholesale channel sales made on credit terms generally require payment within 90 days of delivery, and a substantial majority are collected within 60 days. In periods where the net sales channel mix reflects a greater concentration of wholesale sales (which typically occurs in our first and second fiscal quarters), we typically experience an increase in accounts receivable for the period to reflect the change in sales mix, with payment collections in the subsequent period generally reducing accounts receivable and having a positive impact on cash flows in such subsequent period. While we seek to increase sales in both channels, we expect that our future sales will continue to be substantially comprised of sales in the wholesale channel. We intend to maintain and strengthen our long-standing relationships within our network of distributors, which we believe will be critical to our continued growth and success. In the wholesale channel, we are positioned as a one-stop luxury and ultra-luxury wine shop, offering a diverse mix of high-quality winery brands and varietals at varying luxury and ultra-luxury price points. We believe this strategy will enable us to continue increasing our share of the wholesale luxury and ultra-luxury wine market in the future, as customers will have greater opportunity to engage with and experience wines across our broad portfolio. We continue to innovate with new products at all price points within the portfolio. We strive to enhance customer engagement and increase sales as new customers encounter our wines and existing customers trade up to higher-priced wines. Our sales mix within our wholesale channel has shifted in favor of off-premise sales while on-premise sales have experienced variability during the COVID-19 pandemic, which began impacting our sales inMarch 2020 . Our responses to periods of historical disruption in the wholesale channel have focused on strengthening relationships with our accounts and distributors, introducing new products and maintaining and strengthening our winery brand engagement. We believe this approach has enabled us to strengthen our portfolio and increase our market share relative to competitors during this period of market disruption. We routinely offer sales discounts and promotions through various programs to distributors around the country and retail accounts inCalifornia . These programs, where permissible, include volume-based discounts on sales orders, depletion-based incentives we pay distributors and certain other promotional activities. The expense associated with these discounts and promotions is estimated and recorded as a reduction in total sales in order to arrive at reported net sales. While our promotional activities may result in some variance in total net sales from quarter to quarter, historically, the total impact of such activities on annual net sales has been generally stable, and we expect this trend to continue in the future. In the DTC channel, our holistic approach to consumer engagement both online and offline is supported by an integrated e-commerce platform and portfolio wine shop, seven distinctive tasting room experiences located throughoutNorthern California andWashington , and several award-winning wine clubs, all of which enable us to cross-sell wines within our portfolio. These strategies are designed to maximize each winery brand and property while driving awareness for the Company's other world-class wines and properties, resulting in more and deeper customer connections. We strive to evolve our offerings, experiences and communication to match the generational shifts in wine engagement preferences and related purchasing decisions. In addition, we anticipate that our holistic consumer engagement approach will help our DTC sales remain strong through the near-term impact of the COVID-19 pandemic on consumer purchasing behaviors. 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 product 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. 28 --------------------------------------------------------------------------------
Seasonality
Our net sales are typically highest in the first half of our fiscal year due to
increased consumer demand around major holidays. Net sales seasonality differs
for wholesale and DTC channels, resulting in quarterly seasonality in our net
sales that depends on the channel mix for that period. We typically experience a
higher concentration of sales through our wholesale channel during our first and
second fiscal quarters due to increased purchasing by distributors in
anticipation of higher consumer demand during the holiday season, which has the
effect of lowering average selling prices as a result of the use of distributor
and retail sales discounts and promotions in our wholesale channel. See "-Key
operating metrics." In Fiscal 2020, our net sales in the first, second, third
and fourth fiscal quarters represented approximately 27%, 28%, 25% and 20%,
respectively, of our total net sales for the year.
Gross Profit
Gross profit is equal to our net sales, minus our cost of sales. Cost of sales
includes grape and bulk wine purchase costs. For grapes we grow, cost of sales
includes amounts incurred to develop and farm the vineyards we own and lease.
Cost of sales also includes all winemaking and processing charges, bottling,
packaging, warehousing and shipping and handling. Costs associated with storing
and maintaining wines that age longer than one year prior to sale continue to be
capitalized until the wine is bottled and available for sale.
As we continue to grow our business in the future, we expect gross profit to
increase as our sales grow and as we effectively manage our cost of sales,
subject to any future unexpected volatility in the grape and bulk wine markets
and increased seasonal labor costs. Additionally, we expect gross profit as a
percentage of net sales to remain consistent with historical levels or to
improve to the extent we observe a return to normalized consumer spending
behavior across the industry and within our business, particularly with respect
to on-premise sales in the wholesale channel, which would favorably influence
our gross profit margins on net sales.
Agribusiness
We have developed a diversified sourcing and production model, supported by our
eight wineries and 22 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 consists of selling expenses,
marketing expenses and general and administrative expenses. Selling expenses
consist primarily of direct selling expenses in our wholesale and DTC channels,
including payroll and related costs, product samples and tasting room operating
costs, including processing fees and outside services. Marketing expenses
consist primarily of advertising costs to promote winery brand awareness,
customer retention costs, payroll and related costs. General and administrative
expenses consist primarily of payroll and related costs, administrative expenses
to support corporate functions, legal and professional fees, depreciation,
accounting and information technology, tenancy expenses and other costs related
to management. Although we expect selling, general and administrative expenses
to increase as sales and related support needs expand, we expect our sales
growth rate to outpace the rate of increased selling, general and administrative
expenses as we achieve further efficiencies of scale. We also expect to incur
greater selling, general and administrative expenses as a result of operating as
a publicly traded company.
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Other Expenses
Other expenses consist primarily of interest expense we incur on balances
outstanding under the terms of our Credit Facility and unrealized gains or
losses on our derivative instruments.
Income Tax Expense
Income tax expense consists of federal and state taxes payable to various
federal, state and local tax authorities.
Inventory Lifecycle
Grape Growing on our Estate Vineyards
Although generally over 85% of our wine is typically derived from grapes grown
by third party growers and, to a significantly lesser extent, bulk wine we
purchase, the remainder is sourced from our Estate vineyards that we own or
lease. Once a vineyard reaches consistent yield levels, approximately three to
five years after planting, it will generally produce a relatively consistent
amount of fruit for approximately 15 to 25 years, at which time blocks of the
vineyard will gradually be replanted in stages after a period of lying fallow.
The length of time between initial investment and ultimate sale of our Estate
wines, coupled with the ongoing investment required to produce quality wine, is
not typical of most agricultural industries. In the future, as our business
grows, we expect Estate vineyards to represent a smaller relative share of our
overall sourcing model.
Harvest-to-Release
Of the total case volume we produce and sell, the majority is comprised of red
wines from grape varietals such as Cabernet Sauvignon, Pinot Noir and Merlot,
which can have production lifecycles spanning months and years from harvest
until the time the wine is released, depending on the aging requirements
prescribed by the winemakers responsible for each of our winery brands. Our red
wines generally have a harvest-to-release inventory lifecycle that can range
from 15 to 48 months. Our white, rosé and sparkling wines generally have a
harvest-to-release inventory lifecycle that can range from five to 35 months.
During aging and storage, we continue to capitalize overhead costs into the
carrying value of the wine.
Given the long-term nature of our investment, grape purchasing and bulk wine
purchasing decisions, our production planning processes are designed to mitigate
the risk of over-supply by sourcing a portion of our production needs in the
spot markets to the degree appropriate based on winery brand and vintage. This
opportunistic approach to grape purchases also helps us reduce our exposure to
future grape price volatility.
Other Factors Impacting the Comparability of Our Results of Operations
Impacts of COVID-19
In March 2020 , the World Health Organization declared a global pandemic due to
the spread of COVID-19, the disease caused by a novel strain of coronavirus.
While governmental authorities implemented measures limiting the activities of
businesses and individuals to reduce the spread of COVID-19, wine producers in
the United States are classified as essential businesses, which enabled us to
continue producing and selling our wine. Our operational response for the safety
of our employees and the individuals with whom we work was to adapt our policies
and protocols to meet applicable federal, state and local requirements, which we
continue to revise as appropriate.
Historically, our ultra-luxury winery brands, which deliver higher gross profit
margins, generally sell in larger volumes on-premise than our luxury winery
brands, which typically see higher sales volumes at off-premise retailers. At
the outset of the COVID-19 pandemic, we experienced a significant decrease in
sales of ultra-luxury wines on-premise and a significant increase of sales of
ultra-luxury and luxury wines off-premise. As the economy reopens following the
COVID-19 pandemic, we expect on-premise sales to increase from their pandemic
lows, which we believe will result in further increased sales of our
ultra-luxury winery brands. At the same time, the significant growth in
off-premise sales that we are experiencing during the pandemic may be tempered
and the rate of growth may marginally slow at off-premise retailers. We believe
that the diverse offerings of The Duckhorn Portfolio , which include a broad
spectrum of price points, mitigates some of the risk to our future operations in
periods in which the on- and off-premise relative mix fluctuates.
30
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During the pandemic our tasting rooms have experienced lower tasting fee revenue
due to closed or reduced capacities in order to comply with applicable
regulations despite sustained operating levels of expenses, primarily comprised
of tasting room operating expenses during periods of capacity restrictions or
mandatory closure. Conversely, e-commerce sales increased substantially as
customers sought to purchase our wines in a manner that reduced human contact.
We believe that our tasting rooms will see significant increases in tasting fee
revenue as the pandemic wanes, tourism increases and regulations addressing
occupancy are eased. At the same time, we believe that customers who used
e-commerce platforms to purchase our wines will continue to enjoy the
convenience of those platforms to purchase wines from The Duckhorn Portfolio .
Impact of Wildfires
During Fiscal 2020 and the first quarter of Fiscal 2021, several wildfires
occurred in Northern California . These fires have adversely affected industry
grape supplies, though the full extent is not yet known. Other than smoke
exposure to grapes that had not been harvested, our own vineyards did not
sustain damage during the fires. However, smoke and fire damage to vineyards in
the primary regions and markets where we source fruit rendered some of the
available grapes unacceptable for the Company's production needs, and the
evaluation is ongoing. In response, we have taken steps to obtain alternative
sources of supply that we believe will substantially mitigate the impact of the
fires on our supply. Wildfires and smoke damage to grape yields in 2020 and in
future vintages could result in changes to our production plan, changes to the
quantity or release timing of expected case sales in our sales forecast, and
changes to future gross profit margins as compared to prior periods. We cannot
yet estimate the full impact of wildfire-related disruption to the 2020 harvest,
nor can we estimate the potential future impact on our sales for the fiscal
years in which the 2020 vintage would be available for sale. Repeated instances
of wildfires disrupting overall grape supply may result in significant price
volatility, which could also impact our business.
We continue to enhance our wildfire response plan and to mitigate the supply
risk associated with wildfires in the following ways:
•our diversified sourcing strategy, with a mix of our owned or leased Estate
properties and high-quality grower contracts, covers a wide geographic footprint
across California and Washington ; and
•we have assembled a team of winemakers and operational leadership with deep
industry experience, enabling us to respond effectively to supply disruption in
our active grape sourcing markets or to expand into new sourcing markets if
needed.
Impacts of Purchase Accounting due to Prior Acquisitions
We were acquired by TSG in Fiscal 2017, and subsequently completed acquisitions
of Calera and Kosta Browne in Fiscal 2018 and Fiscal 2019, respectively. In
applying business combination accounting pursuant to U.S. GAAP authoritative
literature in connection with each of these transactions, we recorded acquired
assets and liabilities at their fair values. The impacts of these purchase
accounting adjustments primarily resulted in reductions to deferred revenue,
increases to inventory, increases to long-lived assets and recognition of
indefinite-lived intangible assets and definite-lived intangible assets which
amortize over their assigned useful lives ranging from 9 to 14 years. See Note 6
(Goodwill and Other Intangible Assets) to our condensed consolidated financial
statements for additional information.
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The effects of purchase accounting adjustments on our operational performance
caused our pre-tax income from operations to be lower than we would otherwise
have recognized due to reduced revenue for the fair value adjustment to deferred
revenue, increased cost of sales due to step-up on inventory and increased
operating expenses due to step-up depreciation on property and equipment and
amortization of definite-lived intangible assets. The table below reflects the
line items of our Consolidated Statements of Operations impacted by these
purchase accounting adjustments:
Three months ended April 30, Nine months ended April 30,
(in thousands) 2021 2020 2021 2020
Purchase accounting adjustments to cost of
sales 126 241 1,449 4,836
Impact of purchase accounting on gross profit (126) (241) (1,449) (4,836)
Amortization of customer relationships and
other intangible assets 1,921 1,921 5,762 5,762
Impact of purchase accounting on selling,
general and administrative expenses 1,921 1,921 5,762 5,762
Impacts of purchase accounting on income before
income taxes $ (2,047) $ (2,162) $ (7,211) $ (10,598)
Casualty Gain
In February 2019 , one of our wineries experienced a flood resulting in damages
to inventory, machinery and equipment, and site improvements. As a result of the
flood, we filed an insurance claim which was settled in December 2020 for $32.5
million . The casualty gain consists of payments we received from our insurer
throughout Fiscal 2020 and Fiscal 2021 in excess of recognized losses.
Equity-Based Compensation
Vesting of certain of our Class M Common Units accelerated upon the occurrence
of the IPO. We recognized $8.5 million of additional equity-based compensation
expense on the vesting of certain outstanding Class M Common Units which were
converted to common shares during the third quarter of Fiscal 2021. In addition,
we granted employees, non-employee directors and other service providers
restricted stock units and/or options with respect to an aggregate of 1,627,929
shares of our common stock in connection with the consummation of the IPO. 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.
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 April 30, Nine months ended April 30,
(in thousands, except percentages) 2021 2020 2021 2020
Net sales $ 90,425 100.0 % $ 68,720 100.0 % $ 265,720 100.0 % $ 218,417 100.0 %
Cost of sales 43,496 48.1 32,378 47.1 132,759 50.0 107,458 49.2
Gross profit 46,929 51.9 36,342 52.9 132,961 50.0 110,959 50.8
Selling, general, and
administrative expenses 31,142 34.4 13,156 19.1 65,418 24.6 49,703 22.8
Casualty gain, net (421) (0.5) (24) - (6,636) (2.5) (4,047) (1.9)
Income from operations 16,208 17.9 23,210 33.8 74,179 27.9 65,303 29.9
Interest expense 3,755 4.2 4,221 6.1 10,947 4.1 13,905 6.4
Other (income) expense, net (2,192) (2.4) 3,183 4.6 (5,006) (1.9) 3,707 1.7
Total other expenses 1,563 1.7 7,404 10.8 5,941 2.2 17,612 8.1
Income before income taxes 14,645 16.2 15,806 23.0 68,238 25.7 47,691 21.8
Income tax expense 5,623 6.2 4,189 6.1 19,694 7.4 12,588 5.8
Net income 9,022 10.0 11,617 16.9 48,544 18.3 35,103 16.1
Less: Net loss (income)
attributable to non-controlling
interest - - 2 - 4 - (3) -
Net income attributable to The
Duckhorn Portfolio, Inc. $ 9,022 10.0 % $ 11,619 16.9 % $ 48,548 18.3 % $ 35,100 16.1 %
32-------------------------------------------------------------------------------- Comparison of the Three and Nine Months EndedApril 30, 2021 and 2020Net Sales Three months ended April 30, Change Nine months ended April 30, Change (in thousands, except percentages) 2021 2020 $ % 2021 2020 $ % Net sales$ 90,425 $ 68,720 $ 21,705 31.6 %$ 265,720 $ 218,417 $ 47,303 21.7 % Net sales for the three months endedApril 30, 2021 increased$21.7 million , or 31.6% to$90.4 million compared to$68.7 million for the three months endedApril 30, 2020 . Net sales for the nine months endedApril 30, 2021 increased$47.3 million , or 21.7% to$265.7 million compared to$218.4 million for the nine months endedApril 30, 2020 . The increases in both periods were primarily driven by volume growth, partially offset by negative mix contribution, with our Wholesale to Distributor channel growth outpacing the growth in ourCalifornia Direct to Retail and DTC channels. There were no material pricing changes for the periods presented. Cost of Sales Three months ended April 30, Change Nine months ended April 30,
Change
(in thousands, except percentages) 2021 2020 $ % 2021 2020 $ % Cost of sales$ 43,496 $ 32,378 $ 11,118 34.3 %$ 132,759 $ 107,458 $ 25,301 23.5 % Cost of sales increased by$11.1 million , or 34.3% to$43.5 million for the three months endedApril 30, 2021 compared to$32.4 million for the three months endedApril 30, 2020 . Cost of sales increased by$25.3 million , or 23.5% to$132.8 million for the nine months endedApril 30, 2021 compared to$107.5 million for the nine months endedApril 30, 2020 . The increases in both periods were directly driven by higher sales and decreased impact of step-up cost of wine due to purchase accounting adjustments from prior acquisitions. Gross Profit Three months ended April 30, Change Nine months ended April 30, Change (in thousands, except percentages) 2021 2020 $ % 2021 2020 $ % Gross profit$ 46,929 $ 36,342 $ 10,587 29.1 %$ 132,961 $ 110,959 $ 22,002 19.8 % Gross profit increased$10.6 million , or 29.1% to$46.9 million for the three months endedApril 30, 2021 compared to$36.3 million for the three months endedApril 30, 2020 . Gross profit increased$22.0 million , or 19.8% to$133.0 million for the nine months endedApril 30, 2021 compared to$111.0 million for the nine months endedApril 30, 2020 . The change in gross profit was primarily the result of: •higher sales volume; and •a reduction in step-up cost of wine sold for the nine months endedApril 30, 2021 versus the same period prior year, due to lower balances of remaining inventory with associated step-up from purchase accounting in previous periods. Gross profit margin was 51.9% for the three months endedApril 30, 2021 compared to 52.9% for the three months endedApril 30, 2020 . Gross profit margin was 50.0% for the nine months endedApril 30, 2021 compared to 50.8% for the nine months endedApril 30, 2020 . The decline depicts the shift in sales mix in favor of luxury wines sold in the Wholesale to Distributor channel in the current periods. 33 -------------------------------------------------------------------------------- Operating Expenses Selling, General and Administrative Expenses Three months ended April 30, Change Nine months ended April 30, Change (in thousands, except percentages) 2021 2020 $ % 2021 2020 $ % Selling expenses$ 9,699 $ 7,441 $ 2,258 30.3 %$ 26,425 $ 26,926 $ (501) (1.9) % Marketing expenses 2,314 1,016 1,298 127.8 6,239 5,446 793 14.6 General and administrative expenses 19,129 4,699 14,430 307.1 32,754 17,331 15,423 89.0 Total selling, general and administrative expenses$ 31,142 $ 13,156 $ 17,986 136.7 %$ 65,418 $ 49,703 $ 15,715 31.6 % Selling, general and administrative expenses increased$18.0 million , or 136.7% to$31.1 million for the three months endedApril 30, 2021 compared to$13.2 million for the three months endedApril 30, 2020 . Selling, general and administrative expenses increased$15.7 million , or 31.6% to$65.4 million for the nine months endedApril 30, 2021 compared to$49.7 million for the nine months endedApril 30, 2020 . In both periods, the increase was largely attributable to higher equity-based compensation in the current period, transaction expenses related to the IPO, lower expenses in the prior year comparative period given the uncertainty surrounding the early impacts of the COVID-19 pandemic, timing of compensation-related accruals, higher marketing spend to support new product innovation in the current period and new and ongoing costs related to being a public company. General and administrative expenses were higher for the three and nine months endedApril 30, 2021 , primarily due to equity-based compensation costs of$8.6 million and transaction expenses related to the IPO of$2.3 million incurred in the third quarter of Fiscal 2021. See Note 13 (Equity-Based Compensation) to our condensed consolidated financial statements for further information. Selling expenses were higher for the three months endedApril 30, 2021 partially due to equity-based and other compensation costs. Selling expenses decreased for the first nine months of Fiscal 2021 versus the same period in Fiscal 2020 due to the impacts of reduced business travel and the related costs of in-person sales activities that have been constrained due to COVID-19 restrictions in key markets where we operate, partially offset by increases in compensation costs. We typically expect selling expenses to trend in line with our sales growth as the activities are intended to generate revenues. Marketing expenses increased by$1.3 million and$0.8 million for the three and nine months endedApril 30, 2021 versus the comparative periods due primarily to new product innovation, in addition to increases in equity-based and other compensation costs, partially offset by a reduction in marketing and promotional events over the fiscal year as a result of the ongoing pandemic. Casualty Gain, Net Three months ended April 30, Change Nine months ended April 30, Change (in thousands, except percentages) 2021 2020 $ % 2021 2020 $ % Casualty gain, net$ (421) $ (24) $ (397) 1654.2 %$ (6,636) $ (4,047) $ (2,589) 64.0 % Casualty gain, net increased by$0.4 million , or 1654.2% for the three months endedApril 30, 2021 compared to the three months endedApril 30, 2020 . The increase was primarily due to the receipt of crop insurance proceeds of$0.5 million in excess of recognized losses from the impacts of wildfires resulting in fruit damage and other direct costs which occurred in the first quarter of Fiscal 2021. See Note 14 (Casualty Gain) to our condensed consolidated financial statements for further information. Casualty gain increased by$2.6 million , or 64.0% to$6.6 million for the nine months endedApril 30, 2021 compared to$4.0 million for the nine months endedApril 30, 2020 . The increase was primarily due to the timing of insurance proceeds related to a flood at one of our wineries. See Note 14 (Casualty Gain) to our condensed consolidated financial statements for further information. 34 --------------------------------------------------------------------------------
Other Expenses
Three months ended April 30, Change Nine months ended April 30, Change
(in thousands, except
percentages) 2021 2020 $ % 2021 2020 $ %
Interest expense 3,755 4,221 $ (466) (11.0) % $ 10,947 $ 13,905 $ (2,958) (21.3) %
Other (income) expense, net (2,192) 3,183 (5,375) (168.9) % (5,006) 3,707 (8,713) (235.0) %
Total other expenses, net $ 1,563 $ 7,404 $ (5,841) (78.9) % $ 5,941 $ 17,612 $ (11,671) (66.3) %
Other expenses decreased by $5.8 million , or 78.9% to $1.6 million for the three
months ended April 30, 2021 compared to $7.4 million for the three months ended
April 30, 2020 . Other expenses decreased by $11.7 million , or 66.3% to $5.9
million for the nine months ended April 30, 2021 compared to $17.6 million for
the nine months ended April 30, 2020 . The change in our other expenses for both
periods was primarily driven by downward pressure on LIBOR, which reduced the
liability balance on our interest rate swap, resulting in a gain for the three
and nine months ended April 30, 2021 as compared to losses in the same periods
in the prior year. In addition, our interest expense was also reduced year over
year driven by lower debt balances outstanding for the period, in conjunction
with lower average interest rates on our variable debt. See "-Liquidity and
capital resources" for discussion of our Credit Facility.
Income Tax Expense
Three months ended April 30, Change Nine months ended April 30, Change
(in thousands, except
percentages) 2021 2020 $ % 2021 2020 $ %
Income tax expense $ 5,623 $ 4,189 $ 1,434 34.2 % $ 19,694 $ 12,588 $ 7,106 56.5 %
Income tax expense increased $1.4 million , or 34.2% to $5.6 million for the
three months ended April 30, 2021 compared to $4.2 million for the three months
ended April 30, 2020 . Income tax expense increased $7.1 million , or 56.5% to
$19.7 million for the nine months ended April 30, 2021 compared to $12.6 million
for the nine months ended April 30, 2020 . The change in our income tax expense
was primarily due to state income taxes and non-deductible equity-based
compensation.
Liquidity and Capital Resources
Sources of Liquidity
Our primary cash needs are for working capital purposes, such as producing or
purchasing inventory and funding operating and capital expenditures. We fund our
operational cash requirements with cash flows from operating activities and
borrowings under our Credit Facility. As of April 30, 2021 , we had $5.0 million
in cash and cash equivalents and $286.0 million available in undrawn capacity on
our revolving line of credit, subject to the terms of our Credit Facility.
In response to the COVID-19 pandemic, we implemented measures designed to
protect the health and safety of our workforce, as described in "-Other factors
impacting the comparability of our results of operations-Impacts of COVID-19".
Our response also included evaluating risks related to our inventory and
liquidity management, which we determined to be sufficiently mitigated, subject
to reassessment in the future in response to pandemic-related impacts as they
occur. The full impact of COVID-19 on our future operations remains uncertain
and will be determined by the length and severity of pandemic-related
disruption. Consequently, unforeseen future events could negatively impact our
operations, results of operations, cash flows and liquidity.
Due to the seasonal nature of our operations, our cash needs are greater 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 at least the next 12
months. However, changes in our business growth plan, planned capital
expenditures or responses to an ever-changing and highly competitive industry
landscape may result in changes to our cash requirements. As a result, we may
seek alternative or incremental funding sources to respond to changes in our
business. To the extent required, we may 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.
35
--------------------------------------------------------------------------------Cash Flows The following table presents the major components of net cash flows for the periods indicated.
Nine months ended April 30,
(in thousands) 2021 2020
Cash flows provided by (used in):
Operating activities $ 41,536 $ 41,981
Investing activities (11,400) (11,539)
Financing activities (31,361) (3,534)
Net (decrease) increase in cash $ (1,225) $ 26,908
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 nine months ended April 30, 2021 , net cash provided by operating
activities was $41.5 million compared to $42.0 million for the nine months ended
April 30, 2020 , a decrease of $0.4 million . The decrease in cash provided by
operating activities was driven by the following, largely offsetting factors:
•Operating cash flows increased due to an increase in net income of $12.6
million after adjusting for non-cash items;
•Increased prepaid insurance premiums on new and existing policies, bulk wine
supply management and inventory packaging to support increases in demand
resulted in a decrease to operating cash flow of $16.8 million ;
•Our wholesale sales channel, generally subject to credit terms, saw an increase
in net sales, which drove a corresponding increase in accounts receivable and
resulted in a $12.3 million decrease in operating cash flow;
•Changes in accounts payable and accrued expenses increased operating cash flows
$10.4 million due primarily to timing of invoice payments;
•Increases in accrued compensation of $7.2 million based on the timing of
certain bonus payments and other compensation resulted in an increase in
operating cash flow; and
•The timing related to list member sales as compared to previous periods
decreased deferred revenues and operating cash flows by $1.1 million .
Investing Activities
For the nine months ended April 30, 2021 , net cash used in investing activities
was $11.4 million compared to $11.5 million for the nine months ended April 30,
2020 , a decrease of $0.1 million . Capital expenditures were $11.5 million for
the nine months ended April 30, 2021 and $11.6 million for nine months ended
April 30, 2020 . From time to time we evaluate wineries, vineyards and production
facilities for potential opportunities to make strategic acquisitions to support
our growth. Any such transactions may require us to make additional investments
and capital expenditures in the future.
Financing Activities
For the nine months ended April 30, 2021 , net cash used in financing activities
was $31.4 million as compared to $3.5 million for the nine months ended April
30, 2020 , an increase of $27.8 million . The increase in cash used in financing
activities was primarily the result of an increase in net payments on our
revolving line of credit of $17.0 million , further increased due to no cash
borrowings on our term debt in Fiscal 2021 compared to cash borrowings on
$13.1 million in the same period of prior year. These increases were partially
offset by IPO proceeds received that will be used to repay deferred offering
costs incurred but not yet paid totaling $3.1 million .
36
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Credit Facility
On October 14, 2016 , we entered into the Credit Facility with a syndicated group
of lenders. The Credit Facility provides a combination of term and revolving
line of credit features. The term and revolving line of credit borrowings have
variable interest rates, based primarily on LIBOR plus an applicable margin as
defined in the First Lien Loan Agreement. Interest is paid monthly or quarterly
based on loan type. Our debt is collateralized by substantially all of our cash,
trade accounts receivable, real and personal property. Pursuant to the terms and
conditions of the First Lien Loan Agreement, we have issued the instruments
discussed below.
As of April 30, 2021 , outstanding principal balances on the debt instruments
were $139.0 million for the revolving line of credit, $10.3 million for the
capital expenditure loan, $105.1 million for the term loan (tranche one) and
$14.4 million for term loan (tranche two).
The First Lien Loan Agreement contains customary affirmative covenants,
including delivery of audited financial statements and customary negative
covenants that, among other things, limit our ability to incur additional
indebtedness or to grant certain liens. As of April 30, 2021 , we were not in
violation of any covenants.
Revolving Line of Credit
The revolving line of credit allows us to borrow up to a principal amount of
$425.0 million (including a letter of credit sub-facility of the revolving loan
facility in the aggregate of $15.0 million and a swingline sub-facility of the
revolving loan facility in the aggregate of $15.0 million ), with an incremental
seasonal borrowing amount for harvest costs increasing the total amount to a
maximum of $455.0 million . The revolving line of credit matures on August 1,
2023 . The interest rate ranges from LIBOR plus 125 basis points to LIBOR plus
175 basis points depending on the average availability of the revolving line of
credit.
Capital Expenditure Loan
The capital expenditure loan has a maximum, non-revolving draw-down limit of
$25.0 million with quarterly principal payments and the remaining unpaid
principal and interest due upon maturity on August 1, 2023 . As of April 30,
2021 , the $25.0 million limit was fully drawn. This instrument has an interest
rate of LIBOR plus 190 basis points.
Term Loans
The first tranche of term loans was issued in 2016 for a principal balance of
$135.0 million with quarterly principal payments and the remaining unpaid
principal and interest due upon maturity on August 1, 2023 . This tranche of the
term loans has an interest rate of LIBOR plus 190 basis points.
The second tranche of term loans was issued in August 2018 , allowed for a
principal balance up to $25.0 million with quarterly principal payments and the
remaining unpaid principal and interest due upon maturity on August 1, 2023 . We
drew $16.4 million of the second tranche of the term loan in November 2018 . This
tranche of the term loans has an interest rate of LIBOR plus 163 basis points.
Off-Balance Sheet Arrangements
As of April 30, 2021 , we did not have any off-balance sheet arrangements that
have, or are reasonably likely to have, a current or future 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 consolidated financial statements, which are
prepared in accordance with U.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.
37
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There have been no material changes in our critical accounting policies during
the nine months ended April 30, 2021 , as compared to those disclosed in the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Critical Accounting Policies" in this Quarterly Report on From 10-Q
and in Note 2 (Basis of Presentation and Significant Accounting Policies) to the
notes to our condensed consolidated financial statements included in Part I,
Item 1 of this Report.
Recent Accounting Pronouncements
See Note 2 (Basis of Presentation and Significant Accounting Policies) to our
condensed consolidated financial statements included in Part I, Item 1 of this
Report for additional information regarding recent accounting pronouncements.
Emerging Growth Company status
We are an emerging growth company, as defined in the JOBS Act. Section 107 of
the JOBS Act provides that an "emerging growth company" can take advantage of
the extended transition period provided in Section 7(a)(2)(B) of the Securities
Act for complying with new or revised accounting standards. In other words, an
"emerging growth company" can delay the adoption of certain accounting standards
until those standards would otherwise apply to private companies. Section 107 of
the JOBS Act provides that any decision to opt out of the extended transition
period for complying with new or revised accounting standards is irrevocable. We
have elected to use this extended transition period for complying with new or
revised accounting standards that have different effective dates for public and
private companies. As a result, our financial statements may not be comparable
to companies that comply with the new or revised accounting pronouncements as of
public company effective dates.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Interest Rates
We are subject to interest rate risk in connection with changes in interest
rates on our credit facilities which bear interest at variable rates based upon
LIBOR plus applicable margins pursuant to the terms of our Credit Facility. As
of April 30, 2021 , our outstanding borrowings at variable interest rates totaled
$268.8 million . An increase in the effective interest rate applied to these
borrowings of 100 basis points would result in a $2.7 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 two interest rate
swaps.
Inflation
We do not believe that inflation has had a material impact on our business,
results of operations or financial condition to date. We continue to track the
impact of inflation in an attempt to minimize its effects through pricing
strategies and cost reductions. If however our operations are impacted by
significant inflationary pressures, we may not be able to fully offset such
impacts through price increases on our products, supply negotiations or
production improvements. A higher than anticipated rate of inflation in the
future could harm our operations and financial condition.
Foreign Currency
Our revenues and costs are denominated in U.S. dollars and are not subject to
significant foreign exchange risk. Fluctuations in foreign currency exchange
rates may cause us to recognize transaction gains and losses in our 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 of the Company's
outstanding foreign exchange forward contracts as of July 31, 2020 was two
months and the maximum term for outstanding foreign exchange forward contracts
as of April 30, 2021 was five months.
38
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Commodity Prices
The primary commodity in our product is grapes, and generally more than 85% of
our input grapes are sourced from third party suppliers in the form of grapes or
bulk wine. For these purchased grapes and bulk wine, prices are subject to many
factors beyond our control, such as the yield of different grape varietals in
different geographies, the annual demand for these grapes and the vagaries of
these farming businesses, including poor harvests due to adverse weather
conditions, natural disasters and pestilence. Our grape and bulk wine supply mix
varies from year to year between pre-contracted purchases and spot purchases;
the variation from year to year is based on market conditions and sales demands.
We do not engage in commodity hedging on our forecasted purchases of grapes and
bulk wine. We continue to diversify our sources of supply and look to changes
annually to our product line to optimize the grapes available each harvest year.
Other raw materials we source include glass, corks and wine additives. We
currently source these materials from multiple vendors. We have and will
continue to negotiate prices with these suppliers on an annual basis, conducting
a competitive bidding process for all raw materials to leverage our volume in
lowering the input costs of production.
Item 4. Controls and Procedures.
Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in the reports that we file or submit under
the Securities Exchange Act of 1934, as amended, (the "Exchange Act") is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms and that such information is accumulated and
communicated to our management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
financial disclosure.
As of the end of the period covered by this 10-Q Report, our management, under
the supervision and with the participation of our principal executive officer
and principal financial officer, evaluated the effectiveness of our disclosure
controls and procedures pursuant to 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 April 30, 2021 , our disclosure controls and
procedures were effective to provide reasonable assurance that information
required to be disclosed in reports we file pursuant to the Exchange Act is
communicated to management as appropriate for 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 April 30, 2021 .
Limitations on the Effectiveness of Controls
Our disclosure controls and procedures and internal control over financial
reporting are designed to provide reasonable assurance of achieving their
objectives as specified above. Management does not expect, however, that our
disclosure controls and procedures will prevent or detect all error and fraud.
Any control system, no matter how well designed and operated, is based on
certain assumptions and can provide only reasonable, not absolute, assurance
that its objectives will be met. Further, no evaluation of controls can provide
absolute assurance that misstatements due to error or fraud will not occur or
that all control issues and instances of fraud, if any, within the Company have
been detected.
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