The Duckhorn Portfolio, Inc. (NYSE:NAPA) Q2 2024 Earnings Call Transcript

The Duckhorn Portfolio, Inc. (NYSE:NAPA) Q2 2024 Earnings Call Transcript March 7, 2024

The Duckhorn Portfolio, Inc. misses on earnings expectations. Reported EPS is $0.1374 EPS, expectations were $0.18. NAPA isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good evening, ladies and gentlemen. Thank you for joining today’s Duckhorn Portfolio Q2 2024 Earnings Conference Call. My name is Cole, and I’ll be the moderator for today’s call. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. [Operator Instructions]. I’d now like to turn the call over to our host, Ben Avenia-Tapper, Vice President, Investor Relations. Please proceed.

Ben Avenia-Tapper: Good afternoon, and welcome to the Duckhorn Portfolio’s second quarter 2024 earnings conference call. Joining me on today’s call are Deirdre Mahlan, Interim President, Chief Executive Officer and Chairperson; Jennifer Fall Jung, Chief Financial Officer; and Sean Sullivan, Chief Strategy and Legal Officer. In a moment, we will give brief remarks followed by a Q&A. By now, everyone should have access to the earnings release for the second quarter ended January 31, 2024, that went out at approximately 4.05 PM Eastern Time. The press release and an accompanying presentation are accessible on the company’s website at ir.duckhorn.com. And shortly after the conclusion of today’s call, a webcast will be archived for the next 30 days.

Before we begin, I would like to remind you that today’s discussion contains forward-looking statements based on the environment as we currently see it, and as such, includes risks and uncertainties. If you refer to Duckhorn’s earnings release, earnings presentation, and the company’s most recent SEC filings, you will see a discussion of factors that could cause the company’s actual results to differ materially from these forward-looking statements. Please remember, the company undertakes no obligation to update or revise these forward-looking statements in the future. We will make a number of references to non-GAAP financial measures. We believe that these measures provide investors with useful perspective on the underlying growth trends of the business, and have included in our earnings release a full reconciliation of non-GAAP financial measures to the most comparable GAAP measures.

In addition, please note that all retail scanner data cited on today’s call is according to Circana and will refer to dollar or unit consumption for the 12-week period ended January 28, 2024, and growth versus the same period in the prior year in U.S. track channels, unless otherwise noted. With that, I’ll turn the call over to Deirdre.

Deirdre Mahlan: Thanks, Ben, and good afternoon, everyone. Thank you for joining us today to discuss our second quarter 2024 financial performance. Following my opening remarks, Jennifer will walk us through our quarterly results and updated fiscal year 2024 financial guidance. Amid challenging market conditions, our net sales fell short of our expectations. However, Duckhorn wines consistently outperformed the broader $15 and above luxury wine market as reported by Circana. While we expect to continue to take share and outpace the luxury market, we believe the softness across the industry will persist in the coming quarters. The industry growth rate for luxury wine over the past 12 weeks has been flat to 1%, which we expect to continue, and that is what we assume in our updated guidance for fiscal 2024.

With the largest segment of the Duckhorn Portfolio volume in the $15 to $25 price tier that continues to outperform the broader market, plus the strength of our brand equity and incremental initiatives in the second half, we believe we are well positioned to exceed industry growth. Despite these broader market headwinds, we delivered strong profitability in the second quarter and continue to take share as we focused on those factors within our control. Importantly, we grew adjusted EBITDA by approximately 10% to $42.7 million, an adjusted EBITDA margin of 41.5%, which is a 400 basis point improvement over the prior year period, driven by robust gross margins and strong operating cost management. Not only does this speak to the Duckhorn Portfolio’s strength as a luxury wine operator, it is also evidence of our ability to manage our business effectively and profitably across multiple demand environments.

To highlight our ability to outpace the broader market, we outperformed total wine by more than 300 basis points and the luxury wine market by nearly 200 basis points over the quarter, according to Circana data. However, while we continue to take share, distributor and retailer inventory adjustments did impact our top line results, as we saw evidence of both tiers taking a cautious view of market growth and more assertively managing inventory. The industry outlook for the second half of our fiscal year remains cautious. Incorporating our second quarter results and the challenging market conditions, we are revising the midpoint of our full year guidance, such that the implied second half growth rate is in the low to mid-single-digit range, which reflects a softer near-term outlook for the industry, offset by Duckhorn’s proven ability to outperform the luxury wine market.

Our conviction of the second half comes from multiple factors, which I’ll discuss here, but I also encourage you to refer to our new earnings presentation, which includes a slide detailing the building blocks of our second half expectations. As previously described, our outlook assumes the luxury wine market continues to perform as it has in the recent 12-week period, which has been in the flat to 1% range. We view our proven ability to exceed that industry growth rate as our baseline for the second half. On top of that baseline of steady state growth, we see additional second half upside of approximately 200 to 300 basis points from three distinct initiatives. In order of magnitude, these three items are; first, innovation, which encompasses Decoy Featherweight, our new lowering calorie, lowering alcohol Sauvignon Blanc, as well as the introduction of an Appalachian-specific Decoy-limited Paso Robles Cabernet Sauvignon, plus the continuation of strong growth in Decoy limited offerings.

Second, improved product availability in some of our most popular wines, including Duckhorn Chardonnay and Decoy Limited Merlot. And third, incremental programming with our distributors and retail partners, including reintroducing by-the-glass programs, among other opportunities. These initiatives are expected to add additional upside to growth in the second half, contributing to our revised full year outlook for net sales between $395 million and $411 million. I’ll now turn to the results from the quarter. In the wholesale channel, we saw distributor and retailer inventories decline in dollar terms as they reduced forward-looking forecasts to account for softer market conditions. Despite these challenges and the resulting impact on net sales, the Duckhorn brands continued to grow within the channel with consistent end-consumer demand, as supported by trailing Circana data.

This underpins our confidence in a return to more normalized alignment between shipments and depletions over the longer term, as we look past the near-term industry softness. On the direct-to-consumer side, visitation at our tasting rooms is showing positive signs, but our club membership remains below pandemic highs. As we’ve previously discussed, we see meaningful opportunity for our DTC business, which is one of our four organic growth pillars. DTC, important in its own right as a sales and marketing channel, has a valuable halo effect on the wholesale business. We continue to focus on reaching consumers in the way that resonates most effectively. This includes the curation of ultra-high-end experiences as we leverage the opportunity to build lasting relationships with our most valuable customers.

Drilling down within our portfolio, I want to take time to recognize Decoy, a brand we created more than three decades ago. It has consistently grown through varietal extensions and innovation. Today, Decoy continues to delight consumers, generating strong growth in excess of its price tier and sustaining a position as one of the most popular luxury wines available, both from a sales and brand awareness perspective. Perhaps nothing speaks to the strength of the broader Decoy brand more than our success with Decoy Limited. Launched in 2020 at a higher price point, Limited continues to deliver strong double-digit growth in Circana data. Finally, from a channel perspective, we continue to see growth in the number of accounts, both on-premise and off-premise, that carry our wine.

This increase in accounts is a key part of our wholesale growth strategy and further proof of the strength of the Duckhorn Portfolio as a whole, as well as individual brands within it. I also note that the acquisition of Sonoma-Cutrer unlocks a unique opportunity to introduce Duckhorn Portfolio wines to Sonoma-Cutrer vineyard accounts and vice versa. Based on our early analysis, we see significant opportunity to cross-sell our brands post-closing. The opportunity to increase the number of labels per account is considerable and something we’re incredibly excited about, as we look toward the close of this acquisition. Additionally, as part of our integration planning, we have initiated a comprehensive review of our wholesaler alignment strategy to ensure that the route to market for our combined portfolio is efficient and optimized for growth.

Continuing with our acquisition of Sonoma-Cutrer, I’ll note that we remain on track to close this spring. We are acquiring an incredible asset that is a great fit within our portfolio brand architecture, as evidenced by the opportunity to capitalize on incremental accounts and labels per account, as I just described. When we first announced our plans, we described approximately $5 million of cost synergies, primarily in OpEx. With additional time and visibility in the intervening several months, we now believe that number to be the minimum in cost savings, as we find additional opportunities to extract costs from the combined entity’s operating expenses. We’re making excellent progress and look forward to updating you when we close later this spring.

I’ll conclude by saying, while we have more work to do, we’re pleased with the hard work and execution of our team in a challenging environment. The strength of the Circana data speaks to our robust brand equity and supports our confidence in our ability to weather near-term demand fluctuations, while continuing to drive sustained long-term profitable growth. With that, I’ll turn over to Jennifer to provide more details on the financial results for the quarter and our outlook for the year.

Jennifer Fall Jung: Thank you, Deidre, and good afternoon, everyone. We continue to effectively navigate a dynamic demand environment. Despite the near-term softness in net sales, we delivered profitability well above expectations on strong gross margins and active operating expense management. I’ll now provide the results from the quarter. All comparisons are to the second quarter of fiscal 2023, unless otherwise stated. Beginning with the top line, net sales were 103 million, a decrease of 0.4% as the distributor and retail inventory reset extended beyond our initial expectations. By channel, wholesale to distributor net sales were flat in Q2. As previously discussed, net new accounts and label per account were offset by tighter inventory controls across the supply chain.

Despite these factors with our distributor and retail partners, we continue to deliver on our strategic objectives to leverage the brand and expand our wholesale accounts, both of which represent key drivers of our net sales growth. Distributor inventory days on hand was broadly in line with our expectations of 65 days. California wholesale direct-to-trade declined 2.6%, driven by the same factors that impacted wholesale-to-distributor net sales. The direct-to-consumer channel was down 4.3%, roughly in line with our expectations during what is typically a lighter quarter for the DTC business. As we previously noted, we continue to adjust our DTC business to position it for success amidst a period of post-pandemic transition. Moving down the P&L, second quarter gross profit was 58.3 million, a gross margin of 56.6%, up approximately 330 basis points year-over-year as we optimize our trade spend in line with the lower depletion volumes in the quarter.

In keeping with our expectations for improved second half growth, we have trade spend to be more in line with our historical levels. SG&A was 29.2 million, a decrease of 1% year-over-year. On an adjusted basis, total SG&A declined 0.7 million, or 3%, to 21.9 million, driven by strong cost management throughout the quarter. This represents 50 basis points of leverage despite flat net sales. Note that adjusted operating expenses exclude 1.8 million of transaction costs, primarily related to our pending acquisition of Sonoma-Cutrer Vineyards. Net income was 15.9 million, or 0.14 per diluted share. Adjusted net income was 20.7 million, or 0.18 per diluted share. Adjusted EBITDA was 42.7 million, an increase of 3.9 million, or 10.1% year-over-year.

Adjusted EBITDA margin improved 400 basis points versus the prior year period, to 41.5%, driven by gross margin improvement and strong cost controls. At the end of the quarter, we had cash of 13.1 million and total debt of 283.8 million, resulting in our leverage ratio of 1.9x net debt due to the seasonality of grower payments. I’ll now share our updated full-year fiscal 2024 outlook, which reflects our second quarter results as well as our current expectations for second half growth. These expectations are influenced by near-term softness across the industry, but offset by both our proven ability to outperform luxury wine and incremental growth driven by multiple initiatives rolling out in the second half of the year. As a reminder, our guidance does not include our pending acquisition of Sonoma-Cutrer.

For the full fiscal year 2024, we now expect net sales in the range of 395 million to 411 million, which represents growth of approximately minus 2% to positive 2%, which implies low-to-mid single-digit growth for the second half of 2024, as Deirdre discussed. For adjusted EBITDA, we expect a range of 145 million to 150 million, or flat to 4% growth. This represents an adjusted EBITDA margin of 36.6% at the midpoint, up 80 basis points from our previous guidance as we continue to focus on execution and cost management. For adjusted EPS, we expect a range of 0.63 to 0.65 per diluted share. I also want to provide some color on what we expect from a seasonality perspective, due primarily to the timing of our Costa Brown Appalachian Series offering, the largest annual release from our Costa Brown winery brand.

You can also find this detail in our accompanying presentation. As we’ve described previously, this release will be shipped in the third quarter rather than the fourth quarter, as was the case in fiscal 2023. As a result, we expect significant variance between the third and fourth quarter net sales growth rates versus the respective prior year quarter. More specifically, we expect a second half net sales split of approximately 53% in the third quarter and 47% in the fourth quarter. On the gross margin front, two factors will impact gross margin in the second half of fiscal 2024, both of which are driven by an improvement in product availability for some of our most popular products. First, we’re restarting our wine-by-the-glass program, which drives sales both directly and indirectly to enhance brand awareness, albeit at a lower margin.

The second factor is increased trade spend relative to last year and the first half of the year. We continue to expect second half trade spend to return to historical levels and align with our growth expectations. As a result, we expect the fiscal 2024 third and fourth quarter gross margin to be below the high point achieved in the second quarter. While second quarter net sales were lower than anticipated, we are pleased with our ability to toggle the business to ensure we continue to deliver margin expansion. Importantly, we expect the inventory adjustments caused by a shifting post-pandemic outlook will be smaller in the second half and anticipate they will be largely complete this fiscal year. As a leading luxury wine company with one of the strongest brands in the industry, we are confident in our ability to continue to take share and deliver sustained, profitable, long-term growth.

Thank you. I will now hand it back to Deirdre.

Deirdre Mahlan: Thanks, Jennifer. I’m coming up on my six-month mark as interim CEO of the Duckhorn Portfolio, and despite the challenging industry dynamics, I’m pleased with the progress the organization is making to deliver on our future growth plans, including completion of the Sonoma-Cutrer acquisition and second half innovation launches. We remain committed to delivering sustained, profitable growth and will always strive to create value in the long term for our shareholders. Our long-term growth drivers remain consistent, leveraging our brand strength, evolving our portfolio, expanding our wholesale network, and growing our DTC channel. These drivers will support our growth through the current demand environment and beyond.

Before I move to questions, I’ll provide a brief update on our CEO search. The search committee has made great progress and has narrowed down the initial pool of candidates to several that the board is very pleased with, and I’ll look forward to updating you as we continue with the process. With that, Jennifer, Sean, and I are available to take your questions.

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Q&A Session

Operator: [Operator Instructions]. Our first question is from Nik Modi with RBC. Your line is now open.

Nik Modi: Hi. Thank you. Good afternoon, everyone. So just two quick questions. Deirdre, I was hoping you can comment on just the overall consumption backdrop. Certainly, the change in guidance was a function of inventory dynamics, but I was wondering if you can just comment at the consumer level in terms of, from your perspective, what you see happening. And then the second question you mentioned something about wholesale optimization, and so I was hoping you could just provide a little bit more clarity and maybe what you think about the California business, if you’re rethinking your go-to-market in that state. Thank you.

Deirdre Mahlan: Okay, thanks. First, I’ll give you my view on the consumer, although I would say, as I’m sure you hear from many, this is quite a difficult time to forecast consumption. Clearly, we’re fortunate to be operating in price tiers in the wine sector that actually are in growth and have remained in growth through much of what has been kind of a volatile post-pandemic period. I think the reason for our guidance and what’s reflected here is that we expect kind of a continued variable response from the consumer in terms of their behaviors, both in the on and off-premise. And there’s a dynamic happening that we’re seeing that there seems to be more activity in the on-premise in particular versus what was happening in the pandemic levels, in the pandemic time, and that’s affecting both our DTC and our kind of chain business in the off-premise.

The zero to one range that we quote, that has been stable really for a period. Some periods it’s a little down, some periods it’s a little up. But if you look across consecutive 12-week periods, which take out some of the bumps, that’s pretty much, that’s been stable is probably even not the right word, but it hasn’t deviated too much from that range. So I think as we come through this next six months, it’ll be important to see where everyone is expecting interest rates to come down and some abatement and inflation, what the consumer behavior looks like. I do think it’s important to note that we’re not seeing trading down much out of this price tier in our core consumers. People may be moving from some of the 20s into the 16 or 17, but we’re not seeing evidence of people going from above 15 down to $10.

I mean, that is not a trend that we’re seeing, and you can see that actually in the Circana data. So if we look forward, we’re really barring any trigger that would show that there’s a shift. We’re just expecting that to continue for the rest of the fiscal year in any event as we see it play out. With respect to your second question on the distributors, yeah, I mean, I think Duckhorn has been growing and is now significantly at a scale business, has a couple of big scale brands if you consider the acquisition, the pending acquisition of Sonoma-Cutrer. So we thought this was the right moment for us to take a step back and look at our wholesaler relationships, how we’re aligned. As you can imagine, the Duckhorn Portfolio was represented in some states and Sonoma-Cutrer represented by a different wholesaler in the same state.

So we had some alignment we needed to do anyway, and we decided to take a step back and do a full and comprehensive review with our wholesalers on thinking about the business going forward, and everything’s on the table. We’re looking at all of our business. We’re, of course, happy with, and we’ve talked about California before, but we will always kind of keep evaluating all of the potential opportunities as we think about that.

Nik Modi: Great. Thank you. I’ll pass it on.

Deirdre Mahlan: Thanks, Nik.

Operator: Our next question is from Kaumil Gajrawala with Jefferies. Your line is now open.

Kaumil Gajrawala: Thanks, everybody. This is a little bit of a follow-up on Nik’s question. I think we want to just try to really dig into what caused the wholesalers to decide that they have a much more negative view on the back half, which obviously led to the inventory corrections. What are they observing or seeing to give them that sense? And then maybe the second piece is, for quite some time, you’ve been a distribution story. And I’m curious as we think about your guidance, how much incremental distribution as a contributor to sales growth is embedded in that?

Deirdre Mahlan: Okay. So let me start with the first question. I can talk to you about what our wholesalers and distributors have conveyed to us as we’ve kind of came through the second quarter and kind of can see the weakness in their orders, even though we were still seeing growth in our business. And what I’ve been hearing and our guidance at the end of the first quarter expected this situation to abate. We thought, and clearly, obviously from our first quarter guidance, that that situation would improve, and it did not. In fact, it got a bit softer. And our wholesalers are kind of saying the same thing to us, which is that when you come through 2023, there has been softness in terms of the retail trade, what they saw as retailer destocking, retailers taking smaller deals in terms of the cases that they were buying and being more reticent about buying inventory.

So they were clearly managing their inventory. As the price increases stopped in grocery and they had to worry about their own working capital, increasing interest rates, et cetera. What our wholesalers have told us is they expected that to improve in the second half of 2023, and it didn’t. So then when you got into the second half and through our second quarter, they weren’t seeing improvement in terms of retailer behavior. So they then started taking a more conservative view themselves and manage inventory down. And I think the retailers are seeing what we all know and read about in the press, about the concerns about the consumer on inflation and on food prices, et cetera, and are just looking to make sure that they’re managing their inventories effectively.