The Duckhorn Portfolio, Inc. (NYSE:NAPA) Q3 2023 Earnings Call Transcript

The Duckhorn Portfolio, Inc. (NYSE:NAPA) Q3 2023 Earnings Call Transcript June 8, 2023

The Duckhorn Portfolio, Inc. beats earnings expectations. Reported EPS is $0.16, expectations were $0.12.

Operator: Good morning, and thank you for attending today’s Duckhorn Portfolio Q3 2023 Earnings Conference Call. My name is Jason. I’ll be the moderator for today’s call. All lines will be muted during the presentation portion of the call, an opportunity for questions-and-answers at the end. [Operator Instructions] I would now like to pass the conference over to your host, Sean Sullivan.

Sean Sullivan: Good afternoon, and welcome to the Duckhorn Portfolio’s third quarter 2023 earnings conference call. Joining me on today’s call are Alex Ryan, our President, CEO and Chairman; and Lori Beaudoin, our Chief Financial Officer. In a moment, we will give brief remarks followed by Q&A. By now, everyone should have access to the earnings release for the fiscal quarter ended April 30, 2023, that went out at approximately 4:05 P.M. Eastern Time. The press release is 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 as well as 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 total U.S. food scanner data cited on today’s call will refer to dollar or unit consumption for the 12-week period ended April 30, 2023 and growth versus the same period in the prior year, unless otherwise noted.

With that, I will turn the call over to Alex.

Alex Ryan: Thank you, Sean, and good afternoon, everyone. Thank you for joining us today to discuss our solid third quarter financial performance. Following my opening remarks, Lori will walk us through our quarterly results and upwardly revised fiscal year 2023 financial outlook. She will then turn the call to Sean who will discuss an exciting M&A development. At the end of our prepared remarks, we will open the call for questions. I would like to begin today’s call by offering a few highlights from the quarter. First, from a top line perspective, we performed in line with our expectations as wholesale drove high-single digit net sales growth, while DTC declined due entirely to previously discussed shifts in the timing of our cost around offerings between fiscal Q3 and Q4.

Absent these changes in offering timing, DTC would have been up modestly. Second, our volume grew by 3.5%, generally consistent with our first half performance depletion growth moderately trailed shipment growth. However, we continue to make good progress on our considerable distribution white space opportunity as both accounts sold and the number of labels per account contributed positively in the quarter. Third, our portfolio remained a category growth leader within the $15 per bottle and above luxury subsegment of wine despite a challenging macroeconomic environment weighing on near-term consumer discretionary spending. Mid-single digit consumption growth and continued market share gains were once again led by Duckhorn Vineyard and Decoy.

Of note, Decoy Limited experienced over 15% dollar growth showcasing the strength of the overall Decoy brand and its ability to extend into higher price points and address new consumption opportunities. We have always prided ourselves on our Merlot lines, and we could not be happier with the response to our recent Decoy Limited Merlot release. And fourth, in spite of the gross margin headwinds, the Kosta Browne timing shift posed in the quarter, once again, we managed to generate strong adjusted EBITDA growth supported by robust adjusted gross margin expansion and sound expense control. Now let’s look at on and off-premise dynamics. Off-premise performance moderated relative to our second quarter. However, we continued to realize solid contributions from several key metrics, including accounts sold and number of labels per account, which we attribute to our ongoing investments in our sales force, the appeal of our one-stop luxury wine shop model as well as the quality and brand strength of our portfolio of fine luxury wines.

Third quarter on-premise growth was challenged by somewhat slower dining activity, especially when lapping tough prior year comparisons that benefited from the continued on-premise reopening. However, we still grew our account base and as we have discussed in previous earnings calls, getting into new accounts is a top priority for us as we seek to further penetrate the considerable wholesale distribution white space opportunity we have identified. Furthermore, labels per account growth was generally consistent with prior quarters, reinforcing our view that restauranteurs continue to consider us a trusted partner within luxury wine. I’ll now turn to our high-margin direct-to-consumer business, which performed solidly in line with our expectations for the quarter.

As previously communicated, our cost around Appalachian series offering, our highest volume cost around offering shifted into the fourth quarter, while the Merlot Limited higher tier estate series offering shifted into the third quarter. While this shift negatively impacted our third quarter performance, we look forward to the fourth quarter when our DTC channel performance will realize the benefits from the timing shift of the Appalachian series. Although, the channel was down overall for the third quarter, we continually see healthy trends in our club sales as these exclusive and bespoke offerings consistently pleased our dedicated wine enthusiasts. Additionally, despite the inclement weather during the quarter, which resulted in closures as well as generally unfavorable conditions, the performance of our tasting rooms was quite encouraging, reflected in net sales growth and higher average dollar spend per customer.

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Our bookings for the summer are also looking good and we are excited to continue capitalizing on these positive trends. Last month, we announced that we signed an agreement to acquire a production winery and planted vineyards in Alexander Valley, Sonoma County. The acquisition will bolster our production capacity and provide the company with a fully operational and modern facility with state-of-the-art winemaking equipment appropriate for luxury wines. In addition to the production facility, the property also includes 7 acres planted to Cabernet Sauvignon. Sean and Lori will be discussing this in more detail later in the call. Before I turn the call over to Lori, I’d like to update you on our CFO search process. At the end of May, we are pleased to announce that we have hired Jennifer Fall Jung as our next Executive Vice President and Chief Financial Officer.

I cannot be more excited to welcome Jennifer to the Duckhorn Portfolio, given her strong financial acumen, deep operational experience and proven track record of developing and leading successful strategic efforts at iconic consumer products companies like Funko and the Gap. On behalf of the entire Duckhorn family, I would once again like to thank Lori for her leadership, dedication and immeasurable contributions to the Duckhorn Portfolio over a 14-year tenure with the company. We would not be where we are today, if not for Lori’s steady hand, guiding the company through a global recession, pandemic, IPO and countless other challenges while also instilling a culture of discipline and accountability along the way. Lori leaves Duckhorn Portfolio well positioned for continued success, not only as a public company, but also as an established industry leader in luxury wine.

We are deeply grateful for everything that she has done and wish her the best in her retirement. I’ll now hand it over to Lori to discuss our third quarter performance and updated fiscal year 2023 outlook in greater detail.

Lori Beaudoin: Thank you, Alex, and good afternoon, everyone. It’s a pleasure to be speaking with you on what is officially my final earnings call as CFO of the Duckhorn Portfolio. My 14 years here have been the proudest period of my long career, and I truly value the immensely talented and dedicated team we have at this incredible organization. Based on Jennifer’s extensive experience and our interactions to-date, I have the utmost confidence in her ability to fill my role effectively. Over the course of the next several weeks, I will work diligently with her to ensure a seamless transition and upon my official retirement, I will remain available in an advisory role. I am pleased to be retiring at a period of strength for the company and firmly believe the Duckhorn Portfolio will continue to grow and remain a driving force within luxury wine for many years to come.

I will now turn to our third quarter results. Beginning with our top line, net sales were $91.2 million, a 0.4% decrease in organic growth compared to the prior year period and consistent with our expectations. Results reflected negative price mix contribution mainly attributable to the expected decline in the DTC channel, partially offset by 3.5% growth in volumes and planned price increases. The decrease in our high margin DTC channel resulted from the previously mentioned shift in cadence of the Kosta Browne, Appalachian series, our largest ever Kosta Browne offering, from the third quarter into the fourth quarter. At the same time, our Merlot Limited higher tier estate series offering shifted from the fourth quarter into the third quarter.

Absent these timing shifts, we would have seen low double-digit net sales growth overall for the quarter, which speaks to the health of our business. As Alex noted earlier, third quarter wholesale shipment growth modestly outpaced depletion growth. Depletions growth continued to be driven by accounts sold despite the challenging backdrop and to a lesser extent, number of labels per account, while the growth in our velocity per account tempered. Turning to net sales performance by channel. The wholesale to distributor channel returned to growth in the quarter, increasing 10.3% over the prior year period, representing our strongest growth contributor. The channel saw improvement across most brands and realized benefits from select price increases as well as favorable brand mix led by our Duckhorn Vineyards and Decoy Winery brands.

As we noted earlier, we were especially pleased with the expansion of Decoy Limited, which contributed nicely to our gross margin improvement for the quarter. California direct to trade was up 4.6% compared to the prior year period as we continue to lap the strong on-premise reopening of California and was driven by our Duckhorn Vineyards and Decoy Winery Brands. The direct-to-consumer channel was down 35.2% when compared to the prior year period. This decrease was in line with our expectations and due entirely to the aforementioned cadence shift in our cost of brown offerings. Without the timing shift, DTC modestly outperformed the prior year period. Tasting rooms were a bright spot, growing nicely on a net sales basis despite unfavorable weather throughout the quarter.

Third quarter gross profit was $50.5 million, an increase of $6.5 million or 14.9% compared to the prior year period. On an adjusted basis, gross profit grew to $51 million, an increase of 6% compared to the prior year period. This represented a 55.8% adjusted gross margin, up approximately 330 basis points year-over-year. Improving in all subchannels and driven by favorable brand mix and the successful execution of planned price increases. Total selling, general and administrative expenses were up $0.9 million or 3.7% compared to the prior year period. The increase in the quarter is primarily due to higher compensation costs partially offset by favorable operating expenses relative to expectations due to the timing of certain expenses phasing into the fourth quarter.

On an adjusted basis, total operating expenses increased by $0.9 million or 4.4%. Net income was $16.8 million and diluted EPS was $0.15 per diluted share compared to net income of $15.6 million and $0.14 per diluted share in the prior year period. Adjusted net income was $19 million and adjusted EPS was $0.16 per diluted share compared to $19.2 million and $0.17 per diluted share in the prior year period. Adjusted EBITDA for the quarter increased 9% to $35.8 million. This represented 39.3% of net sales compared to 35.9% of net sales in the prior year period. This 340 basis point increase reflects robust gross profit generation driven by higher sales volumes, favorable brand mix, the successful execution of planned price increases and a benefit from the timing shift of certain planned operating expenses into the fourth quarter.

At the end of the quarter, we had cash of $36.1 million and total debt of $223.3 million resulting in our leverage ratio declining to 1.7 times net debt. Let’s turn now to our outlook for the rest of the fiscal year. Given our performance in the third quarter, we are raising and narrowing our guidance for fiscal year 2023 net sales, adjusted EBITDA and adjusted EPS. Our guidance now calls for net sales of $400 million to $404 million, reflecting approximately 7.5% to 8.5% organic volume led growth. Adjusted EBITDA of $138 million to $140 million and adjusted EPS of $0.64 to $0.66 per diluted share. To reflect our continued margin outperformance, we now expect adjusted gross margin expansion for fiscal 2023 to approach 200 basis points an improvement versus our prior guide of modest expansion.

Keep in mind, our gross margins differ by subchannel and we can experience overall gross margin variability depending on subchannel mix, but with minimal impact to bottom line profitability as we also manage different operating expense levels across our subchannels. It is also important to note, especially considering the softening demand within the broader luxury space that variability in month-to-month channel performance can influence our performance in any given quarter, including those late in the fiscal year. That said, we remain confident in our ability to finish the year strong and deliver the broad based growth embedded in our fiscal year guidance. Overall, we are pleased with the third quarter. We remain in an advantageous position within our industry despite a macro environment that has seen some challenges in broader luxury products and we look forward to a strong fourth quarter to close out the year.

I will now turn it to Sean to go over the details of our recently announced acquisition.

Sean Sullivan: Thank you, Lori. As Alex mentioned, we are pleased to be under contract for the acquisition of a production winery in Alexander Valley, Sonoma County. Our strategy with respect to the acquisition of production assets, as we have noted before is to optimize the balance between in-house production and the use of custom crush partners in a manner that enhances the quality of our wines, increases diversification and optionality and reflects an efficient use of capital. Production wineries of this scale are rarely available in California. And this acquisition reduces our reliance on third-party custom processing, storage and bottling facilities and takes a longer-term view with respect to necessary capacity additions into the future.

By optimizing our production processes and affording us greater visibility into our cost of goods in future years, we view this acquisition as an investment in our future growth, our winery brands and our financial performance. The acquisition is well positioned to support our organic growth plans and could dovetail nicely with the acquisition of a winery brand in the future. The value of entitlements, land and buildings are difficult to quantify specifically. But we believe that they collectively hold value significantly greater than the acquisition price as we fully utilize the winery. With that in mind, we currently plan to ensure the building alone for more than 1.5 times the acquisition value. This winery will be predominantly used to support our Decoy Winery Brand.

And more broadly, it will provide our winemaking teams with the space, tools and technology they need to remain at the forefront of luxury wine making. From an environmental standpoint, the facility is designed to significantly reduce the environmental impact of winemaking on-site and includes a solar panel array capable of producing enough energy to power over 400 homes annually. Processes for the reuse of 100% of water used during the winemaking process and cooling by environmentally friendly refrigerant. And finally, we note that an acquisition of this type and size will provide a natural path for career growth for our employees. And we also expect that new employees will be added at the appropriate time to ensure ideal staffing at all of our production facilities.

The transaction is subject to customary closing conditions and we expect the transaction will close in the next couple of weeks. We plan to transition into the winery quickly, achieving 80% capacity use within the first half of calendar year 2024, while the remaining capacity should be ready for the 2024 harvest. With that, I’ll turn it back to Lori to discuss the financial aspects of the acquisition.

Lori Beaudoin: Thank you, Sean. As we previously announced, the purchase price was approximately $55 million, and the acquisition will be financed through the company’s existing credit facility. After the closing of this acquisition, we expect our leverage ratio to go from 1.7 times to 2 times net debt with a path to continue deleveraging over time. I am pleased by the acquisition and the benefits we believe it will provide to our future financial results through greater control of our cost of goods as well as both medium-term gross profit and adjusted EBITDA margin accretion. This accretion will follow some modest near-term pressure on adjusted EPS as a result of incremental interest expense and depreciation. This acquisition is consistent with Duckhorn’s commitment to making excellent luxury wines, planning for consistent growth and efficiently allocating capital. With that, I will pass it back to Alex to wrap up our prepared remarks.

Alex Ryan: Thank you, Lori. I’m very pleased with our strong financial results and consistent outperformance of the luxury wine industry. While the near-term macro environment remains dynamic, I’m confident that the Duckhorn Portfolio will continue to benefit from premiumization over the long term as our recent results demonstrate the resiliency of our customers and brands. Additionally, any shifts in consumer behavior and the recent softening demand across the broader luxury space do not have any impact on our long-term growth strategy and the considerable distribution white space opportunity we have ahead of us. Building on the strength of our brands and sales force, we continue to leverage our advantaged position within the luxury wine space to finish this year strong and in our fiscal year 2024 with momentum.

We remain committed to delivering sustainable, profitable growth and will always strive to create value over the long term for our shareholders. With that, Lori, Sean and I are available to take your questions.

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Q&A Session

Operator: [Operator Instructions] Our first question is from Lauren Lieberman with Barclays. Your line is now open.

Lauren Lieberman: Great. Thanks. I’ve got a couple of questions. But first, I just wanted to go back to some of the comments, Alex, you’ve made about some slowdown in on-premise. I mean it’s all, as to be expected, given the consumer environment, obviously, comparisons to next year. But as you look forward and you mentioned in your closing comments, the ongoing opportunities for white space expansion. Is it reasonable to think that this continued account development is enough to still support growth even through a recession. And I guess there’s a range of how that a recession could be. But just there’s earlier talk about ’24, but just trying to triangulate the white space story with kind of slower consumer trends. Thanks.

Alex Ryan: Yeah, Lauren. It’s a good question. And yeah, I do still believe in the white space opportunity. We might have to work a little harder out there, as you can imagine, but we still think that the brand propositions to new accounts and additional penetration on existing accounts is still within our grasp. And so the strategy hasn’t changed, really a whole lot in that regard. And remember, bear in mind, that’s just a big — one significant part of our business, but the majority of that long-term opportunity though is still going to be kind of the off-premise channel as it as our existing growth has shown. So I think in combination, we’re going to still stick with that strategy, and I think the opportunities are hard to go out there and get.

Lauren Lieberman: Okay. Great. So the – and also in your commentary, it was really just in the on-premise you talked about starting to see some slowing, but off-premise, it sounds like at this point, no real signs of changing consumer trends and the premiumization given your comments equally limited (ph) are still as strong as ever.

Alex Ryan: We’re still staying good — good positive growth there. And it’s outpaced on-premise a little bit, but we still think that, that’s going to remain strong.

Lori Beaudoin: Yeah, Lauren. Hi. This is Lori. Thanks for joining us today. But when we think about on-premise, our growth is especially impressive. We continue to take share. We have steeper comps than some of our competitors because we weren’t out of stock in the past where some of our competitors were. So we have some steep — steep comps just to look again with regard to off-premise. But we’re continuing to take share and grow it just like we said we would. That’s where our biggest opportunity is. Remember, we did add some of the sales team, expanded our sales team, and we’re seeing great results from that. So yeah, we aren’t seeing any slowness in off-premise.

Lauren Lieberman: Okay. Fantastic. And then last thing, and I’ll pass it on. For the acquisition, it sounds really exciting to be fun to see kind of what that — how that evolves. But pretty clear, we should be thinking about this as dilutive in ’24. But then I’m guessing flips to accretive in ’25 when some of that the benefits from them in-housing production become more apparent. Is that reasonable?

Lori Beaudoin: Yeah. In my takes about the first 24 months because remember, our cost of goods on the majority of our products take a little bit longer than a 12-month period to start flowing through. So most of this will flow through our cost of goods as we build and as we start selling those wines through, we will see some of the benefits, but the interest is more near term.

Sean Sullivan: And I’ll just add that, if you think about [Multiple Speakers] Q – Lauren Lieberman That time horizon.