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Position
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(Address, including zip code, of Principal Executive Offices)
(i707)
i302-2658
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading
Symbol(s)
Name of each exchange on which registered
iCommon Stock, par value $0.01 per share
iNAPA
iNew
York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. iYes☒No ☐
Indicate
by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). iYes ☒ No ☐
Indicate
by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,”“accelerated filer,”“smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
☐
Accelerated filer
☐
iNon-accelerated
filer
☒
Smaller reporting company
i☐
Emerging growth company
i☒
If
an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. i☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Act). Yesi☐No☒
The following terms are used in this quarterly report unless otherwise noted or indicated by the context:
•"Company,""we,""us,""our,""Duckhorn" and "The Duckhorn Portfolio" refer to The Duckhorn Portfolio, Inc. and its consolidated subsidiaries.
•"2016 Equity Plan" refers to the Company's board approved 2016 Equity Incentive Plan.
•"ASC"
refers to Accounting Standards Codification developed by the FASB.
•"ASU" refers to Accounting Standards Updates issued by the FASB to communicate changes to the ASC.
•"Controlled Company" refers to a company of which more than 50% of the voting power for the election of its directors is held by a single person, entity or group.
•"COVID-19" refers to the ongoing pandemic surrounding COVID-19, the disease caused by a novel strain of coronavirus that was declared a global pandemic by the World Health Organization in March 2020.
•"Credit Facility" refers to the existing first lien credit facility pursuant to that certain First Lien Loan and Security Agreement, dated as of
October 14, 2016 (as amended by Amendment No. 1, dated July 28, 2017, as amended by Amendment No. 2, dated as of April 19, 2018, as amended by Amendment No. 3 dated as of August 1, 2018, as amended by Amendment No. 4 dated as of October 30, 2018, as amended by Amendment No. 5 dated as of June 7, 2019, as amended by Amendment No. 6 dated as of August 17, 2020 and as amended by Amendment No. 7 dated as of February 22, 2021), by and among the Company, the borrowers named therein, the lenders
named therein and the Bank of the West, as administrative agent.
•"DTC channel" and "DTC" refers to our sales and distribution channel through which we sell wine directly to consumers without any licensee intermediaries (wholesale or retail), which is permissible through in-person sales at one of our tasting rooms or, where permitted by law, through our multi-winery e-commerce website.
•"Estate vineyards" refers to vineyards controlled or owned by the Company.
•"Estate wines" refers to wine made with grapes that share geographical provenance
and are farmed, fermented, aged and bottled on-site at Company controlled vineyard and facilities.
•"Exchange Act" refers to the Securities Exchange Act of 1934.
•"FASB" refers to Financial Accounting Standards Board.
•"First Lien Loan Agreement " see Credit Facility.
•"Fiscal 2017" refers to our fiscal year ended July 31, 2017.
•"Fiscal 2018" refers to our fiscal year ended July 31, 2018.
•"Fiscal 2019" refers to our fiscal year
ended July 31, 2019.
•"Fiscal 2020" refers to our fiscal year ended July 31, 2020.
•"Fiscal 2021" refers to our fiscal year ended July 31, 2021.
•"Fiscal 2022" refers to our fiscal year ended July 31, 2022.
•"IPO" refers to our initial public offering, completed in March 2021.
•"JOBS Act" refers to the Jumpstart Our Business Startups Act of 2015.
•"LIBOR"
refers to London Interbank Offered Rate.
•"Luxury wine" refers to wines with suggested retail prices of $15 or higher per 750ml bottle.
•"On-premise" refers to retail accounts that are a business with a license that allows a customer to purchase our wines and consume them at the licensed location, such as restaurants, bars and hotels.
•"Off-premise" refers to retail accounts that are a business with a license that allows a customer to purchase our wines for consumption at a location other than the retailer’s licensed location, such as grocery stores and liquor stores.
•"Retail" refers to establishments that are licensed to purchase our wine for resale to consumers, such as grocery stores, liquor stores and restaurants.
•"SEC" refers to U.S. Securities and Exchange Commission.
•"Securities Act" refers to The Securities Act of 1933.
•"TSG" refers to TSG Consumer Partners LLC, together with certain affiliates.
•"Ultra-luxury wine" refers to wines with suggested retail prices of $25 or higher per 750ml bottle.
•"U.S." refers to the United States.
•"U.S.
GAAP" refers to the United States Generally Accepted Accounting Principles.
•"VIE" refers to variable interest entity.
•"Wholesale channel" refers to our sales and distribution channel through which we sell wine to distributors and, in California, directly to retail accounts.
This Quarterly Report on Form 10-Q and other materials filed or to be filed by us with the Securities and Exchange Commission contains statements that are or may be considered to be, forward-looking statements. Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies and other future conditions. Forward-looking statements can be identified by words such as “anticipate,”“believe,”“estimate,”“expect,”“intend,”“may,”“plan,”“predict,”“project,”“target,”“potential,”“will,”“would,”“could,”“should,”“continue,”“contemplate” and other similar expressions, although not all forward-looking statements contain these identifying
words. Important factors that could cause actual results and events to differ materially from those indicated in the forward-looking statements include, among others, the following:
• our ability to manage the growth of our business;
• our reliance on our brand name, reputation and product quality;
• the effectiveness of our marketing and advertising programs, including the consumer reception of the launch and expansion of our product offerings;
• general competitive conditions, including actions our competitors may take to grow their businesses;
• overall decline in the health of the economy, consumer discretionary spending and consumer demand for wine;
• the occurrence of severe weather
events (including fires, floods and earthquakes), catastrophic health events, natural or man-made disasters, social and political conditions 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.
You should not rely on forward-looking statements as predictions of future events. We have based the forward-looking statements contained in this Quarterly Report on Form 10-Q primarily on our current expectations and projections about future events, and trends that we believe may affect our business, financial condition and operating results. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties and other factors described in the section titled “Risk factors” in our Fiscal 2021 Annual Report on Form 10-K 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.
Long-term
debt, net of current maturities and debt issuance costs
i111,887
i114,625
Deferred
income taxes
i86,667
i86,667
Other
long-term liabilities
i1,014
i1,458
Total
long-term liabilities
i308,247
i324,098
Total
liabilities
i438,084
i380,879
Commitments
and Contingencies (Note 11)
i
i
Equity
Common
stock, $ii0.01/ par value; ii500,000,000/
shares authorized, iiii115,046,793///
issued and outstanding at both October 31, 2021 and July 31, 2021
i1,150
i1,150
Additional
paid-in capital
i728,362
i726,903
Retained
earnings
i94,907
i73,634
Total
The Duckhorn Portfolio, Inc. equity
i824,419
i801,687
Non-controlling
interest
i591
i551
Total equity
i825,010
i802,238
Total
liabilities and equity
$
i1,263,094
$
i1,183,117
The
accompanying notes are an integral part of these Condensed Consolidated Financial Statements (unaudited).
Notes to Condensed Consolidated Financial Statements (unaudited)
1. iDescription
of business
The Duckhorn Portfolio, Inc. and its subsidiaries (the "Company" or "Management") headquartered in St. Helena, CA, produces luxury and ultra-luxury wine across a portfolio of winery brands, including Duckhorn Vineyards, Paraduxx, Goldeneye, Migration, Decoy, Canvasback, Calera, Kosta Browne, Greenwing and Postmark.
The Company's revenue is comprised of wholesale and DTC sales. Wholesale revenue is generated through sales directly to California retailers and restaurants, sales to distributors and agents located in other states throughout the U.S. and sales to export distributors that sell internationally. DTC revenue results from individual consumers purchasing wine directly
from the Company through club membership, the Company's website or tasting rooms located in Napa Valley, California; Anderson Valley, California; Sebastopol, California; Hollister, California; and Walla Walla, Washington.
The Company owns or controls through long-term leases certain high-quality vineyards throughout Northern and Central California and Washington. Vinification takes place at wineries owned, leased or under contract with third parties predominately
located in Napa Valley, California; Anderson Valley, California; Hopland, California; Hollister, California; Sebastopol, California; and Walla Walla, Washington.
In the first quarter of Fiscal 2022, the Company completed a secondary offering where certain existing shareholders sold i12,000,000
shares of the common stock at a price of $i20.50 per share. In November 2021, an additional i626,467 shares of common stock were sold pursuant to the partial
exercise of the underwriters' option to purchase additional shares. The Company did not receive any of the proceeds from the sale of the shares by the existing stockholders. In connection with the offering, the Company incurred costs of $i0.9 million of which $i0.4 million
was incurred in the fourth quarter of Fiscal 2021. These costs are reflected in selling, general and administrative expenses on the Condensed Consolidated Statement of Operations.
2.iBasis of presentation and significant accounting policies
i
Basis
of presentation
The Company’s Condensed Consolidated Financial Statements are prepared in accordance with U.S. GAAP and Article 10 of the Securities and Exchange Commission’s Regulation S-X. As permitted under those rules, certain footnotes or other financial information that are normally required by U.S. GAAP may be condensed or omitted. These Condensed Consolidated Financial Statements have been prepared on the same basis as the Company's audited annual financial statements and, in the opinion of Management, reflect all adjustments, consisting only of normal recurring adjustments, which are necessary for the fair statement of the Company's financial information for
the interim periods presented. These interim results are not necessarily indicative of the results to be expected for the year ending July 31, 2022, for any other interim period or for any future year.
The Condensed Consolidated Financial Statements are unaudited and should be read in conjunction with the audited consolidated financial statements and related notes thereto for the year ended July 31, 2021.
i
Principles of consolidation
The
Condensed Consolidated Financial Statements include the accounts of The Duckhorn Portfolio, Inc. and its subsidiaries, including a consolidated VIE of which the Company has determined it is the primary beneficiary. All intercompany balances and transactions are eliminated in consolidation.
i
Accounting estimates
The preparation of Condensed Consolidated Financial
Statements requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the Condensed Consolidated Financial Statements and the reported amounts of revenues
and expenses during the reporting period. Such estimates include, but are not limited to, the following: useful lives and recoverability of long-lived assets, inventory obsolescence and reserves, capitalized indirect inventory costs, allowance for doubtful accounts receivable, calculation of accrued liabilities, customer incentive reserves, uncertain tax positions, contingent
liabilities, fair value of assets and liabilities acquired in connection with business combinations, equity-based compensation and deferred revenues. Actual results could differ from those estimates.
iPreferred stock
The Company has i100,000,000
shares of $i0.01 par value preferred stock authorized, iino/ne
of which are issued and outstanding.
iVariable interest entities
The Company evaluates its ownership, contractual relationships and other interests in entities to determine the nature and extent of the interests, whether such interests are variable interests and whether the entities are VIEs in accordance with ASC 810, Consolidations. These evaluations can be complex and involve Management
judgment as well as the use of estimates and assumptions based on available historical information, among other factors. Based on these evaluations, if the Company determines that it is the primary beneficiary of a VIE, the entity is consolidated into the financial statements. At October 31, 2021 and July 31, 2021, the Company's ownership percentage of the sole identified VIE was ii76.2/%.
The VIE's net assets, were $i2.4 million and $i2.2 million at October 31, 2021 and July 31, 2021, respectively. The assets and liabilities, which may only be
used to settle its own obligations, are primarily related to property, equipment and working capital accounts, which generally represent the amounts owned by or to the Company for the goods under current contracts.
i
Recent accounting pronouncements
As an “emerging growth company”
as established by the JOBS Act, the Company is permitted to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. The Company has elected to use the adoption dates available to private companies. As a result, the Company’s financial statements may not be comparable to the financial statements of issuers who are required to comply with the effective date for new or revised accounting standards that are applicable to public companies.
Recently issued accounting pronouncements not yet adopted:
In February 2016, the FASB issued
ASU No. 2016-02, Leases (Topic 842), and several amendments, codified as ASC 842, which supersedes prior guidance on accounting for leases under FASB ASC 840, Leases. ASU No. 2016-02, among other provisions, (i) requires lessees to classify leases as either finance or operating leases, (ii) generally requires all leases to be recorded on the Condensed Consolidated Statements of Financial Position through the recognition of right-of-use assets and corresponding lease liabilities and (iii) expands mandatory qualitative and quantitative disclosures regarding leasing activities. The FASB issued ASU No. 2020-05, “Revenue from Contracts with Customers (Topic 606) and Leases (Topic 842) Effective dates for certain entities”, which extends the effective date for all other entities, for annual reporting periods beginning after December
15, 2021, and for interim periods within fiscal years beginning after December 15, 2022. The amended standard is effective for the Company beginning with the year ended July 31, 2023. Early adoption is permitted. The Company’s assessment of the lease standard’s impact on the Condensed Consolidated Financial Statements is ongoing, and is expected to result in the recognition of right of use assets and lease liabilities related to the Company’s operating leases.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments–Credit Losses
(Topic 326), Measurement of Credit Losses on Financial Instruments, and also issued subsequent amendments to the initial guidance, collectively, ASC 326, to replace the incurred loss impairment methodology in current U.S. GAAP with a methodology that requires the reflection of expected credit losses and will also require consideration of a broader range of reasonable and supportable information to determine credit loss estimates. For many entities with financial instruments, the standard will require the use of a forward-looking expected loss model rather than the incurred loss model for recognizing credit losses, which may result in the earlier recognition of credit losses on financial instruments. This guidance will be effective for the Company beginning with the year ended July 31,
2024, with early adoption permitted. The Company is currently evaluating the impact this standard could have on the Condensed Consolidated Financial Statements.
In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting (“ASU 2020-04”), and further issued subsequent amendments to the initial guidance. In order to ease the potential burden in accounting for reference rate reform, ASU 2020-04 provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships and other transactions that reference the LIBOR
or another reference rate expected to be discontinued because of reference rate reform, if certain criteria are met. ASU 2020-04 applies only to contracts, hedging relationships and other transactions that reference LIBOR or another reference rate expected to be discontinued. The standard is effective immediately and may be applied prospectively through December 31, 2022. The Company is currently evaluating the impact of reference rate reform and the optional expedients provided by this standard on its contracts.
In May 2021, the FASB issued ASU No. 2021-04, Earnings per Share (Topic 260),
Debt - Modifications and Extinguishments (Subtopic 470-50), Compensation-Stock Compensation (Topic 718), and Derivatives and Hedging - Contracts in Entity's Own Entity (Subtopic 815-40), to clarify the accounting for modifications or exchanges of equity-classified warrants. This amendment applies to freestanding stock options, which the Company granted in Fiscal 2021. In accordance with the ASU, if there is a modification and the option is still determined to be classified as equity, the modification should be accounted for as an exchange of the original option for a new option. This guidance will be effective for the Company beginning with the year ended July
31, 2023, with early adoption permitted. The Company is currently evaluating the impact of this update and will monitor for modifications or exchanges of the issued freestanding stock options, but at this time does not anticipate the adoption of ASU 2021-04 to have a material impact on the Condensed Consolidated Financial Statements.
3. iRevenue
Disaggregated
revenue information
i
The following table presents the percentages of consolidated net sales disaggregated by sales channels:
(a) Includes
$i1.8 million of sales related to bulk, grape and merchandise sales for the three months ended October 31, 2021 these same sales were immaterial for the three months ended October 31, 2020.
(b) Includes shipping and handling revenue of $i0.6
million and $i0.4 million for the three months ended October 31, 2021 and 2020, respectively.
When
the Company receives payment from a customer prior to transferring the product under the terms of a contract, the Company records deferred revenue, which represents a contract liability. The Company’s deferred revenue is primarily comprised of cash collected from DTC members for purchases ahead of the wine shipment date. The Company does not recognize revenue until control of the wine is transferred and the performance obligation is met.
As
shown on the Condensed Consolidated Statements of Financial Position, the balance of deferred revenue was $i3.1 million at July 31, 2021, the beginning of the period, and was $i3.9
million at October 31, 2021, the end of the period. Revenue recognized during the three months ended October 31, 2021, which was included in the opening contract liability balance for this period totaled $i2.0 million.
The
Company capitalizes into inventory depreciation related to property and equipment used in the production of inventory. For the three months ended October 31, 2021 and the year ended July 31, 2021, the amount capitalized was $i2.6 million and $i12.5
million, respectively.
5.iProperty and equipment
i
Property
and equipment was comprised of the following major components as of:
Depreciation
expense was $ii0.3/ million for both the three months ended October 31, 2021
and 2020. See Note 4 (Inventories) for depreciation expense capitalized into inventory.
6.iOther intangible assets
ii
Intangible
assets were comprised of the following components:
The
Company’s amortization expense for the three months ended October 31, 2021 and 2020 was $ii1.9/
million. For the next five years, the Company anticipates the annual amortization of the definite-lived intangible assets that have been recorded as of October 31, 2021 to be $iiiii7.7////
million per year.
7.iAccrued expenses
i
The
Company’s accrued expenses balance consisted of the following amounts:
(a) Trade
spend refers to estimated amounts the Company owes to distributors for depletion-based incentives granted for meeting specific depletion targets.
(b) The Company intends to use the cash surrender value life insurance policies in settling its deferred compensation plan liability. The cash surrender value of the life insurance policies was $i1.8
million and $i1.7 million at October 31, 2021 and July 31, 2021, respectively.
/
8.iDebt
The Company is subject to the requirements of various financial covenants pursuant to the term loans and revolving line of credit, including a debt to net worth maximum and a fixed charge coverage ratio as defined in the Credit Facility. As of October 31, 2021, the Company was not in violation of any financial covenant.
Included in interest expense in the Condensed Consolidated Statements of Operations is amortization related to debt issuance costs of $ii0.4/
million for both the three months ended October 31, 2021 and 2020.
Revolving line of credit
At October 31, 2021, $i314.0 million was available to draw under the revolving line of credit, excluding the incremental seasonal borrowing amount of an additional $i30.0 million
of capacity. The weighted-average interest rate was i2.0% on the amount outstanding at October 31, 2021. There were iino/
amounts outstanding on the letter of credit sub-facility or the swingline sub-facility at October 31, 2021.
9.iDerivative instruments
The
Company manages exposure to interest rates and foreign currency movements by entering into derivative contracts from time to time, as movements in such markets could impact the financial results and Condensed Consolidated Statements of Financial Position.
iThe changes in estimated fair values of derivative instruments result from changes in interest rates and foreign currency exchange rates. Such changes serve to offset exposure in related business assets or liabilities.
The Company is exposed to credit loss in the event of nonperformance by a counterparty. Certain of the Company's derivative instruments are subject to master netting agreements. In certain circumstances, this agreement allows the Company to net-settle amounts payable or receivable related to multiple derivative transactions with the same counterparty. The fair values of derivative instruments
are presented on a gross basis, even when the derivative instruments are subject to master netting arrangements. Collateral is generally not required of the Company or of the counterparties to the master netting agreements, and no cash collateral was received or pledged under such agreements as of October 31, 2021 or July 31, 2021. The Company does not enter into derivative instruments for trading or speculative purposes. The Company's accounting policies do not apply hedge accounting treatment to derivative instruments.
i
As
of October 31, 2021, the Company held the following interest rate swap agreements, which fixed the interest rate on the applicable notional amount of outstanding variable rate debt:
As discussed in Note 11 (Commitments and contingencies), the Company manages annual barrel purchases by engaging domestic and foreign cooperages to provide specified barrel quantities on agreed delivery dates. Some of these invoices are paid in Euros. In order to reduce the foreign exchange risk associated with the Euro to U.S. Dollar conversion rate, the Company enters into foreign currency forward contracts
aligning settlement dates with expected barrel delivery and the anticipated payments to various coopers.
i
The total notional amounts of the Company’s derivative instruments outstanding are as follows:
Total
derivative instruments not designated as hedging instruments
$
i100,000
$
i102,369
/
Results
of period derivative activity
i
The estimated fair value and classification of derivative instruments on the accompanying Condensed Consolidated Statements of Financial Position are as follows:
The
amounts and classification of the gains and losses in the Condensed Consolidated Statements of Operations related to derivative instruments not designated as hedging instruments are as follows:
The
Company applies a fair value hierarchy pursuant to ASC 820, Fair Value Measurement, which consists of three levels of inputs that may be used to measure fair value:
Level 1 Inputs to fair value are quoted prices in active markets for identical assets or liabilities;
Level 2 Inputs to fair value are based on observable data other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data such as interest rates or yield curves for substantially the full term of the instrument;
Level 3 Inputs to fair value are based on unobservable data for the instrument and are supported by little or no market activity.
Following is
a description of the valuation methodologies used for instruments measured at fair value in the Condensed Consolidated Financial Statements, as well as the general classification of such instruments under the valuation hierarchy.
Interest rate swap contracts: The fair value of the Company’s interest rate swap agreement is estimated with the assistance of a third party, using inputs that can be corroborated by observable market data (Level 2 of the fair value hierarchy).
Foreign currency forward contracts: The fair value of the Company’s
outstanding foreign currency forward contracts is estimated with the assistance of a third party, using inputs that can be corroborated by observable market data (Level 2 of the fair value hierarchy).
Deferred compensation plan: Contributions to the Company’s deferred compensation plan are managed by a third-party administrative agent. The fair value of the total contributed plan assets and liabilities are based on inputs that can be corroborated by observable market data (Level 2 of the fair value hierarchy).
The Company’s other financial instruments consist mainly of cash, accounts receivable, accounts payable, accrued
expenses, and debt. The carrying value of all other financial instruments, except debt, approximates fair value due to the short-term nature of these assets and liabilities. The carrying value of the Company's debt approximates fair value as the interest rates are variable and reflective of market rates. Debt is categorized as a Level 2 liability within the fair value hierarchy.
i
The
Company’s assets and liabilities measured and recorded at fair value on a recurring basis at October 31, 2021, were as follows:
The Company leases approximately i150 acres of vineyard property in California under various third-party operating lease agreements, with terms ranging from one to i30
years, expiring in future years through December 2040. The Company also leases office space, office equipment and visitor centers under third-party operating leases. Some lease agreements contain purchase options and many include renewal options at specified dates throughout the lease terms. Rental expense was $i1.0 million for three months ended October 31, 2021 and $i1.1
million for the three months ended October 31, 2020, the majority of which is capitalized into inventory.
i
At October 31, 2021, the future minimum payments under the non-cancelable operating lease agreements by fiscal year are as follows:
The Company has entered into long-term grape purchase contracts with various growers to supply a significant portion of its future grape requirements. The lengths of the contracts typically vary from one to ieight
years, and prices per ton are either determined at the outset for the contract duration or are negotiated annually. The Company's grape purchase contracts generally include acceptance provisions based on qualitative and quantitative grape quality characteristics. For the 2021 harvest, the Company contracted for approximately i34,000
tons of grapes at a cost of $i68.1 million in Fiscal 2022. For the 2020 harvest, the Company purchased approximately i12,000
tons of grapes at a total cost of $i26.5 million in Fiscal 2021. The increase was largely attributable to lower quantities available for the 2020 harvest at the Company's contractually defined quality levels due to wildfires compounded with higher demand and production levels in current and future periods.
Purchase commitments
The
Company enters into various contracts with third-parties for custom crush, storage and mobile bottling services. The costs related to these contracts are recorded in the period the service is provided. The contracts for custom crush services typically have minimums that the Company is required to pay if certain grape volume thresholds are not delivered. The Company does not record these minimums related to service contracts as contingent
liabilities on the Condensed Consolidated Statements of Financial Position given the harvest yield size,
resulting volumes and qualities of grape deliveries are not known or estimable until harvest, when all related contingencies would be resolved.
Contingent liabilities
The Company evaluates pending or threatened litigation, operational events which could result in regulatory or civil penalties, environmental risks, and other sources of potential contingent liabilities during the
year. In accordance with applicable accounting guidance, the Company establishes an accrued liability when those matters present loss contingencies, which are both probable and reasonably estimable. As of October 31, 2021, there were no material contingent obligations requiring accrual or disclosure.
In the ordinary course of business, the Company enters into agreements containing standard indemnification provisions. The aggregate maximum potential future liability of the Company under such indemnification provisions is uncertain, as these involve potential future claims against the
Company that have not occurred. The Company believes the probability of incurring future obligations under these indemnification provisions is sufficiently remote. As of October 31, 2021 and July 31, 2021, no amounts have been accrued related to such indemnification provisions.
12. iEquity-based
compensation
2016 Equity Plan
Restricted shares
On August 1, 2021, i133,076 shares vested, based on the passage of time, with a weighted average grant date fair value of $i14.23
and a total fair value of $i1.9 million. The remaining i266,158
shares will vest over their remaining requisite service period on August 1, 2022.
13. iCasualty loss
Wildfires
Several wildfires occurred in northern California in the first quarter of Fiscal 2021. Other than smoke exposure to unharvested grapes, the
Company's owned and leased vineyards did not sustain damage during the fires. Fire and smoke exposure related expenses are reported on the casualty loss line in the Condensed Consolidated Statement of Operations and were immaterial in the current fiscal quarter. Smoke and fire damage to vineyards in the primary markets where the Company sources fruit rendered some of the available grapes unacceptable for the Company’s production needs. Based on an internal analysis of the impacts of these wildfires, Management believes the potential impact to the Company's operational results to be immaterial and intend to continue to monitor the ongoing effects to the business for any material changes to that conclusion.
14. iEarnings
per share
Basic earnings per share is calculated by dividing the net income by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share reflects the dilution that would occur if any potentially dilutive instruments were exercised or converted into shares of common stock.
The
following is a reconciliation of the Company's basic and diluted income per share calculation:
Three months ended October 31,
(in thousands, except share and per share amounts)
2021
2020
Numerator
- Net income attributable to The Duckhorn Portfolio, Inc.
$
i21,273
$
i17,523
Denominator:
Weighted
average number of shares of common stock outstanding - basic
i115,046,793
i101,713,460
Dilutive
stock options and restricted stock(a)
i349,233
i—
Weighted
average number of shares of common stock outstanding - assuming dilution
i115,396,026
i101,713,460
Earnings
per share attributable to The Duckhorn Portfolio, Inc.
Basic
$
i0.18
$
i0.17
Diluted
$
i0.18
$
i0.17
________________________________________________
(a) Calculated
using the treasury stock method.
/
There were i2,925 outstanding common stock awards deemed anti-dilutive for the three months ended October 31, 2021 and ino
outstanding awards deemed anti-dilutive for the three months ended October 31, 2020.
Item 2. Management’s discussion and analysis of financial condition and results of operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and the related notes to those statements included elsewhere in this Quarterly Report on Form 10-Q. In addition to historical
financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. See “Cautionary note regarding forward-looking statements” included in this Quarterly Report on Form 10-Q. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed in Part I “Item 1A. Risk factors” included in our Annual Report on Form 10-K for Fiscal 2021.
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. We 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. We also sell directly to consumers through our DTC channel, which comprised approximately 15% of our net sales in the first three months of Fiscal 2022. 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.
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 October 31,
(in
thousands)
2021
2020
Net sales
$
104,181
$
91,638
Gross profit
$
52,410
$
44,275
Net
income attributable to The Duckhorn Portfolio, Inc.
The following table represents the reconciliation of adjusted EBITDA to net income attributable to The Duckhorn Portfolio, Inc.:
Three months ended October 31,
(in thousands)
2021
2020
Net
income attributable to The Duckhorn Portfolio, Inc.
$
21,273
$
17,523
Interest expense
1,606
3,580
Income tax expense
7,377
6,136
Depreciation
and amortization expense
4,829
5,116
EBITDA
35,085
32,355
Purchase accounting adjustments(a)
193
561
Transaction
expenses(b)
1,745
—
Change in fair value of derivatives(c)
(442)
(1,548)
Equity-based
compensation
1,459
288
Loss on debt extinguishment(d)
—
272
IPO
preparation costs(e)
—
196
Wildfire costs(f)
49
1,555
COVID-19 costs(g)
—
43
Adjusted
EBITDA
$
38,089
$
33,722
________________________________________________
(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 and Kosta Browne in Fiscal 2018 and Fiscal 2019, respectively, and certain other transactions consummated prior to our acquisition by TSG, which resulted in fair value adjustments to inventory and long-lived assets.
(b) Transaction expenses include legal and professional fees and change of control payments incurred in connection with our acquisition of Kosta Browne in August 2018 and our IPO in March 2021. Also included are expenses incurred for abandoned transactions and the secondary offering completed in October 2021. These expenses were directly related to such transactions and were incremental to our normal operating expenses.
(c) See Note 9 (Derivative instruments) to our Condensed Consolidated Financial Statements for additional information.
(d) Loss on debt extinguishment includes charges for unamortized deferred financing fees we recognized in connection with amendments to our Credit Facility.
(e) IPO preparation costs include professional fees incurred for outside consultants to advise
us on legal, accounting and tax matters related to our preparation for becoming a public company, which were not directly attributable to an offering.
(f) Wildfire costs 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 are reported on the casualty loss line in the Condensed Consolidated Statements of Operations. See Note 13 (Casualty loss) 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
in California, we believe the wildfires and related costs we experienced are not indicative of our core operating performance.
(g) 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 period 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 U.S. GAAP. Certain judgments and estimates are inherent in our processes to calculate these metrics.
Net sales percentage by channel
We calculate net sales percentage by channel as net sales made through our wholesale channel to distributors, through our wholesale channel directly to retail accounts in California 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.
The
variations in the net sales percentages by channel between the three month periods ended October 31, 2021 and 2020 were largely driven by the ongoing signs of recovery from COVID-19 disruption across consumer markets and the continued, gradual return toward historical consumer spending norms. The increase in net sales within the DTC channel was bolstered by higher visitor center sales as compared to the prior year period, coupled with timing of member shipments which we do not expect to reoccur. Further impacting our wholesale channel sales, consumer purchasing and consumption patterns appeared to be shifting back toward levels more consistent with pre-pandemic trends. We expect our sales channel mix and consumer purchasing patterns to continue to normalize toward historical levels in conjunction with the gradual lessening of on-premise sales location restrictions related
to COVID-19 and with the expansion of certain markets in future periods.
Net sales growth contribution
Net sales growth is defined as the percentage increase of net sales in the period compared to the prior period. Contribution to net sales growth is calculated based on the portion of changes in net sales for a given period that is driven by two factors: changes in sales volume and changes in sales price and mix. Volume contribution presents the percentage increase in cases sold in the current period compared to the prior 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.
Growth in net sales was attributable to continued strong sales volume growth and a positive price / mix contribution, demonstrating the shift back toward pre-COVID-19 trends as we saw growth in our on-premise and DTC sales, which drive increased sales in our ultra-luxury brands that sell at higher average sales prices. In the prior year period, we saw immense growth primarily driven by off-premise sales of our luxury winery brands that drove a negative price / mix contribution. Our consistent use of distributor and retail sales discounts and
promotions in our wholesale channel to gain market share has historically and will continue to put downward
pressure on price / mix contribution given an increase in net sales. We expect price / mix contribution will continue to move toward historical levels as consumer purchasing and consumption habits return to normal following the COVID-19 pandemic. We expect that volume contribution will continue to be the primary driver of changes in our net sales in future periods, and to the extent that growth is fueled by sales of our lower-priced luxury winery brands, we may expect lower or negative price / mix contribution in the future.
Components
of results of operation and key factors affecting our performance
Net sales
Our net sales consist primarily of wine sales to distributors and directly to retail accounts in California, which together comprise our wholesale channel, and directly to individual consumers through our DTC channel. Net sales generally represent wine sales and shipping, when applicable. Sales are generally recorded at the point of shipment and are recorded net of 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 our California wholesale sales channel, to retail accounts nationally.
The following factors and trends in our business have driven net sales growth over the past fiscal years and are expected to be key drivers of our net sales growth for the foreseeable future:
•Further leverage brand strength. We believe our comprehensive growth plan will continue to increase brand awareness and grow sales of our winery brands to our existing consumer base and a new generation of consumers. This plan is made possible by our omni-channel platform, which enables us to grow, both through increased volume with existing and new customers and accounts as well as through periodic price increases, particularly on our higher end, smaller lot DTC wines.
•Insightful
and targeted portfolio evolution. Our curated portfolio and historical growth result from long-term dedication to continuous evolution and alignment with the luxury wine consumer. We believe we can drive additional sales through our wholesale and DTC channels. As we continue to scale, we believe our growth mindset, coupled with our differentiated production and distribution platform, will enable us to adapt and remain at the forefront of our industry.
•Distribution expansion and acceleration. Purchasing by distributors and loyal accounts that continue to feature our wines are key drivers of net sales. We plan to continue broadening distribution of the wines in our portfolio as well as to increase the volume of wine sold to existing accounts. We believe our long-standing existing commercial relationships coupled with exceptional portfolio strength position
us to capture distribution growth opportunities and accelerate sales to existing distributors and retail accounts in California.
•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 four 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.
The primary market for our wines is the United States, which has historically represented approximately 95% of our net revenue. Accordingly, our results of operations are primarily dependent on U.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 all U.S. states (except California, where we sell directly to retail accounts) and in over 50
countries globally.
We also have developed strong relationships with consumers who 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 in California and to distributors in other states occur below suggested retail price. We work closely with our distributors to increase the volume of our wines and number of products that are sold by the retail accounts in their respective territories. In California, 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 suggested retail prices. 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.
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 in March 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 periods of market disruption.
We routinely offer sales discounts and promotions through various programs to distributors around the country and to retail accounts in California. These programs, where permissible, include volume-based discounts on sales orders, depletion-based incentives we pay distributors and certain other promotional activities. The expense
associated with these discounts and promotions is estimated and recorded as a reduction of 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 throughout Northern California and Washington, 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 offerings and cross-selling wines in our portfolio of winery brands, we focus on increasing customer conversion and customer retention. As we continue to invest in enhancing our DTC channel, we expect to continue to increase customer engagement, which we believe will result in greater customer satisfaction and retention.
Seasonality
Our net sales are typically highest in the first half of our fiscal year 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 2021, our net sales in the first, second, third and fourth fiscal quarters represented approximately 27%, 25%, 27% and 21%, respectively, of our total net sales for the year.
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 toward 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 world-class, strategically located Estate vineyards
and strong relationships with quality-oriented growers. In addition, our sourcing model includes the purchase of high-quality bulk wine from established suppliers to add a highly flexible element of diversity to our supply model. Generally, over 85% of our total production is sourced from third-party growers and, to a significantly lesser extent, the bulk wine market. Our ability to adjust the composition of a particular vintage among our grape and bulk wine sourcing supply channels allows us to tailor inputs based on varying market or seasonal factors, which we believe enables us to produce the highest possible quality wine while optimizing gross profit.
Consistent with other agriculture enterprises, the cost of our wine fluctuates due to annual harvest yields, which vary due to weather and other events. In addition to agricultural factors, price volatility in the grape and bulk wine markets, competition for supply and seasonal
labor costs also impact our cost of sales. We may continue to experience fluctuations in the costs of producing wine, which could impact our gross profit.
Selling, general and administrative expenses
Selling, general and administrative expenses consist of selling expenses, marketing expenses and general and administrative expenses. Selling expenses consist primarily of direct selling expenses in our wholesale and DTC channels, including payroll and related costs, product samples and tasting room operating costs, including processing fees and outside services. Marketing expenses consist primarily of advertising costs to promote winery brand awareness, customer retention costs, payroll and related costs. General and administrative expenses consist primarily of payroll and related costs, administrative expenses to support corporate functions, legal and professional fees, depreciation,
accounting and information technology, tenancy expenses and other costs related
to management. 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.
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 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. As governmental authorities implemented various measures limiting the activities of businesses and individuals to reduce the spread of COVID-19, wine producers in the United States were generally classified as essential businesses, which enabled us to continue producing and selling our wine. For the safety of our employees and the individuals with whom we work, we adapted our policies and protocols to meet applicable federal, state and local requirements, and we continue to monitor and revise our policies as appropriate.
The comparability of our results of operations have been significantly impacted by the effects of the COVID-19 pandemic on our business, industry, customer behavior, key markets where we operate and
as a result of macroeconomic factors. Accordingly, certain period-over-period comparison have been and may continue to be influenced by disruption due to the COVID-19 pandemic.
At the outset of the COVID-19 pandemic in the third quarter of Fiscal 2020, we experienced a significant decrease in sales of ultra-luxury wines sold through our on-premise wholesale sales channel and a significant increase of sales of ultra-luxury and luxury wines sold at off-premise retailers. Historically, our ultra-luxury winery brands, have delivered higher gross profit margins, and generally sell in larger volumes on-premise than our luxury winery brands, which typically see
higher sales volumes off-premise. This shift in sales channel mix continued through the majority of Fiscal 2021. As we observe continued signs of reopening across the domestic consumer product markets and reversion toward consumer consumption and purchasing habits which we believe to be more in line with trends observable before the COVID-19 pandemic, we expect on-premise sales to increase from their pandemic lows, resulting in higher sales of our ultra-luxury winery brands. At the same time, the significant growth in off-premise sales that we have experienced during the pandemic may be tempered, and the rate of growth may marginally slow at off-premise retailers. Although we have observed strong customer demand during periods impacted by pervasive stay-at-home restrictions, and cannot predict the future impact on consumer spending as these restrictions continue to lessen, 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.
During the pandemic, our tasting rooms have also experienced lower tasting fee revenue due to reduced capacities or mandatory closure in order to comply with applicable regulations despite sustained operating levels of expenses, primarily comprised of tasting room operating expenses during periods of capacity restrictions or mandatory closure. 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 limiting 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, Inc.
Impact of wildfires
During 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. In response, we took steps to obtain alternative sources of supply that we believe substantially mitigates the impact of the fires on our supply. Based on our internal analysis of the impacts of the wildfires, we believe
the potential future impact on our operational results to be immaterial. We intend to continue monitoring the ongoing effects on our business for any material changes to that conclusion. Wildfires and smoke damage to grape yields have resulted in disruption and could continue to disrupt the overall grape supply market, introduce changes to our production plan, impact the quantity or release timing of expected case sales in our sales forecast, or result in changes to future gross profit margins as compared to prior periods.
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 (Other intangible assets) to our Condensed Consolidated Financial Statements for additional information.
The effects of purchase accounting adjustments on our operational performance caused our pre-tax income from operations to be lower 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 Condensed Consolidated Statements of Operations impacted by these purchase accounting adjustments:
Three months ended October 31,
(in thousands)
2021
2020
Purchase
accounting adjustments to cost of sales
$
193
$
561
Impact of purchase accounting on gross profit
(193)
(561)
Amortization of customer relationships and other intangible assets
1,921
1,921
Impact
of purchase accounting on selling, general and administrative expenses
1,921
1,921
Impacts of purchase accounting on income before income taxes
$
(2,114)
$
(2,482)
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 October 31,
(in thousands, except percentages)
2021
2020
Net sales
$
104,181
100.0
%
$
91,638
100.0
%
Cost
of sales
51,771
49.7
47,363
51.7
Gross profit
52,410
50.3
44,275
48.3
Selling,
general, and administrative expenses
23,158
22.2
16,805
18.3
Casualty
loss
49
—
1,555
1.7
Income from operations
29,203
28.0
25,915
28.3
Interest
expense
1,606
1.5
3,580
3.9
Other (income) expense, net
(1,093)
(1.0)
(1,323)
(1.4)
Total
other expenses
513
0.5
2,257
2.5
Income before income taxes
28,690
27.5
23,658
25.8
Income
tax expense
7,377
7.1
6,136
6.7
Net income
21,313
20.5
17,522
19.1
Less:
Net (income) loss attributable to non-controlling interest
(40)
—
1
—
Net income attributable to The Duckhorn Portfolio, Inc.
Net
sales for the three months ended October 31, 2021 increased $12.5 million, or 13.7% to $104.2 million compared to $91.6 million for the three months ended October 31, 2020. The increase in the period is driven by volume growth and a positive price/mix contribution, with increases in the percentage of net sales seen in both our California Direct to Retail and DTC channels. There were no material pricing changes for the periods presented.
Cost of sales increased by $4.4 million, or 9.3% to $51.8 million for the three months ended October
31, 2021 compared to $47.4 million for the three months ended October 31, 2020. The increase in the period was 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 October 31,
Change
(in thousands, except percentages)
2021
2020
$
%
Gross
profit
$
52,410
$
44,275
$
8,135
18.4
%
Gross profit increased $8.1 million, or 18.4% to $52.4 million for the three months ended October
31, 2021 compared to $44.3 million for the three months ended October 31, 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 three months ended October 31, 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 50.3% for the three months ended October 31, 2021 compared to 48.3% for the three months ended October 31, 2020. The increase, due to movement towards historical trends in consumer
spending patterns with the continued recovery of on-premise sales locations, depicts a shift in sales mix in favor of ultra-luxury wines sold throughout all of our sales channels. These shifts are especially prevalent in our Wholesale California and DTC channels in the current period. As our luxury winery brands contribute to outsized volume growth in the future, we may expect downward pressure on gross profit margins in future periods.
Operating
expenses
Selling, general and administrative expenses
Three months ended October 31,
Change
(in thousands, except percentages)
2021
2020
$
%
Selling
expenses
$
10,398
$
8,324
$
2,074
24.9
%
Marketing expenses
2,172
1,746
426
24.4
General
and administrative expenses
10,588
6,735
3,853
57.2
Total selling, general and administrative expenses
$
23,158
$
16,805
$
6,353
37.8
%
Selling,
general and administrative expenses increased $6.4 million, or 37.8% to $23.2 million for the three months ended October 31, 2021 compared to $16.8 million for the three months ended October 31, 2020. The increase was largely attributable to compensation costs due to our expanded workforce, higher equity-based compensation as a public company as compared to the prior year period, transaction expenses incurred for the secondary offering (see Note 1 (Description of business) for additional information related to the offering), higher general and administrative costs related to being a public company and higher selling expenses in support of revenue-generating activities as travel restrictions lessened versus the comparative prior year period.
General and administrative expenses were higher for the three months ended October
31, 2021, primarily due to equity-based compensation costs and public company costs that we had not incurred in the prior year period shown. Selling expenses were higher for the three months ended October 31, 2021 due to equity-based and other compensation costs along with the impacts of increased business travel and the related costs of in-person sales activities beginning to occur again that had previously been constrained due to COVID-19 restrictions in key markets where we operate. Marketing expenses increased by $0.4 million for the three months ended October 31, 2021 versus the comparative period due primarily to increases in equity-based compensation and other
compensation costs, further increased due to the prior year period showing reductions in marketing and promotional events as a result of the ongoing pandemic.
Casualty
loss
Three months ended October 31,
Change
(in thousands, except percentages)
2021
2020
$
%
Casualty
loss
$
49
$
1,555
$
(1,506)
(96.8)
%
Casualty loss decreased by $1.5 million, or 96.8% for the three months ended October 31, 2021
compared to the three months ended October 31, 2020. In the first quarter of Fiscal 2021, a series of wildfires occurred resulting in incremental costs to us. These costs, largely occurring in the same quarter as the fires, included 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. See Note 13 (Casualty loss) to our Condensed Consolidated Financial Statements for further information.
Other
expenses
Three months ended October 31,
Change
(in thousands, except percentages)
2021
2020
$
%
Interest
expense
$
1,606
$
3,580
$
(1,974)
(55.1)
%
Other (income) expense, net
(1,093)
(1,323)
230
(17.4)
%
Total
other expenses, net
$
513
$
2,257
$
(1,744)
(77.3)
%
Other expenses decreased by $1.7 million, or 77.3% to $0.5 million for the three months ended October
31, 2021 compared to $2.3 million for the three months ended October 31, 2020. Our interest expense was reduced year over year driven by lower debt balances outstanding for the period, in conjunction with lower average interest rates on our variable debt. The change in our other (income) expenses, net, was primarily driven by downward pressure on LIBOR and a lower overall swap nominal balance, which reduced the liability balance on our interest rate swap, resulting in a gain for the three months ended October 31, 2021. In addition, see “—Liquidity and capital resources” for discussion of our Credit Facility.
Income
tax expense
Three months ended October 31,
Change
(in thousands, except percentages)
2021
2020
$
%
Income
tax expense
$
7,377
$
6,136
$
1,241
20.2
%
Income tax expense increased $1.2 million, or 20.2% to $7.4 million for the three months ended October
31, 2021 compared to $6.1 million for the three months ended October 31, 2020. The change in our income tax expense was primarily due to increased pre-tax income in the current period, as the effective tax rate remained largely consistent year over year.
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 October 31, 2021, we had $5.2 million
in cash and $314.0 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 evaluated 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 generally greatest during harvest, a period which can span from August to November based on agricultural conditions and other factors outside our control. We believe that our expected operating cash flows, cash on hand and borrowing capacity on our revolving line of credit, will be adequate to meet our cash needs for the next 12 months. However, changes in our business growth plan, planned capital expenditures or responses to the impacts of the global pandemic or to an ever-changing and highly competitive industry landscape may result in changes to our cash requirements.
If our cash needs change in the future, we may seek alternative or incremental funding sources to respond to changes in our business. To the extent required, we may seek to fund additional liquidity through
debt or equity financing, although we can provide no assurance that such forms of capital will be available when needed, if at all, or available on terms that are acceptable.
Cash flows
The following table presents the major components of net cash flows.
Three months ended October 31,
(in thousands)
2021
2020
Cash
flows provided by (used in):
Operating activities
$
22,747
$
2,487
Investing activities
(5,896)
(7,686)
Financing activities
(15,848)
252
Net
increase (decrease) in cash
$
1,003
$
(4,947)
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 three months ended
October 31, 2021, net cash provided by operating activities was $22.7 million compared to $2.5 million for the three months ended October 31, 2020, an increase of $20.2 million. The increase in cash provided by operating activities was driven by the following factors:
•Operating cash flows increased due to an increase in net income of $5.4 million after adjusting for non-cash items;
•The combination of increased prepaid insurance premiums on new and existing policies and bulk and bottled wine supply management to support increases in demand resulted in a decrease to operating cash flow of $8.8 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 $0.4 million increase in operating cash flow;
•Changes in accounts payable and accrued expenses increased operating cash flows $32.2 million due primarily to timing of invoice payments, predominately related to grape grower purchases during the annual harvest period;
•Decreases in accrued compensation of $4.6 million based on the timing of certain compensation-related payments resulted in an increase in operating cash flow; and
•Higher list member sales as compared to previous periods, partially due to shipment timing, decreased deferred revenues and operating cash flows by $4.3 million.
For the three months ended October 31, 2021, net cash used in investing activities was $5.9 million compared to $7.7 million for the three months ended October 31, 2020, a decrease of $1.8 million. Capital expenditures were $5.9 million for the three months ended October 31, 2021 and $7.7 million for three months ended October 31, 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 three months ended October 31, 2021, net cash used in financing activities was $15.8 million as compared to net cash provided by financing activities of $0.3 million for the three months ended October 31, 2020, an increase of $16.1 million of net cash used in financing activities. The increase in cash used in financing activities was primarily the result of an increase in payments and a decrease in borrowing on our revolving line of credit, netting to $13.0 million cash used for the three months ended October 31, 2021 in comparison to $4.0 million cash provided by the net revolving line of credit activities for the three months ended October 31, 2020.
Capital resources
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 October 31, 2021, outstanding principal balances on the debt instruments were $111.0 million for the revolving line of credit,
$7.9 million for the capital expenditure loan, $101.8 million for the term loan (tranche one) and $14.0 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 October 31, 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 October 31, 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 October 31, 2021, we did not have any off-balance sheet arrangements that had, or are reasonably likely to have in the future, a material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.
Critical accounting policies and estimates
Our management’s discussion and analysis of our financial condition and results of operations are based on our Condensed Consolidated
Financial Statements, which are prepared in accordance with U.S. GAAP. The preparation of these Condensed Consolidated Financial Statements requires the application of appropriate technical accounting rules and guidance, as well as the use of estimates. The application of these policies requires judgments regarding future events. These estimates and judgments could materially impact the Condensed Consolidated Financial Statements and disclosures based on varying assumptions, as future events rarely develop exactly as forecasted, and even the best estimates routinely require adjustment.
There have been no material changes in our critical accounting policies during the three months ended October 31, 2021, as compared to those disclosed in the "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies" in our Annual
Report on Form 10-K for Fiscal 2021.
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.
Our ongoing business operations cause us to be exposed to certain market risks, including fluctuations in interest rates, commodity prices and other costs related to production inputs, foreign currencies and inflation.
Interest rates
We are subject to interest rate risk in connection with changes in interest rates on our credit facilities, which bear interest at variable rates based upon LIBOR plus applicable margins or predetermined alternatives rates, as applicable, pursuant to the terms of our Credit Facility. As of October 31, 2021, our outstanding borrowings at variable interest rates totaled $231.9 million. An increase of 100 basis points in the effective interest rate applied to these borrowings would result in a $2.3 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 an interest rate swap in March 2020. See Note 9
(Derivative instruments) to our Condensed Consolidated Financial Statements for further information on the interest rate swap.
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 Condensed Consolidated Statements of Operations. The Company
uses foreign exchange forward contracts to offset a portion of the foreign currency exchange risks associated with forecasted purchases of barrels from France. The Company had no outstanding foreign exchange forward contracts as of October 31, 2021. See Note 9 (Derivative instruments) to our Condensed Consolidated Financial Statements for further information.
Sensitivity due to fluctuations in foreign currency exchange rates was not material as of October 31, 2021.
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. We do not engage in forward, future or other derivative hedging activities to attempt to manage future price volatility of raw materials or other production-related inputs. As a result, some of these prices change over time, and future changes to commodity prices, raw materials or other significant inputs in our wine production could have a material impact to our future results of operations.
Item 4. Controls and procedures.
Disclosure
controls and procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required financial disclosure.
As of the end of the period covered by this 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 defined in Exchange Act Rule 13a-15(e) and 15d-15(e). Based upon this evaluation,
our Chief Executive Officer and Chief Financial Officer concluded that as of October 31, 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 October 31, 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.
From time to time, we are involved in various legal proceedings arising from
the normal course of business activities. Legal expenses associated with loss contingencies are accrued if reasonably estimable and the related matter is probable of causing the Company to incur expenses or other losses based on future contingent events in accordance with the Company's policies, otherwise legal expenses are expensed as incurred. We are not presently a party to any litigation the outcome of which, we believe, if determined adversely to us, would individually or taken together have a material adverse effect on our business, operating results, cash flows or financial condition.
Item 1A. Risk factors.
For
a discussion of our potential risks and uncertainties, please see the information under the heading "Risk Factors" in our Annual Report on Form 10-K for Fiscal 2021. There have been no material changes since our previous 10-K filing.
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Pursuant to the requirements of the Securities Exchange Act of 1934 the
registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
