The Duckhorn Portfolio, Inc. (NAPA) Earnings Call Transcript & Summary

Good afternoon. Thank you for attending today's Duckhorn Portfolio Fiscal Year 2023 Second Quarter Earnings Conference Call. My name is Tamia, and I will be your moderator for today. [Operator Instructions] It is now my pleasure to pass the conference over to your host, Sean Sullivan, Chief Strategy and Legal Officer. You may proceed.

Good afternoon, and welcome to The Duckhorn Portfolio's second quarter 2023 earnings conference call. Joining me on today's call are Alex Ryan, our President, CEO and Chairman; and Lori Beaudoin, our Chief Financial Officer. In a moment, we will give brief remarks followed by Q&A. By now, everyone should have access to the earnings release for the fiscal quarter ended January 31, 2023, that went out at approximately 4:05 p.m. Eastern time. The press release is accessible on the company's website at ir.duckhorn.com. And shortly after the conclusion of today's call, a webcast will be archived for the next 30 days. Before we begin, I would like to remind you that today's discussion contains forward-looking statements based on the environment as we currently see it, and as such, includes risks and uncertainties. If you refer to Duckhorn's earnings release, as well as the company's most recent SEC filings, you will see a discussion of factors that could cause the company's actual results to differ materially from these forward-looking statements. Please remember, the company undertakes no obligation to update or revise these forward-looking statements in the future. We will make a number of references to non-GAAP financial measures. We believe that these measures provide investors with useful perspectives on the underlying growth trends of the business and have included in our earnings release a full reconciliation of non-GAAP financial measures to the most comparable GAAP measures. In addition, please note that all total U.S. food scanner data cited on today's call will refer to dollar or unit consumption for the 12 week period ended January 29, 2023, and growth versus the same period in the prior year, unless otherwise noted. With that, I will turn the call over to Alex.

Thank you, Sean, and good afternoon, everyone. Thank you for joining us today to discuss another strong quarter of financial performance, demonstrating sound execution of our long-term growth strategy and continued outperformance of the luxury wine subsegment. Following my opening remarks, Lori will walk us through our quarterly results, and will also provide an update on our raised guidance for fiscal year '23. Then we will open the call for questions. I would like to begin today's call by offering a few highlights from the quarter. First, we delivered nearly 5% organic net sales growth at the high end of our expectations for the quarter and lapping the robust 18% growth we realized in the prior year period. This marks a sequential acceleration on our 2 year trends with wholesale volume remaining the primary driver to our growth. Second, demand for our high-quality luxury wines remains very healthy, and our wholesale depletion growth once again exceeded the pace of shipments in the quarter. We continue to execute against our considerable distribution white space opportunity, extending the reach of our high quality luxury brands into new doors and adding additional labels in existing accounts. During the quarter, we made solid progress on increasing the number of accounts in which our wines are sold and the number of labels in each account, both on and off-premise and across account types. Third, the premiumization trend toward luxury wine continues. Luxury remains the fastest growing subsegment in wine and our strong consumption trends continue to far outpace the subsegment and the broader category, led by our largest winery brands, Duckhorn Vineyards and Decoy, we were once again a growth leader among scaled luxury suppliers, marked by continued distribution gains. This superior performance resulted in consistent share gains measured in both dollars and volume. We continue to see little, if any signs of trade round within the Duckhorn Portfolio, and believe that this is a result of both the resiliency of our more affluent luxury consumer during times of uncertainty, as well as our superior brand strength. Fourth, the strength of our business extends beyond wholesale with performance in our high-margin DTC channel continuing according to plan, up nearly 60% in the quarter. Our exclusive limited time Kosta Browne single-vineyard series and Burgundy releases were tremendously successful. In addition, sales from our wine clubs were solid across our winery brands, which speaks to the multiple ways we are successfully connecting directly with our loyal consumers and driving top line growth. And fifth, our highly diversified approach to great sourcing and wine production, coupled with clear visibility into our cost structure, enabled us to deliver strong results up and down the P&L, with adjusted gross profit margin and adjusted EBITDA margin each several 100 basis points above the prior year period and also ahead of our plan. This quarter's strong performance is rooted in our omnichannel growth strategy, which is diversified and well balanced across our winery brands. In both on and off-premise, we continue to see strong depletions, reflecting solid gains in accounts sold and the number of labels in each account as well as velocities per account that remain above pre-pandemic levels. Returning to the longer-term channel dynamics, our on-premise depletions growth outperformed off-premise depletions growth, increasing double-digits in spite of a challenging comparison in the prior year period. On-premise depletions continue to grow, underscoring the momentum we have in that channel as restaurateurs continue to view us as a trusted partner that consistently supplies high-quality luxury wines that consumers prefer. The underlying health of our off-premise channel is also strong as depletions continue to grow in line with our expectations. We observed good balance between national and independent accounts and cases, accounts sold and number of labels in each account contributed as strongly as expected over this time frame. As we have discussed before, the off-premise channel remains our greatest opportunity for future growth. As we further optimize our pricing and strategically invest in sales to drive distribution and awareness of our winery brands, we are confident that we can continue to take share in the channel. Our high-margin direct-to-consumer business realized tremendous growth in the quarter. We have previously discussed the change in the timing of the offerings of our ultra-luxury cost of brown wines that we are implementing over the course of this year. Consistent with that new cadence, the single-vineyard series offering moved from the first quarter into the second quarter, where it joined our highly innovative Kosta Browne Burgundy offering, which together provided a considerable tailwind to sales and gross margin. As you may recall, the Kosta Browne is sold predominantly in the DTC channel through a limited allocation model, each of these wines is offered only once per year, and these limited time offerings afford some of our most passionate customers an opportunity to purchase some of the rarest wines in The Duckhorn Portfolio. Given the scarcity and small production size of these ultra luxury wines, the backlog to be eligible to purchase Kosta Browne wine is extensive, and we consistently sell out every offering. As we enter the second half of our fiscal year, we expect a similar performance from the Kosta Browne releases in each of the next 2 quarters. Notably, our Appalachian series offering Kosta Browne's largest offering ships in the fourth quarter. And because this is a shift in timing compared to the prior year, we expect it will serve as a considerable driver to our top and bottom line performance later in the year. Complementing the strength of Kosta Browne were solid trends in our wine club sales as our most loyal customers enjoyed cherished favorites along with our new innovative offerings. At our tasting rooms, results were generally stable in spite of inclement weather that temporarily impacted visitation during the quarter. As we look ahead, we are encouraged by how early bookings are shaping up for this spring. Our innovation extends well beyond the boundaries of DTC. Our new wines have also achieved great success at scale in the wholesale channel. One of our proudest accomplishments is the success of Decoy Limited, our elevated blue label Decoy offering. Leveraging the strength of the Decoy winery brand, we have managed to deliver incremental growth by filling a previously open space in the portfolio. Since the initial introduction of Decoy Limited with 4 varietals offered in early 2021, Decoy Limited has continued to post outsized growth through increased distribution of the original varietals and the market's warm acceptance of new offerings, with strong initial sell-in of our new Decoy Limited Brute Rose and limited Alexander Valley Merlot serving as recent positive examples. We are delighted to be bringing to the market these delicious wines at the attainable luxury price point, and we are increasingly being recognized for it, by both the consumer and trade. In fact, Decoy Limited Red Blend was recently named the 2022 #2 value wine by Wine Spectator across all wine varieties globally rated 90 points or higher and widely available at $40 or less. This recognition highlights and validates our ability to provide outstanding wine at an attainable luxury price point. In summary, I'm very pleased with our second quarter and first half performance. The underpinnings that support continued premiumization and the outperformance of the luxury subsegment relative to the total wine segment remain intact, and the key components of our long-term growth strategy that have allowed us to outpace the luxury subsegment only continues to strengthen. We had in the back half of the fiscal year with good momentum. I am confident in our ability to continue to deliver strong, highly profitable growth, which is reflected in the upwardly revised full year guidance that we are announcing today. With that, I'll now turn it over to Lori to discuss our second quarter performance and updated fiscal year 2023 outlook in greater detail.

Thank you, Alex, and good afternoon, everyone. It's delightful to speak with you about another solid quarter as our highly diversified and scaled omnichannel luxury platform, coupled with sound execution of our long-term growth strategy, continue to provide strong financial results. Beginning with our top line, net sales were $103.5 million, a 4.8% increase in organic growth compared to the prior year period. These results reflect 5.2% growth in price mix, driven primarily by favorable channel mix and price increases. As anticipated, our high-margin DTC channel delivered robust growth in the quarter, benefiting from the previously mentioned change in cadence of the Kosta Browne single-vineyard series offering from the first quarter into the second quarter, as well as the highly successful inaugural Kosta Browne Burgundy offering. Positive price mix was partially offset by a de minimis 0.4% decline in volumes. This was in line with our expectations and primarily driven by Duckhorn Vineyards and Decoy, as we lapped a tremendous 24.8% volume growth comparison in the prior year period. As Alex noted earlier, second quarter wholesale depletion growth outpaced shipment growth with accounts sold and to a slightly lesser extent, number of labels in each account continuing to serve as the driving forces behind our top line results, while velocity per account remained consistently strong. Turning to net sales performance by channel. As we forecasted, the direct-to-consumer channel was our greatest growth contributor in the quarter, increasing 58.9% over the prior year period. This significant increase was due predominantly to the offering cadence shift for the Kosta Browne offerings I mentioned a moment ago. Wine club sales growth also contributed nicely to the quarter, while revenue from our tasting rooms was flat, with visitations impacted by inclement weather. California direct-to-trade was up 1.1% compared to the prior year period. We were pleased with this result, particularly given the challenging 19% year ago comparison, when California saw significant reopening at on-premise businesses. Our wholesale to distributor channel declined 4.5% compared to the prior year quarter. While this is an outlier relative to our historical performance, these results were in line with our expectations. And once again, one year performance only tells part of the story. Looking at our 2 year trends, the channel increased 27.4%, a sound acceleration relative to the 22.4% growth rate realized in the first quarter. Second quarter gross profit was $55.2 million, an increase of $5.7 million or 11.5% compared to the prior year period. On an adjusted basis, gross profit grew to $55.5 million, an increase of 11.6% compared to the prior year period. This represented a 53.6% adjusted gross margin, up approximately 320 basis points year-over-year, driven by improved channel mix from DTC and price increases implemented earlier in the fiscal year. Total selling, general and administrative expenses were largely in line with our expectations, up $5.7 million or 24% compared to the prior year period. This increase is primarily attributable to professional fees and planned growth investments intended to optimally position us for continued execution against our significant multi-year wholesale distribution white space opportunity. On an adjusted basis, total operating expenses increased by $2.9 million or 14.8%. Net income was $14.9 million and diluted EPS was $0.13 per share compared to net income of 17.9 and $0.16 per share in the prior year period. Adjusted net income came in at $21.1 million, and adjusted EPS was $0.18 per diluted share compared to 19.5 and $0.17 per diluted share in the prior year period. Adjusted EBITDA for the quarter increased 13.1% to $38.8 million. This represented 37.5% of net sales compared to 34.7% of net sales in the prior year period. This 280 basis point increase reflects our solid top line growth as well as robust gross profit generation, partially offset in the quarter by planned growth investments, including in our sales force. At the end of the quarter, we had cash of $7.3 million and total debt of $225.8 million, resulting in our leverage ratio declining to 1.7x net debt. Let's now look to our outlook for the rest of the fiscal year. Given our strong year-to-date performance and confidence in our ability to execute throughout the remainder of the year, we are raising our guidance for the fiscal year 2023, which now calls for net sales of $398 million to $404 million, reflecting approximately 7% to 8.5% organic volume-led growth. Adjusted EBITDA of $135 million to $138 million, adjusted EPS of $0.63 to $0.65 per diluted share. We are also making a few updates to certain assumptions underlying our full year guidance, namely interest expense and adjusted gross margin. We now expect interest expense of approximately $11 million to $12 million, which is down from the $13.5 million to $14.5 million range we indicated last quarter and reflects some upside from interest rate hedges. To reflect our second quarter and first half outperformance, we now expect adjusted gross margins for fiscal 2023 to reflect modest expansion, which is an improvement versus our prior guide of flat to down approximately 50 basis points year-over-year. While we are raising our guidance for the full fiscal year, as it relates to cadence, we would point you to the detailed quarterly net sales guidance we provided on our last 2 calls, including our discussion of Q4. As a reminder, our largest Kosta Browne offering, the Appalachian series has shifted entirely from the third quarter into the fourth quarter starting in this fiscal year. It is also important to remember that variability in monthly wholesale channel performance can influence any given quarter, including those late in the fiscal year. However, we remain confident in our overall ability to deliver outsized and broad-based growth embedded in our guidance for the second half in both our wholesale and DTC channels. Overall, we are very pleased with the second quarter and our strong results in the first half have provided us with a high degree of confidence as we enter the back half of fiscal year 2023. As we discussed when we reported earnings after the first quarter, I plan to retire in the next few months. Accordingly, this is likely to be the last quarterly earnings conference call for which I will have the pleasure of joining you. I'm pleased to be retiring from the Duckhorn Portfolio at a time when the company continues to deliver strong performance with momentum into the future. With that, Alex has a few closing comments.

Thank you, Lori. We truly appreciate your invaluable contributions to the company that will leave a lasting impression for years to come. Our national search for Lori's successor continues along our expected time line. To close, I'd like to reiterate my confidence in premiumization serving as a persistent tailwind to the industry and for The Duckhorn Portfolio to continue to outperform the fastest-growing subsegment in wine, luxury. To ensure that we remain a category growth leader, we are committed to making the necessary investments in our business to support the continued execution against our considerable wholesale distribution white space opportunity, and as we scale, we will be vigilant in bringing a healthy balance between growth and profitability as we seek to maximize long-term shareholder value. With that, Lori, Sean and I are available to take your questions.

[Operator Instructions] The first question comes from Gerald Pascarelli with Wedbush Securities.

Understanding that DTC is obviously going to see lumpiness and we're kind of over 2 months into the quarter here, can you maybe speak to some of the quarter-to-date trends that you've seen in your wholesale business from a top line perspective? Is it performing relative to your expectations from both the volume and pricing perspective? Just looking for any kind of color that you've seen headed into the third quarter here.

Gerald, thanks for joining us this afternoon. I can tell you that our third quarter Kosta Browne offering has completed and it's been fully subscribed, and we're very excited about it. But also remind you that historically, that has -- it happens with Kosta Browne. It's generally fully subscribed, and we've seen the same thing with this quarter. And that gives us a lot of confidence into our Q4 plans as well because a big piece of the growth in Q4 is the Kosta Browne Appalachian offering. So we expect similar results there as well.

Right. Understanding DTC from your core wholesale channel, I guess, just looking for like any kind of read on how things are trending from the downtick it was implied down for. Sorry about that.

Okay. All right. Sorry, I didn't understand. Yes. So we don't expect any change in Q3 from our expectations. We're increasing our guidance slightly because we've had strong performance across the top -- up and down our P&L, and we expect continued strong performance. And in our forecasting in Q3 and Q4, we have very reasonable expectations on depletions, and we expect things to continue. We don't see any changes coming down the pipe.

The following question comes from Gregory Porter with Evercore.

Just 2 quick question in terms of your guidance. What would be the key driver, I guess, of the upside for your guidance change? And then secondarily, is there any assumption of a weakening consumer environment in the back half? Or is the assumption that kind of things stay as they are now?

Sure. Yes. So on the top line, we're really rolling through all of the first half outperformance, and some of the things that we're thinking about as we think about that is in our wholesale channel, inventories are really in a good position. We're forecasting shipments, which align very well with our targeted days on hand. We're seeing the benefits rolling through from our pricing changes. And also, we're seeing benefits from the strategic investments that we've made in our sales team. And then as I've mentioned earlier, we have our depletion plan for Q3 and Q4 is really reasonable based on what we've seen in the first half. And then the historic experience we've had with our Kosta Browne offerings and how reliable those are and how we have them planned in the quarters. And then I believe your second question had to do with trade down?

Yes. Just with the consumer environment is baked in.

Yes. Just to follow-up on that. It's a good question. And right now, we're not making any adjustment for changes in our consumers' behavior. And I stress that point, the people buying and enjoying our wines, which has been obviously a big part of our high performance.

We haven't seen our consumer trading out of luxury, and we don't anticipate that they will, they will still stay within the luxury subsegment.

The following question comes from Kaumil Gajrawala with Credit Suisse.

Can you maybe clarify and give some more details on your comments on incremental investing. I think you said increasing sales force, a few other things. Are they -- is this incremental in the sense that the quarters obviously come in better -- not the quarter, the first half has come in better than expected, maybe freeing up some additional marketing spend? Or is this something that was maybe always part of the plan?

Kaumil, thank you for the questions. So we don't have any change in our guide. We announced our fiscal year '23 guidance. We mentioned that we'd be investing in Summit in our sales team. And those investments have been made, and we're seeing results, but -- and we don't have any changes to our plans in that regard.

And I'd just add from a strategy perspective, historically, we've looked at companies that have invested during downturns. And they have generally performed better when the upswing or period of dislocation ends. And so we believe that the investments we've made in innovation and efforts to secure a high-quality great supply and investment in people and systems, that's going to bode well for us in the long-term.

Kaumil, it's a good question. With those investments going to help us continue to take share, and we're very confident in that. And I think to Sean's point, by taking share now and into the future, we think -- when the really good days come back, we'll be extremely well poised to continue to capitalize on that in the luxury market.

Okay. Great. And then maybe an update on the incremental distribution. You mentioned wholesale strength that you continue to gain distribution. I think you shared some figures at ICR on kind of the opportunity and how far along you are? I'm just curious if you could maybe give an update or talk about your progress on some of these shelf-space wins.

Sure. So the focus that we spoke of, that I think you're referring to is our -- what we view is our total addressable market of accounts that are appropriate for our wines. And in our year end earnings in October, we spoke to what we view as our goals for our potential to increase that penetration from 24% to 29% over the course of the fiscal year period. For where we are now in that journey, which is obviously early, we feel very good -- we continue to feel very good about not only meeting that goal, but also effectively getting where we want to be on the other 2 vectors, which is increasing the number of SKUs on the shelf and then obviously increasing velocity over time of those SKUs. So we feel like where we should be to make good progress on that goal.

The next question comes from Andrea Teixeira with JPMorgan.

Lori, congrats again on your retirement, and thank you for educating all of us. One of the questions that I had is like -- and you included very strong, of course, from Kosta Browne and also the improvement in Decoy Limited. But I think when we look at Nielsen, and I know, obviously, there are puts and takes there. Can you kind of help us understand kind of like the disconnect a bit with the track channel data? And then related to -- and just a clarification also on your guide, I understand like Lori said, you raised a bit. It seems that the top line bit was about $11 million and EBITDA bit by $7 million. So you only raised at the end of the fiscal year by $4 million and then $2 million, respectively. So wondering if you're seeing -- it doesn't look like you're embedding any deceleration there, but perhaps just being conservative, how to think about the bridge to guidance?

Andrea, I'll take the first one, and I think I will pass the second one to Lori. We're seeing really solid -- we can all skin scanner data, Nielsen and others in many different ways, but we're seeing really solid Nielsen data reporting on our subsegment and certainly on our company. So we're not anticipating really any changes than continued growth in that area and resulting growth with us. And as you guys will all recall, scanner data represents about 1/3 of our overall business. And because of the diversification theme, we've stressed numerous times, that 1/3 is important, but there is 2/3 of other areas of business that continue to perform and we'll kind of continue to -- we feel confident, get us to where we're guiding and continued growth in the future. So I think we should -- we all -- Nielsen is a good guide, but it's difficult in a time period. So again, it's not our exclusive barometer.