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

I was just going to add, Brian. So our long-term growth algorithm is high single digits, right? And volume is our growth driver. But we won't do that at any expense, right? So we won't make crazy acquisitions that don't make sense to us. They need to be accretive. We grow our volume, but we also have resources that we commit to that to help ensure we're going to grow it. So we don't discount crazy, we won't -- there are certain levers we know we can pull and others that we know we should stay away from. So we invest in our sales team. We invest in our internal back end of the work as well to make sure we can grow and scale so we think of it, as Alex said, very long term, and we have strategy, how we're going to get there. We do the TAM analysis. We know what we have to go after to get there in the long run. So I think all that adds up to really make it so that we have a lot of confidence in achieving our goals.

And we've studied -- as you mentioned, we talked 4 years ago, we spent a lot of money, a lot of time to make sure we're well prepared to enter this new world and we've seen a lot of mistakes. You and I off-line could probably agree on some of our competitors have made, right? We manage inventory for the benefit of the market, not for our distributor for us. It's for the benefit of the market because, ultimately, that don't take you where you want to go. So making sure that all the important things are managed correctly and all the little things are managed correctly. I think we've got a good handle on it, very confident, though, that we do have a handle on it and it is sustainable. It never -- nothing's easy. All the good things are never easy but I think it is absolutely sustainable to continue to hold our luxury position, the luxury performance and results into the future, and we're setting ourselves up, as Lori said, on a long-term basis to be able to continue to achieve that.

The other point of differentiation that we talked a lot about was knowing what you are in terms of luxury and particularly present at this point, the fact that we have a tailwind of premiumization that has been strong for the past 20 years and we are firmly and solely in luxury, which differentiates ourselves from pretty much all of the competitors that had a much broader lens intro...

Sean brings up a very interesting point. I think in the world of business today, right, being solely into something might be a little scary. We are in the band of luxury that has the most scale and growth, right? We could agree that a $500 bottle wine is luxury or growth in scale is there. At that $20 to $200, we think we've carved out and I think the data is showing it, the sweet spot of luxury, and we firmly believe that luxury is not going away. They may might move around in luxury, but the luxury buyer today is probably not going to jump to buy a $4 bottle wine. We just -- the data doesn't bear it out. We're seeing none of that. So we think we're in the right spot of the luxury category.

That makes sense. So it's a luxury company. As much as it is a wine company, it's also a luxury company.

Being the fact that a lot of pure play wine comps out there, sure, we're up there with all the great luxury companies we want to talk about.

All right. And then just follow-up or second question is just the weather in California has been in the headlines, right, a lot of rain, a lot of snow, so just to the extent that -- is it a positive? Is it a negative? Just again, as we're thinking about like...

Net positive. We're a farming company, a big part of our business is farming, right? That's really important. The infrastructure in California needs water, we're in good shape. There's a couple of trees that blue down and all that stuff. But the reality is it's not really impacted the important parts of sales and distribution for us. Sales were [indiscernible] little slow in December because of weather, they bounced back in January. So we believe those customers want to be part of the wine lifestyle. Net-net for the future of farming in California, I think the rains are absolutely good.

And Brian, as Alex talked and says, vineyards go to sleep in the winter, right? So they can flood, it doesn't matter because there's nothing happening in the vineyard in the winter, and it's really good for the soils for the water to soak in and to refill the aquifers. So the rains have been excellent for California in general and for us in particular.

I think we had another question upfront. About weather. Okay. Did they answer your question?

On a broader picture, the way I look at climate change is -- it is absolutely real, and we have to be doing our parts and we have a lot of ESG initiatives and just farming initiatives to offset the risk climate change. Diversification though will always be the leading offset to that risk. We have vineyards in many, many, many locations to really -- and it's been proven historically for us, at least for 40 years, but I think you can look beyond that, that diversification of vineyard locations continually year in and year out allows us to manage our costs, our quantity, our style, our quality consistently -- on a consistent basis for the production of our wines. So nobody should be comfortable with climate change, but we're comfortable that our strategy of diversification of our supply and production is going to offset that allow us to continue to do what we do well.

And our ESG strategy at large is based on what fortifies and strengthens our business because we believe that's the best way not only to provide the sustainability of the broader environment, but also of our business. And so we talk about things like even rootstock we choose when we replace a vineyard, the different avenues we have of production and balancing and optimizing in-house versus custom crush. All of those things go back to Alex's point of diversification and really build resiliency as we look forward to the eventuality of climate change and being able to manage it in a very productive and cost-effective way.

Okay. Lori, I'm ready for some financial questions.

Okay.

So maybe just to start, right? And this came up on the call last week. I think there's maybe been a little bit of confusion, but you've raised the guidance on gross margins twice this year from being down, call it, 50 to 100 bps. Now you're talking about moderate expansion that happened in the course of 2 quarters. So just -- what's been driving the upside? Anything you need to help us just in terms of the balance of the year, kind of how we should think about specifically the gross margin line?

Yes. Thank you. So we've guided to modest margin expansion for the year. So that won't hold true for Q3 as much as Q4 because remember the cadence switch for the Kosta Browne shipping, but for the end of the year. And that's mostly driven by realization of the pricing strategy that we've put in place and then also some brand mix is helping us there. And remember, we have really 3 channels that have different gross margins. And as our wine sell-through in the different channels, I'll remind you, it's a direct-to-consumer, direct in California and then the other 49 states and export. They have different gross profit margins, but they also have different operating expense. And so when it comes right down to earnings, they have very similar earnings results. So we're a little bit different than a normal CPG company where gross profit margin will really influence the bottom line. It's not so for us as much as -- it's more brand-driven. Brand will go straight to the bottom line as well as, like I said, this benefit from some of the pricing strategies we've implemented.

So we're somewhat channel-agnostic, right? Because the profitability all the way down is -- so it makes it easier to make sales decisions that way.

We don't have conflicting -- competing channels.

Right, exactly. And then maybe the one other thing that's kind of been unique to NAPA, you probably haven't experienced as much inflation as other CPG companies. I mean it's something I think we've spent a lot of time talking about. But eventually, I would think some of that would catch up, whether it's higher farming costs or labor costs for vineyards. Just kind of remind us the cadence of how your costs flow through the P&L on sort of a delayed basis.

Sure. Yes. So cost of a bottle of wine, 65% to 85% of that is the fruit, the grape's component. And that we contract out long term in advance. We grow some of our own fruit as well as we have long-term relationships with a lot of growers. And we have -- what is it now 250 to 300 grow our partners that we work with. And we have long-term contracts with those folks. So we know today what our fruit cost will be, for the most part, for the '24 harvest. And those fruit contracts don't vary with current near-term inflation. They're based on an industry index. And we have -- those contracts were constantly going in and out of them depending if it's a good grower. We have good relationships with them. They deliver us great fruit. Those continue on for a long term. So we've got great visibility into the cost up to 85% of the cost of 1 bottle of wine. Long term out. So it takes us 5 to 48 months to produce wine depending on where that wine falls within our portfolio. So we have visibility into where that cost is going to come through. Now as you mentioned, the near term, we've had some price increases. The other big piece of that is our packaging. So the packaging component can change a little more near term, right? So the bottles that we bottle the wine in some of our whites go to market much quicker than some of the reds. And those -- we have long-term contracts as well, and they have prices that can change on an annual basis, but those price changes are capped. So we know what the cost of that is. We have a lot of levers as we go through our cost of goods. Every label that we make has a target margin so we focus on it on a label-by-label basis. We have a target margin. Sometimes, we're a little over. Sometimes, we're below. We don't have to have it exact for every label. But on average, our winemakers, our production team have a target for a particular brand. And we have a lot of long-term history of hitting our margins because of these levers they can pull. So that's how we go about it when we think about cost and margin on our wines.

Great. And Alex, maybe this is the next topic is something I know you're very passionate about. I've heard you speak very passionately about it, tasting. Something on -- you've done a really nice job of reinvesting in the business, in particular, the sales force. I feel like you view it as a key kind of competitive advantage. Can you just talk about your sales force, both on- and off-premise, particularly the on-premise piece, which I think doesn't get as much attention as it probably deserves and just how you kind of see that going forward?

I'll go back by saying luxury wine, I think luxury purchases at some level, but certainly luxury wine, it's a very emotional purchase, right? You don't need a $75 bottle wine necessary. So there's a lot of hand-to-hand combat out there in the market. It's about developing relationships, you're selling an emotional product that you don't absolutely need so it's a block and tackling, having good people, having people out there telling the story in the markets. We have consistently since the beginning of time, invested in having the right salespeople and kind of continually decreasing more focused geographies throughout the United States as we've grown, again, kind of looking back there. Right now, we're looking at really making sure that we target investment in salespeople in the areas that are going to get us the best buck actually, but really making sure we have the right amount of people and there's a ramp-up to it. To tell the Duckhorn story, you can't just start tomorrow and be fully effective as a ramp-up. There's -- they're understanding the market, understanding you're making your contacts within the buying industry. So we do make step-up investments from time to time to make sure it's offensive, really. I don't want to -- if I need salespeople behind the 8 ball, then I'm too late. It's a long way of saying, having the right people on the ground to leverage our distributor sales force, to leverage and make sure the goals of our distributors are being attained to and making sure that we have good visibility into the market on and off in any given market, United States, around the world, it's just critically important on making investments during a downturn usually pays off in the upswing. We've seen it time and time again. And I think that it also has been evidenced by the fact that depletions are on target to make sure we hit our goals, almost more importantly, the data showing that we're taking share from somebody. And it's not just because our products are great because they are, but it's also the route in which we're going to market in the contacts, relationships we're building with key customers. And then the trust and the reliance that we're giving as a company. And we will continue to do that. I think that we -- the last year, we all noted in your write-ups that we did make a lockstep change in investment. In some sales systems and salespeople, we're seeing in those markets. I mean increased depletion rate, growth rates, which is what you're looking for. And over the next 6 months to 3 years of these people depending on the market get fully ingrained, we're going to expect to see continued taking up share and increased sales rates. On that particular subject, I'll also throw in marketing, right, making marketing investments, digital marketing, traditional marketing. And then remember also in our industry, direct-to-consumer sales, you could look at that as a high gross margin sales channel. You could also look at is just marketing. Our customers are paying for our market. Those are the highest most connected ways in which we talk to our customers is our direct-to-consumer sales because those people then do buy a lot of our wines through their traditional wholesale channels. So I think it would be silly to expect us as a luxury company, not to make sure that we have the highest quality marketing and sales approach in the industry. But by the same token, as we've all noted, we got to make sure that we maintain the right kind of operational efficiencies going forward for a luxury company. And I think we've got that well in hand.

Great. We touched on marketing. So maybe we can move on to cash flow. Lori, obviously, the company has a pretty healthy cash flow profile. You've delevered the balance sheet pretty materially since the IPO. I think there's a lot of questions. We're seeing a lot of headlines, obviously, about some wineries in NAPA that may be having some financial issues, obviously, over the past week. Just kind of pose for us kind of where NAPA sits, right? Obviously, balance sheet is in a good spot. But how do you think about cash flow, capital allocation M&A? And then, Alex, just you speak to a lot of contact, obviously, in the industry. Just kind of what are you hearing from folks out there even in the past week given that...

Typically, people drink a lot of wine during banking crisis. Somebody had to break that up.

Peter. So as you mentioned, we do have a very strong balance sheet, and we're very happy about that. That doesn't just happen. We have been well aware of some macroeconomic concerns out there this time. So we've been very thoughtful. We have a very positive cash flow business, and we're able to delever, which is what we have been doing, 1.7x. And we'll continue to do that. So our preference is to delever, but we also have, as you mentioned, the strong balance sheet, which gives us the ability to invest if we find the right opportunity. Opportunities have to be accretive before we will invest. So we've looked at a lot of things, and we continue to do that. But we don't -- we would never lever more than like 4x just because that doesn't make sense to us to put the business at risk. So in terms of thinking about M&A, we will invest in both brands as well as vineyards, wineries, those types of things. And Sean, maybe you can update us on currently how we're -- what we're seeing out there available M&A and how we're approaching it.

Yes. I think you said it very well. And then we are focused on doing the right deals as they come along. The SVB situation, as you alluded to and other banking failures, we thankfully had no meaningful exposure, and we're in good shape there. There were some that did have a presence in wine. I'm not sure when all falls out from that if there will be too much that flows from that given how the Fed has stepped in but we're -- it did really change our analysis when it comes to either branded wineries, which would be kind of what you think of as bolt-ons or production and production assets and vineyards that we think of as rightsizing our winemaking and our fruit sourcing. The focus is on running the model, finding something that's accretive, making sure it's firmly and luxury, making sure it works well with our brand architecture and is something where we can add further value. And as Lori has managed our leverage ratio to where it is today, that gives us both, I think, superb capital allocation and also some dry powder when coupled, especially also with our public company stock as a currency to be creative and to do deals that I think would make sense. But given that we have a long-term growth algorithm based entirely on organic, our feeder never to the fire to have to do that. And that's a really plus position for one to be in.

Great. Just a minute, I don't know if there's any other questions in the room. Now I'm going to go to my last question, which is the one I've been waiting for, right. Brian, ask them the question.

Okay, guys. Fun one. what's your favorite wine in the portfolio right now that we're all going to go out and buy right after the -- got to pick one. I know you love all your children.

I love all my children. My wife and I've been drinking the Duckhorn Sauvignon Blanc [Audio Gap] which is somewhat untypical and it makes a richer larger style Sauvignon Blanc, I think while we're all down here in Florida, where it's a little warmer than anywhere else in the United States. I think that's what I would suggest we have with our next -- when you guys get together and write in your notes, I have a last Sauvignon Blanc right next to your laptop.

Yes. It's interesting that you mentioned the Canvasback, which is an amazing one, and really over delivers, I think, for the price point. But right now, I'd have to say Paraduxx, Red Blend is really one of my all-time favorites. How about you, Sean?

I have two. They're both in the same family. Decoy Limited right now is drinking so well and it is available broadly. It is in particular, I'm loving the Cab and then our Merlot just came out. First time we've done Decoy Limited Merlot, it's phenomenal. It really is. Run, don't walk, to buy some.

Is everybody aware of the brands just in your personal life or just where you guys are fairly aware of the brand? Okay. Good news, that's good.

Awesome. Great. Well, guys, thank you so much for your time. Really appreciate it. Everybody go out and have a nice glass of wine from Duckhorn and we'll leave it there.

Thank you, Peter. Appreciate it.

Thank you.