Duckhorn Portfolio Inc (NAPA) 2022 Q2 法說會逐字稿

Greetings, and welcome to The Duckhorn Portfolio Second Quarter 2022 Earnings Conference Call. (Operator Instructions)

As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Sean Sullivan, Executive Vice President, Chief Administrative Officer and General Counsel.

Good afternoon, and welcome to The Duckhorn Portfolio's Second Quarter 2022 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.

Everyone should have access to the earnings release for the period ended January 31, 2022, the second quarter of our fiscal year 2022. It went out at approximately 4:15 p.m. Eastern Time. The press release is accessible on our 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, let me remind everyone that today's discussion contains forward-looking statements based on the environment as we currently see it, and as such, does include 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 that 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 IRI consumption data cited on today's call will refer to dollar consumption for the 12-week period ended January 23, 2022, and growth versus the same period in the prior year, unless otherwise noted.

And with that, I'll turn the call over to Alex.

Thank you, Sean, and good afternoon. We appreciate all of you joining us here today. The Duckhorn Portfolio continues to set the standard for American fine wine. I'm proud of the beautiful luxury wines we make, and today, I'm excited to share with you another great quarter of outstanding financial results, both on the net sales and adjusted EBITDA lines. Later in the call, we will also be discussing our upwardly revised outlook.

I will start with an overview of our second quarter results. In this unpredictable environment, I'm very appreciative of our team's unrelenting ability to adapt and outperform the high-growth luxury wine market. In spite of Omicron's short-term disruption to the economy, we were able to deliver continued strong performance in on-premise, while our off-premise business showed great resiliency and actually accelerated on top of solid positive growth observed earlier in the year. The continued introduction of new luxury wines and the strategic investments we've made in our sales force over the course of the pandemic have afforded us an immeasurable benefit, continued profitable share gains across all channels.

Specifically, I would like to highlight 5 notable data points from the quarter. First, we generated 18% net sales growth on an organic basis, and our adjusted EBITDA also grew by approximately 12% when comparing against the prior year quarter, burdened by public company costs. This performance underscores our ability to sustainably deliver on both the top and bottom line for stakeholders.

Second, our top line strength was driven by 24.8% volume growth, and our depletions were broadly in line with the shipments, highlighting the fact that consumer demand for our high-quality luxury wines remains robust. In fact, according to IRI, The Duckhorn Portfolio was the fastest-growing wine supplier among the top 15 wine suppliers in the U.S. We are growing dollars by high teens and over -- and at over 3.5x the rate of our closest competitor within the top 15.

Third, our Duckhorn Vineyards and Decoy brands continue to lead our portfolio of high-growth luxury wines. Combined, our 2 leading winery brands grew dollar and volume consumption by high-teen percentages on average approximately 3x faster than the broader $15 per bottle U.S. wine market. Fourth, our Decoy winery brand, the gateway duck, has proven itself to be a sustained powerhouse. Not only was it the #2 winery brand within the over $15 per bottle U.S. wine segment in dollar consumption, but it was also the fastest-growing winery brand within the top 15 U.S. brands across all price points. And yet, we believe we still have considerable addressable white space relative to our scaled peers.

Finally, on-premise was once again a growth driver for our wholesale to distributor channel. However, our off-premise channel continues to build a top -- the high level of growth we achieved during the COVID-19 restrictions as well. Much like our broader results, off-premise also showed continued sequential strength with double-digit growth in depletions, bolstered by strong results in shipments, accounts sold and points of distribution.

Now let's focus on some of our channel dynamics. When we last spoke in early December, COVID's latest variant, Omicron, was spreading rapidly across the country and creating considerable uncertainty about how it would influence consumption patterns and the supply chain. The data from this past quarter shows that in our primary markets, the variant did little to dissuade consumers from dining out. The on-premise channel has continued its recovery, while we are seeing further share gains for our wines on narrowed-down wine lists, with distribution growth coming from both new and existing accounts.

In addition to the outsized growth seen on-premise, as it continues to move back toward pre-COVID levels, our off-premise business performed exceptionally well in the quarter. Compared against the first quarter of this fiscal year, results accelerated nicely, with off-premise depletions up by double digits from the prior year quarter, supported by strength in key sales performance -- performance metrics such as accounts sold and points of distribution. This is another example of how we are not simply holding our share of at-home consumption, but we're continuing to grow it.

We believe we are well-positioned to continue to be the preferred choice of retailers seeking a partner capable of providing both the convenience of a one-stop luxury wine shop as well as the quality and brand strength of our portfolio of fine luxury wines. Although we are seeing broad-based strength across our portfolio, our Duckhorn Vineyards and Decoy brands continue to serve as the most significant drivers of our growth in luxury wine share gains. In aggregate, when compared to luxury portfolios of our peers, we are amongst the highest contributors to dollar growth within the over $15 per bottle price point for U.S. wines, with both brands up double digits.

As the #2 winery brand in luxury wine dollar consumption, Decoy drove the lion's share of this growth. At the same time, Decoy's distribution opportunity for the future is considerable as we believe Decoy has a lower ACV relative to its key scale peers, and accordingly, we believe we can narrow this distribution gap over the coming years for 3 reasons.

First, Decoy's rise to luxury prominence is a result of its compelling offering of exceptional quality at an accessible price, a combination that appeals to a broad array of consumers. Second, our data analytics have found that the Decoy consumer over-indexes as more affluent, educated and younger than the average for luxury wines. These favorable demographics bode well for the brand and our continued effort to drive trade up into new price points, as we've seen with the highly successful Decoy Limited Blue Label. Third, as a result of these demographics, which are equally attractive to on-premise and off-premise retailers, we believe our partners will be further incentivized to offer our Decoy and Decoy Limited wines additional space on the wine list and the shelf. And because Decoy serves as the gateway duck for the rest of our portfolio, we are also optimistic that future Decoy distribution growth will lead to distribution growth for the other winery brands in the portfolio as well.

I would also like to take a moment to address what we are seeing in the current inflationary environment. As a function of our scale as well as our diversified sourcing and production capabilities, we are afforded relatively good visibility into our cost of goods and have been somewhat insulated from recent cost pressures observed across the supply chain. Relatedly, keep in mind that our largest COGS input is grapes, the cost of which rises and falls based on the unique dynamics of the grape market for each varietal and location. As you know, we have a thoughtful pricing strategy for our wines that is designed to enhance the long-term growth of the business. We do not expect to deviate from this long-term strategy, although the timing of some of those increases has been and may continue to be hastened by the broader environment, and our goal is keeping our healthy margin product profile in line with our cost structure over time.

Keeping in mind our goals for competitive brand positioning and the maintenance of margins, we make changes when prudent. Let me be clear that our laser focus on growth will always take priority as we look at these pricing questions.

In summary, I'm very encouraged by our second quarter and first half results. While Decoy continues to outperform our expectations and serves as the driving force behind our robust growth, we also see broad-based strength across the luxury portfolio and in all channels. And it's because of this broad strength as well as our advantaged position within the high-growth luxury wine market that I am confident in our ability to achieve the results discussed today's -- discussed in today's upwardly revised full year guidance.

This growth will be supported by our agile and experienced leadership team that continues to grow and strengthen our business. To that end, as you may have seen in a separate release this afternoon, we are pleased to announce that Gayle Bartscherer will be joining the executive team as Executive Vice President, Chief Marketing and DTC Officer in the next few weeks. Gayle has over 20 years of experience in the luxury wine industry and brings a deep understanding of luxury wine marketing and the DTC business. Most recently, Gayle served as Senior Vice President, International Sales, Marketing and Business Development at Jackson Family Wines. We are thrilled that Gayle will be joining our team and look forward to working with her and benefiting from her notable experience in DTC.

On behalf of the Board and the executive team, I'd also like to thank Carol Reber for her outstanding work as Duckhorn Portfolio's Chief Marketing Officer. Her 11-year tenure strengthened our brand equity and vastly grew our DTC presence. We owe numerous successes to Carol. We are in a stronger position as she leaves the CMO role, and we are grateful for her continued help during this transition.

With that in mind, I would like to turn it over to Lori to discuss our second quarter performance and updated fiscal year 2022 outlook.

Thank you, Alex, and good afternoon, everyone.

Let me open by walking through the details of our strong second quarter results. Net sales for the quarter were $98.7 million, an 18% increase versus the prior year quarter. This high level of growth was broad, the result of strong double-digit growth in shipments incurred by similar positive movements in accounts sold and points of distribution.

Volume growth was up 24.8% and was partially offset by negative 6.8% price/mix contribution, which resulted primarily from the timing shift for select DTC volume out of the second quarter and into the first quarter, and from our leading Duckhorn Vineyards and Decoy winery brands, once again outpacing the other winery brands. Wholesale to distributor sales growth also exceeded the growth of our unique California direct-to-retail channel and our DTC channel. And on a like-for-like basis, pricing changes were immaterial to our results. As Alex noted earlier, our depletions remain strong, nearly in line with our 24.8% shipment growth for the quarter and modestly accelerating on a 2-year stacked basis.

Turning to our performance by channel. Wholesale to distributor growth exceeded all other channels, up over 30% versus the prior year quarter. This strength was a result of the continuing return of our on-premise business, coupled with accelerated off-premise growth. We also continue to reap ongoing benefits from the distribution gains realized throughout the pandemic, which we see in our exceptional quarterly net sales growth on a 2-year stack basis.

The California direct-to-retail channel also grew and greatly benefited from revitalization of on-premise sales, increasing 19% and remaining above 25% growth on a 2-year stack basis, primarily due to our ability to improve our Kosta Browne fall offering shipment timing. DTC channel growth was down 24% versus the second quarter last year. You may recall, we had discussed the forward shift the last time we spoke in December.

Second quarter DTC channel reflected strong interaction with our consumers in our tasting rooms and through our luxury wine clubs. Our Napa Valley tasting rooms were particularly strong and led to tasting room sales that are nearly double Q2 2021. Similarly, our wine club net sales were up 8% due to strong retention of existing members and heightened seasonal visitation bringing us new members.

Gross profit was $49.5 million, an increase of $7.7 million or 18.5% versus the prior year quarter. Adjusted gross profit was $49.7 million, an increase of $7.1 million or 16.5%. Gross profit margin was 50.1%, up approximately 20 basis points. This margin expansion was driven by a favorable sales mix shift in brand and more than offset any unfavorable channel mix impact.

Total general and administrative expenses were lower than our expectations for this quarter, up $6.3 million or 36.3% to $23.8 million. The increase was partially attributable to higher general and administrative costs and equity compensation than were present in the prior year quarter when we were a private company. The remaining increase in operating expense was driven by fees related to capital markets transactions, greater workforce-related costs and elevated selling expenses, primarily to support sales activities such as travel to meet our customers.

Our effective tax rate was 26%, which was slightly below the 26.2% effective tax rate for the prior year quarter. Net income was $17.9 million and diluted EPS was $0.16 per share which compares against net income of $22 million and diluted EPS of $0.22 per share in the prior year quarter.

Adjusted net income was $19.5 million and adjusted EPS was $0.17 per diluted share, which compares favorably against the second quarter of the prior year, when adjusted net income was $16.8 million and adjusted EPS was $0.17 per diluted share.

These positive results reflect the continued strength of our top line, partially offset by an increase in selling, general and administrative costs, including public company costs. On an apples-to-apples basis, if we burden second quarter of fiscal 2021 results with public company costs and use current diluted share count, fiscal 2021 second quarter adjusted EPS would have been $0.14 per diluted share. This comparison yields an adjusted EPS growth of over 20%.

Adjusted EBITDA for the quarter increased 6.6% to $34.3 million, which represents 34.7% of net sales. This is compared against Q2 2021 adjusted EBITDA of $32.2 million, which represents 38.5% of net sales. Like I noted earlier, it's important to remember that results for our recent second quarter include approximately $1.4 million in public company costs that did not exist in the prior year quarter when we were a private company. If we look at this on a comparative basis and burden fiscal 2021 second quarter results with a similar level of public company costs, adjusted EBITDA in the most recently completed quarter would reflect a growth rate of nearly 12%.

At the end of the quarter, we had cash of $4.8 million and net debt of $253.4 million with a leverage ratio of 2x.

I would like to take a moment now to discuss our outlook for the rest of fiscal 2022. As Alex discussed, our first half performance demonstrated continued strong performance and sales execution. We are also mindful that COVID-19 and geopolitical upheaval present meaningful uncertainties as we forecast our business.

We expect strong brand performance to continue through the second half, although growth rates will moderate as we cycle the recovery of on-premise in the back half of last year. That said, in light of our strong first half, we have confidence in the strength of our brands, and we are raising our fiscal 2022 guidance versus the outlook we first provided you on our October call.

We now expect net sales of $364 million to $369 million or 8% to 9.5% organic growth, reflecting a fairly equal but marginally greater dollar contribution from Q3 versus Q4; adjusted EBITDA of $121 million to $125 million, or 3% to 6.5% growth; adjusted EPS of $0.55 to $0.58 per share, which assumes 25% effective tax rate and 114.5 million to 116.5 million diluted shares outstanding; and no change to our prior guidance with respect to planned regular capital expenditures, excluding strategic opportunities for vineyard purchases, production assets or M&A.

As the industry and broader economy do their best to navigate through a period of considerable inflation, we continue to believe that we are in an advantaged position because of our highly flexible sourcing and production model, our differentiated go-to-market strategy and the strong brand equity that we have fostered for our high-quality luxury wines for over 45 years. Due to this strategic positioning, we evaluate price regularly and have the ability to shift the timing of pricing and promotional actions based on inflationary or deflationary periods. In response to this sustained inflationary interval, we are accelerating the timing of certain planned price increases. However, we do not expect price changes to have a material impact on our fiscal year 2022 results, and we will remain vigilant in reassessing our pricing strategy in the future.

Should this current environment continue and we further accelerate planned price increases, we will communicate these changes to our partners and continue to work closely with distributors and retailers while these changes are implemented. As Alex stated clearly, growth is paramount. Future timing adjustments will be thoughtful and with an eye to maintaining our top line momentum.

With that, I will turn the call back over to Alex for his closing comments.

Thank you, Lori.

As I look at the company today, having reported on the first half of this fiscal year, I am confident that The Duckhorn Portfolio remains well positioned to build upon our considerable distribution and market share momentum as we move forward. The past 6 months of success is a continuation of our storied 45-year-old history of delivering sought-after luxury wines and profitable growth well in excess of the industry average. Irrespective of what conditions exist around us, we are always focused on our guiding principles and strategic focus that has sustained us for 45 years and presents substantial runway for continued profitable growth.

I would like to close my comments by reiterating our 5 pillars of our sustained long-term growth: first, operating our scaled omnichannel platform in addition to our diversified sourcing and production capabilities; second, leveraging our marketing and brand strength, especially our one-stop luxury wine shop sales approach; third, driving innovation and bringing new experiences in high-quality luxury wines to our growing consumer base; fourth, investing behind DTC as the marketing engine of the company that provides an important opportunity for us to engage with consumers, create Duckhorn evangelists and drive adoption across all channels and brands; and fifth, thoughtfully pursuing strategic assets to optimize grape sourcing and production and high-quality luxury winery brands through M&A. We view this last pillar as a supplement to both our long-term organic growth and industry-leading margin profile.

With that, Sean, Lori and I are available for your questions.

(Operator Instructions) The first question comes from Kaumil Gajrawala with Credit Suisse.

On the growth, can you maybe dissect it a little bit in terms of maybe how much came from distribution versus maybe something that might look like more of a same-store sales type of equivalent?

Yes. Thank you for the question. Really good question. So our growth for the quarter came predominantly from points of distribution, similarly to how it's come in the past. So we had a growth of 21% in the accounts sold and 21% in POD as well. So that's where we see this, the growth coming from, of course, led by our Decoy brand, which, as Alex mentioned, is our gateway duck.

Yes. Got it. And maybe just taking a step back and thinking out a bit further on the opportunity for distribution. Obviously, it's -- you've had a very successful run of late. It can't go on forever. Can you maybe just talk about how far along you are and how much runway you think is left?

Yes, sure. Thank you. That's a really great question too. So we see considerable opportunity for us out there. So both against our white label as well as our new Blue limited label for the Decoy. So if you look -- if you were to happen to look at the IRI data for the last 52-week period ending in January, you'd see that Decoy's ACV sits in the mid-70s versus mid-80s to low 90s of some of the major-scaled luxury peers. So that really gives us great confidence in the strength of that brand and the long runway that we have out there for continued growth for not only Decoy, but also for Decoy Limited, and that the distribution for Decoy Limited is about half of that of what we have for our white label. So we have considerable space out there to grow that as well.

The next question comes from Lauren Lieberman with Barclays.

Great. I want to talk a little bit about profitability and inflation. Maybe just first how gross margin continues to be quite a bit lower than we talking about inflationary pressure and that being a trigger to move to expedite some of the pricing actions. So the major areas where you're seeing the solution, well-known that grape production you have the most visibility into, and that goes -- and you have great visibility, but clearly, inflation is still impacting you more than anticipated. So I'd love your thoughts on that.

Yes. Thank you, Lauren. Good afternoon, and thanks for the question. So you were cutting out a bit there for me, but I think I was understanding your question. You're asking about what kind of inflation we're seeing. And then is that correct?

That's right. That's right. Because we're knowing that grapes are a big [pick], right? You have visibility but still inflation's obviously higher than anticipated.

Yes, yes. So as we've discussed, our grape pricing is the biggest cost of our cost of goods, and we have great visibility into the cost of the grapes in -- several years out. Our grapes are more strictly -- fluctuate, if you will, based on really a -- the growing season, the agriculture related to the grape cost. So we know what those are. We aren't seeing increases in prices. We are seeing somewhat from last year. And just in that last year's grape prices were suppressed due to the growing season with the smoke.

So we've seen slight increases for harvest year '21, but that's really coming back to normal costing for grapes. So we do see some pressures that originally we had thought were transitory being in some of our labor costs. We have some cost of glass. But as you'll recall, Lauren, our contracts are relatively long term for our -- the majority of our inputs, and so we have caps on the amount that those items can increase. So we aren't seeing significant increases in our inputs for our cost of goods, more around some freight, but that too is limited as the majority of our contracts are negotiated as delivered.

Okay. But to be clear, it was still enough to be a catalyst that you -- to decide if you should, use your words, price increases [could be a plan] to move on sooner?

Oh, sure. Yes. So as we've talked in the past also with regard to pricing, we take a very holistic and methodical approach to our pricing. We work to maximize the return, if you will, from our trade spend and our discounting. But we also look at our plan frequently. So we have programs that are out there that are in place, and we also have upcoming programs that we can work to pull different levers. So just based on some of the inflationary issues that we've seen, the pressures and our understanding and realization, I think, with the rest of the country that inflation is here to stay for a while. We have accelerated some of our changes on our pricing, so with regard to some of the programming and some of those type of spend. So we have accelerated pricing, and we do that in combination with our partners, our distributors and retailers so that they are well aware of what the changes are. And so we work with them to make sure that everybody understands. And -- but we did move things forward.

The next question comes from Kevin Grundy with Jefferies.

(Operator Instructions)

Can you guys hear me okay?

Now we can.

Okay. Perfect. Great. Congrats on the strong results. Just picking up on the sales guidance and the decision to raise that, clearly, strong first half of the year. First quarter was strong, second quarter as well. Maybe just comment a bit on how you see the balance of the year other than the fact that the first half of the year was clearly better. The back half now you're going to be facing more difficult year-over-year comparisons. What's really changed, if anything, with respect to the balance of the year as you see it relative to the initial guidance?

And then, Alex, within that, if you wouldn't mind, just touch on any concerns that you may have with respect to the strength of the consumer, given inflationary pressures more broadly. To Lauren's point, not really seeing a lot of pricing in wine to speak of, including in your portfolio. Maybe that's an opportunity, maybe it's not. But just comment broadly on sort of any risk you may see to the strength of the consumer, given what they're under broadly from an inflationary pressure perspective today.

Go ahead, Lori.

Yes. Kevin. Nice to talk to you today, and thanks for the questions. So yes, so we are raising our guidance in the back for the fiscal year. We're extremely excited about the strength of our brands. And thinking about the back half, traditionally, our back half has a little bit slower growth than the first half of the year, without the benefit of the seasonality of some of the holidays and that type of thing going on. But when we look at our -- the back half, we feel that our growth will come up equally between the third and fourth quarter, with some marginally greater increased contribution in the third quarter. And so we have a little bit of impact from our Q3 versus what we experienced last year.

And I think if you remember, in our Q2, some of our shipments were deferred or held up a bit, if you will, by our distributors who were holding the shipments for early part of Q3 to include some new product innovations that we're shipping in the early part of Q3. So this year, Q3 is comping against that, which we don't have that pull forward in Q3. And also, we do have a little bit of impact from our Kosta Browne, our spring list offering. So KB remains to be supply constrained, and that is impacting our Q3 as well.

And then Alex, do you want to?

Yes. Kevin, our brands are quite strong right now. And clearly, they're being led by Duckhorn and Decoy, I think you can see that. And consumers are reaching for our wines. That's a good thing going into the back half. The inflationary pressures on the consumer, I'd be remiss if I didn't say I'm concerned with it, but we think our trade is getting behind our brands because they are pulling through, they are turning. We think the distributors continue to see us as a very efficient way of getting a lot of luxury wines into the marketplace. So I think that, that would be the offset to some inflationary pressures.

And then finally, take it geopolitical or inflation, when -- typically, when consumers get a little nervous, they go to trusted brands. And I think with 45 years of doing a really good job, we would fit into that category. So yes, we watch it carefully, and we try to address our price increases and our programs to make sure we are taking care of our consumers, but we are concerned with the inflationary environment. But again, we're increasing guidance and we feel that we've got the programs and the strategies in place to weather through that, not knowing what's going to end up, but let's assume it's going to continue to be somewhat of an inflationary unknown environment. We think we have the brands and the relationships in place to make sure our goals are hit and our wines continue to sell. So we're confident.

That's helpful. Just one quick follow-up. Alex, maybe just on sort of overall view on trends in the U.S. wine industry. We kind of went through the bumpy period. And then on-premise, of course, took a hit in December and January with Omicron. All of total beverage alcohol did as well. As we look at the Nielsen data, it still looks a little bit soft for the wine industry. Some of that is comp related, maybe some of it not. So maybe just your thoughts on overall trends within the U.S. wine industry, understanding that premium continues to hold up better than other parts. But just broadly, I think your thoughts there would be helpful. And then I'll pass it on.

Got it. Great question. I think you helped me answer it. Thank you. I appreciate that. It makes it easier on me. I'm not going to comment on total wine because there are so many subsegments in there, and we compete in only one segment, and that segment is doing really, really well. Ultra premium wine, $15 plus has been and remains strong. And I think that that's due to people deciding that the story and the wine -- the wine environment is exciting for them to continue to grow in.

So we're bullish in that area. We're staying focused on that area. I think the next step is -- I think we're firmly planted there. So as others try to get into that area, we have a leg up because we have been only focusing in that area. So I wouldn't -- as you look to Napa, I wouldn't spend a lot of time looking at the overall wine category because I believe that the ultra-premium section is growing and will continue to grow, and that's where we're focusing, and that's where the action is. So -- and the data bears that out, you've seen as much as I have. So we're excited to be there. We're going to focus -- continue focusing on it.

The next question comes from Peter Galbo with Bank of America.

Lori, I just wanted to ask maybe a clarification on the sales guide, kind of following up on Kevin's question. I understand that you're lapping kind of big numbers from last year, although I think in your remarks, you mentioned you're lapping tough on-premise from last year. I would think into the back half of this year, of this fiscal year, like you're still not even all the way back to 2019 levels. So I would think that would still maybe a tailwind. And as I think about just recent scanner through the quarter also being strong, just wondering how to think about those as potential sources of upside actually to even the revised sales guide?

Yes. So as we think about the back half, we've really -- we're very confident, as I said. So we would have a little bit more growth if it weren't for the supply constraints on our KB shipments. So we've worked really hard to solve our supply constraints that we talked about with regards to KB. Our production is doing a great job of meeting our expectations. And we're working to shore up that supply for in the future. But as we think about -- it's really the story for the back half is Q3 and how that comps against the huge growth in the prior year. I think if you remember, we had 40% growth in Q3 last year.

So we do feel very confident in our ability to continue to grow off that large growth last year. But we do have this supply constraint in our KB shipments, which is a huge contributor compared to last year in that quarter.

Got it. Okay. And I think last quarter, Lori, you had mentioned you were still expecting kind of gross margin -- modest gross margin expansion for the year and in 2022. Obviously, this quarter, you had modest expansion, but with kind of some of the mix impact. Just curious with that and with the inflationary outlook you've talked about, is that still the case? Or is there a revision to that comment?

Yes. So we do expect some slight margin improvement in the back half, not so much in Q3, which is when the KB would have shipped with our phenomenal margin with regard to that brand. So we do expect some slight margin improvement, mostly driven by brand mix in the back half. So Q3, not so much with regard to margin improvement, but that will be picked back up in Q4. And so for the back half, we expect to see very similar margins to what we've seen in the first half.

The next question comes from Robert Ottenstein with Evercore.

This is actually Greg on for Robert. Great results today. Just a quick question on the pipeline you have with M&A. You guys talked about this year being a big year for you guys maybe. I was just wondering if you have any new updates for that as well as what sorts of assets you guys are looking towards. And then if you could also just maybe touch on new innovation you have and any plans there?

It's Sean. I'll take the first piece of that and pass it to Alex. So yes, I think we do continue to see the bearing out of what we talked about with 2022 being an active year for M&A on the brand front. Our effort is going to be, as we've talked about before, focused on luxury winery brands and highly disciplined. So the increase in activity we see is broad-based, and we're focused on a piece of that.

The valuations, they, I think, continue to be reasonable. They are increasing. We've seen recent deals have EBITDA multiples in the mid- to high double digits. We think that, that is a reasonable and thoughtful place where we could do a good deal. So I think we have a focus on that, and that's where the primary element of M&A is going to be for us. All the time, as we've talked about before, we are looking at vineyards and production facilities separate and apart from brands. We talked about 3 new vineyard parcels that we closed on during the last quarter. So I think the year, as you said, is going to be an interesting one. We're very well positioned and excited about it, but I would just be remiss if I didn't note that our organic story is very compelling in the center of it. So our feet are to the fire, if you will.

And I think, Alex, you want to talk about our NPDs, new product development?

Yes. Let me just add on to what Sean said, and I think it's important that we all continue to take this away. As I've stated earlier and numerous times, we're going to stay focused in luxury because that's where the real performance and growth and opportunity lies.

So all winery M&A opportunities may not measure up to the criteria that we place in front of them, margin profile, growth profile, price points and such, brand positioning, imaging, all that stuff. So there's a strong pipeline, but it narrows quickly into the things that would fit in, you would expect that would fit into NAPA. So that's where we're spending most of our time trying to find those jewels, if you will, that can fit into our profile and to be supportive of our long-term goals.

On innovation, we've talked about this a number of times. We have a lot of products that we've both introduced and in the pipeline to continue to grow. I was just going to mention something. I think it kind of helps to want to -- maybe it's Lauren's comment. I'd be nervous if our growth was going to slow down in the future if I wasn't continuing to create new products, and that's just part of our overall goal. So not only have we introduced, for example, the Blue Label, the Decoy Limited. And it takes -- just keep in mind, it takes about 2 or 3 years to get a product fully distributed into the overall broad U.S. market. So the gift keeps giving once you come up with a new product. But we have a lot of new and exciting products that we'll be strategic releasing in the future over time to, again, to offset the risk on any one particular product and continue our growth engine far into the future.

So you can continue to expect to hear updates on new products coming throughout the year. We have an exciting one which we've been teasing you guys on, and I apologize that. That's just good marketing on our part, coming out in the fourth quarter of this year. So stay tuned.

If I could just squeeze in one more about the wine seltzer, if you could maybe just give us a quick update on how that's doing. Any plans you guys have there? The tracked channels have been strong. But any more color you guys could provide would be great.

Yes. Just a quick one. Seltzer was planned to be and is a small, small part of our business. Our distributors are working with it, the trades working with it, but again, it's so small, and obviously, seltzer itself hit a little headwind. It's meeting our objectives, but it's not going to be a big part of our business going forward, and we've really echoed that throughout the -- our launch and our development of that. It was just -- again, broadening out the Decoy name was the primary goal there. So not much more to update on that.

The next question comes from Nik Modi with RBC Capital Markets.

This is Filippo Falorni on for Nik. I wanted to go back to the on-premise channel. We've seen after the Omicron impacts, significant acceleration in restaurant reservation and mobility trends in the second half of February and early March. I guess first, are you seeing a similar sequential improvement as well in your on-premise business in terms of total reported growth? And then second, maybe you can talk about your share gains in the channel and whether those are continuing. What is driving those?

Yes. Thank you, Filippo. Thanks for the question. So we are very excited about the growth we saw in on-premise in the quarter. We saw great growth in November, December, slowed some in January, but we are also very excited about the growth we saw in off-premise at the same time. So if you recall, we had really strong gains that we had realized in off-premise during COVID, and we continue to not only retain those points that we gained at that time, but we're also growing from them. So we're seeing really strong growth off both. But the growth in Q2 was led on a percentage per channel increase by on-premise for sure.

Got it. And sequentially, I guess, as you exited the quarter, did you see also a further acceleration in the business given less restriction, less mask mandates?

Yes. Yes, we have seen a return to the on-premise growth. And so -- and we continue to -- I think we discussed a little bit in the past, we are continuing to gain our listings, if you will, on wine lists. We're seeing pared-down wine lists, but we're very excited to see that our wines are on those shorter wine lists, which is really helping with the sell-through.

The next question comes from Andrea Teixeira with JPMorgan.

This is Drew Levine on for Andrea. I wanted to ask about the distributor inventory levels, just given the really strong continuing underlying demand. Can you maybe talk about, I guess relative to historical levels, if they're sort of in line, if you have some room to make up on shipments and if you're planning on sort of shipments to be in line with the depletions in the back half of the year?

Yes. So thank you, Drew, for the question. So traditionally, in Q2, we see our distributor inventory floor. Inventories increase somewhat so that they make sure they don't run out during the holidays. And we saw similar results. So we do expect that the distributor floors will re-level, if you will, in Q3. But we don't expect much variance between depletions and ships in the quarter. We expect them to be fairly similar.

Perfect. And then I just wanted to go back to the inflation point. I understand that you have long-term contracts with your suppliers. But are they asking you to sort of bear the burden with them on some of these increases? Or I know you mentioned labor but -- and some freight, but is there really just not much underlying inflation in those categories?

Yes. So in some cases, they're being -- they're asking us for some partial sharing, but we're really not seeing much change. So we have, like I said, these long-term contracts with caps and so we do sit down and we work with our partners, of course, like anybody would. But we aren't predicting increase -- considerable increases in our cost of our inputs at all.

There are no additional questions waiting at this time. So I'll pass the conference to Alex Ryan for additional remarks.

I want to thank you again for joining us today to review our second quarter.

In summary, we remain confident in our ability to continue to profitably outperform the high-growth luxury wine segment and are excited to meaningfully raise our fiscal year 2022 guidance following a very strong first half performance. We look forward to speaking with you again in early June when we report our fiscal year 2022 third quarter results. Goodbye.

That concludes The Duckhorn Portfolio's Second Quarter 2022 Earnings Conference Call. Thank you for your participation. You may now disconnect your lines.