Naked Wines plc (OTCQX:NWINF) Q2 2023 Results Conference Call December 7, 2022 4:00 AM ET
Company Participants
Nicholas Devlin – CEO
James Crawford – CFO
Conference Call Participants
Grace Gilberg – Jefferies
Nicholas Devlin
Good morning. Welcome, everyone to the Naked Wine’s Interim Results for Fiscal ’23. Thank you everyone joining us earlier this morning, and I imagine there’d be a number of investors there in North America who will be picking this up on record later.
Want to take you through today the results in the first half of the year ending September, and talk a little bit about the positioning of Naked and our longer-term plans in light of that. Now as a reminder, a lot of you would be very familiar with Naked as a business. Obviously, we exist to solve a set of problems in the wine industry. Solve problems on behalf of both winemakers and wine consumers. And we — I mean I’ve been prone by doing this virtually, but I have got no presentation in front of me. Who was kind of expecting kind of things going straight. Not a slicker start.
So what we want to talk about, first of all, today, just give you a little bit of overview of the key themes we’re going to cover in today’s presentation. Obviously, we talked to you recently in October, where we outlined the strategic [indiscernible] towards profitability.
I think the key message today is a chance to show a little bit more of the underlying business performance that fits behind that. And I think you can see from the first half of the year, that our results put us very much on track to deliver that pivot to profitability. And we’re going to talk to you about the steps we’ve taken to secure liquidity, and James will take you through the state of the balance sheet.
We can show you the results from the first half of the year, and in particular, you’ll see that we are materially delivering on that level of profitability. And then I will talk to you a little bit more about our business model and the long-term opportunity.
So I’m going to keep it pretty short and hand over to James, who I’m very pleased to have back on-site with me. Our other update today is that James has agreed to return on a full-time basis as CFO. So thank you very much, James, pleased to have you here. And I will hand over to you.
James Crawford
Thank you, Nick. Good morning, everybody. So again, the summary I’m going to walk through is a set of slides that really demonstrate how the performance in H1 is supportive of the change in approach that we’ve outlined and demonstrates that the pivot to profitability is being delivered. We see solid revenue and adjusted profit performance, shows the benefits of an international footprint, in particular, given currency changes. We’ve got a balance sheet that supports the strategy, in particular, following the covenant renegotiation. We’re demonstrating an ability to drive value per order and mitigate inflation, which everyone is challenged by at the moment.
We’re beginning to enhance paybacks. We’re getting them back towards what we think of as the Goldilocks zone around 2x payback, and we’re actually seeing that LTV benefit that supports that, within the current cohort economics. Cost base has been reconfigured to reduce going forward, and we expect our standstill EBIT measure to converge with adjusted EBIT over the course of the next 12 to 18 months.
So looking at the results for H1, sales were up by 4% on a reported basis, that’s minus 3% constant currency. That is the benefit of having businesses in the U.S. and Australia, which are obviously translating back favorably with the weaker pound year-on-year. As you know, we reduced investments in new customers, almost halving year-on-year as we moderated that investment to drive paybacks up. G&A costs have continued to increase in the half, that will moderate going forward.
That increase reflects a combination of us spending money on what we call R&D brand building investment and also annualization of roles from prior years, as well as the translation impact of the FX rates and inflation in salaries. But the net of all of that, is that adjusted EBIT increased to GBP4.6 million for the half, which is a nearly fourfold increase year-on-year on a reported basis and a threefold increase at a constant currency basis. We closed the half with net cash of GBP23 million, and that means that there’s GBP41 million of kind of credit facility capacity above that total liquidity, GBP64 million.
Moving forward on to Slide 10. I think important to note that we set out guidance in October, as we announced the pivot to profitability, about an inventory reduction of GBP40 million and really wanted to demonstrate the deliverability of that. So as of the end of November, what this chart is showing is, what our forward inventory commitments look like. The blue section of the bar is kind of legally committed purchase orders. The gray piece is the uncommitted, but in negotiation.
And you can see that there’s considerable headroom versus the dash line on the left, which is our indicative COGS for the remainder of FY ’23 and FY ’24. So the difference between those 2 lines would represent a destock, and therefore, very clear that having consumed cash to build inventory and expecting to continue to do that somewhat in H2, we would expect to see that unwind in an orderly way during fiscal ’24, and we’re reiterating the guidance we’ve given previously, targeting somewhere of the order of GBP145 million of inventory at the end of FY ’24.
On the following Page 11, wanted to look at another driver of the balance sheet, which is our angel funds, which are an important source of funding for the business. Several people have asked whether or not we’re seeing redemptions in those increase as a result of any of the press about the business. The answer is no, we’re actually seeing the lowest levels of redemptions, when you look at the percentage of that balance, which is being redeemed on a monthly or even on a rolling 6 monthly basis.
That is lowest because of 2 reasons; it’s, A, we’ve been doing less new customer recruitment and new customers have the highest churn rate, and therefore, you get kind of a faster cycle time of balances going into accounts and being withdrawn. We’re also doing higher quality recruitment and we’ll demonstrate that a little bit in payback in a moment. But when you get higher quality recruits, you get people who stick around for longer. They build balances in their accounts, and as a result, you see a lower level of withdrawals of those angel funds.
Moving on to Page 12, really wanted to demonstrate how in a high inflation environment, we’ve been able to increase order contribution and how have we done that. So our average repeat order value is trending upwards around 6%. We are seeing some uplift in COGS around 3%, because we have a kind of long-term sourcing model. We have been somewhat cushioned to get some of the inflationary impact you could have seen in COGS. As a result, our gross profit per order is trending upwards around about 9% group-wide.
Fulfillment costs are where we have seen the biggest and sharpest impact of inflation, and they have been trending up around about 15% on a per order basis. It’s a combination of logistics costs, fuel surcharges, higher labor costs and warehouse sites, things like that. But by taking the action we’ve taken to try and drive order values up, which is a combination of pricing and merchandising approach. Actually, that drops through to repeat contribution per order being about 4% higher year-on-year.
And I think there’s potentially more to come here. We are holding excess stock that is generating incremental warehousing costs, because we had planned some of the distribution footprint for higher volumes than we’re now generating, we will be realizing kind of underutilization charges, if you will, within that footprint. We expect to be able to unwind some, if not all of these over the next 12 to 18 months. So there’s potential for further enhancements here.
That’s the repeat side of the business. Looking at the growth investments on Page 13, I think interesting to look over an extended period of what’s happened to our growth investment patterns. The gray bars show spend, you can see how spend increased significantly as we went through the start of the pandemic around about March 2020. And the blue line shows the payback on that investment and the payback sharply moved upwards at the start of the pandemic, as customers started shopping online almost in an unprompted way.
As we continue to invest at those high levels and as we’ve continued to reassess the value of the customers that we have recruited there, you can see the paybacks dropped significantly during kind of the middle of 2021. And recognizing that, recognizing the drivers of that in terms of fulfillment cost inflation, normalization of consumer behavior, is what has triggered us to take the pivot towards profitability that we’ve undertaken.
And you just see at the right-hand side of that chart, our payback metric and it’s shown here on a rolling 3-month basis, is starting to tick back upwards towards the 2x that we have always said would be the Goldilocks Zone for this business.
If we move to Page 14, we can get a little bit more granular about that. So on the left-hand side, you can see our paybacks by month for the prior year and the current year, always a bit spiking. But you can certainly see at the right-hand side of that chart, an uplift to north of 2x in some months of our payback during Q2. And that’s what drove our payback in Q2 to an average of 1.9x versus 1.5x in the first half — our third quarter rather.
Getting beneath the drivers of that, payback is a result of 2 things, how much does it cost to acquire a new customer, and what is the expected value of that customer. And of the 0.4x improvement in payback we’ve generated, about 0.3x of that comes from a lower cost per joiner. So that’s a number which is kind of bankable baked in. 0.1x of that comes from enhanced LTV, lifetime value per joiner, our expectation that a customer is going to be worth more than they were.
And moving to Page 15, recognizing that that’s a forecast for a lifetime value, we are demonstrating how we’re beginning to see some improvement in the realized value of those customers. So comparing fiscal ’22 and fiscal ’23 revenue per joining customer, you can see that the blue line, as it goes through 60, 90 and 120 days, the early purchasing patterns of a customer. beginning to diverge and we are seeing materially higher sales per joining customer than we were a year ago. And with margins being relatively stable, you see on the right-hand side, exactly the same trend emerging in the contribution we’re realizing from those customers, with a substantial enhancements in the contribution of the joiner of 120 days year-on-year. That gives us confidence that the forecast we’re seeing for enhanced LTV, which underpins some, but not all of the enhanced payback is becoming real.
Final area to look out on Page 16 is the cost base. We announced this with our pivot to profit in October, but we have taken action to moderate the increases that we’ve been seeing in the cost base. We removed 32 roles during the first half. We’re continuing to review costs with longer lead times, things like office expenditure. But the run rate that we’re now seeing, supports a lower cost base in terms of total SG&A in H2. We are also eliminating from the SG&A base, the R&D spend, which is our kind of brand marketing trial budget. Any marketing activity we undertake of that nature going forward will be embedded into our growth investment or our RRP contribution, and will not be called out as a separate cost, so we’ll be measuring payback on that going forward.
So moving to Page 17 and bringing all of that together and looking at adjusted EBIT in what we call standstill EBIT. For those of you who may not be as familiar with standstill EBIT, it’s a KPI we’ve used over the years to try and estimate what the profitability of the business would be, if we were only investing in growth such that our repeat contribution was held flat. It’s one of many subscription KPIs that we look at. We need to determine whether we need it going forward, If we’re in a more kind of stable profit-driven focus, but we felt it worth addressing it, because it’s not delivering an attractive number in this half. And worth understanding why that is. So if we look at the history of standstill EBIT, you could see that our adjusted EBIT was negative in fiscals ’19 through ’21, and we were saying that this business had potential to deliver strong adjusted EBIT, if we weren’t investing so much in growth.
That standstill EBIT potential appeared very, very strong while the pandemic was influencing the KPIs that go into this calculation. And then as that unwinds in fiscal ’23, we see a rapid reversal in standstill EBIT, which is really driven by the FY ’22 investment returns being poor. And calculation says, if we had to invest to replenish the contribution we lose to churn at the investment paybacks we were delivering in FY ’22, it would require a substantial investment in order to do that.
Now as I’ve just shown, as payback is improving, we expect that payback to change, so I expect these numbers to reverse again in fiscal ’24, and actually with our guidance for improving profitability versus FY ’23 in FY ’24, we should see convergence between the standstill EBIT measure and the adjusted EBIT measure next year.
And that brings us to guidance; fairly simple slide, because what it says is there’s no change to the guidance from that, what we gave in October. Still expecting revenue between GBP340 million and GBP360 million, still targeting new customer acquisition investments of GBP20 million to GBP24 million. Our G&A costs, excluding share-based payments in R&D should be GBP42 million to GBP44 million for the year. As mentioned earlier, the R&D costs will go away into FY ’24. The other SG&A costs should remain at a similar level in FY ’24. As a result of all of that, adjusted EBIT for this fiscal year of GBP9 million to GBP13 million is expected, and we expect that to improve further in FY ’24. October and November trading, which is profitable, is supporting that and in line with our expectations.
That concludes the financial section. I’m going to hand over to Nick, who’s going to talk about our long-term opportunity.
Nicholas Devlin
Thank you very much, James. So I think you can see from that set of numbers that we’re well on track to deliver the pivot to profit that we’ve outlined. So I want to talk a little bit more in this section about how you should think of business — Naked over the medium to long term.
So turning to Page 20. On Page 20, we have — we just outlined, I think, a simple framework to think about the long-term differentiation in Naked’s business. And at its core, the investment thesis, I think, remains similar to that which we outlined pre-pandemic. But I think it’s some important elements actually fundamentally strengthened by the level of scaling that the business has experienced over the course of the last 2.5 years.
In terms of market outlook, we will retain the attractive exposure to multiple markets, but now over 50% of group revenue is delivered in the U.S., our biggest market and a market that’s structurally is very attractive for our business. We’re able to deliver a combination of exceptional value to consumer in that market, at the same time delivering far higher contribution margins, given our ability to operate as a winery and disintermediate distribution of retail tiers in the U.S. All of that means, we’ve been able to build scale within that market and we’ll show you how that scale has progressed over the course of the last few years. But we are the world’s largest purely online direct consumer wine business, and we’ve got a #1 position in that sector in our key American market.
I want to talk a little bit more in detail about our winemaker relationships. I think ultimately, when you compare Naked to a peer group of online wine companies, the thing that really sets this business apart is that we were founded with a genuine mission to change and make more efficient the way that wine is produced. And that’s manifested instead, a very long term, very deep and very valuable relationships with winemakers and suppliers. Now unquestionably, we’re in a period where we are overstocked and we’re having to work to address that. But within that, we’ve been able to maintain those relationships, and I think they are a really important part of what sets us apart from our competitors.
And what those relationships give you, is a business with a set of exclusive and valuable brands. And we have been growing those brands and increasingly getting recognition from consumers and from industry bodies for the quality of wine that we’re producing. And so I want to talk to you a little bit about that as well.
Now underpinning that and the benefit of operating now for over 10 years in the U.S. and Australia and so nearly 15 years in the U.K., we have an unparalleled set of proprietary data, data about our consumers, our products, and that is something that enables us to deliver a more efficient business, that it helps our winemakers to make better and better wine more efficiently to meet our consumers’ needs. And you see that reflected in the very high Buy It Again ratings our products get. But it also powers our investment model and lets us underpin the business where ultimately, as James outlined, we’re investing money based on a data-driven prediction and belief in how valuable customers are likely to be.
And to make that business model work, you need a few things to be true. You need to have a highly sticky customer base. You need to create real advocacy and loyalty amongst your customers to give you predictable long-term value. And again, I think you can see that we continue to do that. And the long-term thesis that this is a business with very satisfied customers, experiencing great value and translating into high loyalty remains very much intact.
So if we move to Page 21, we’re just going to go through a little bit of the proof points behind this. I think the revenue share is self-explanatory. Something additional that we’re highlighting here, is with an increased focus on profitability, we’re giving a view on the segmental profitability of the business. And you can see that in terms of adjusted EBIT delivery, the U.S. is equally the most important part of the business. And if you start to think about this over a medium term and what is potentially a sustainable net margin for the business, you can see that the higher contribution margins we’re able to deliver in the U.S. ultimately translates through to an opportunity to deliver a business as we are increasing our Naked U.S. materially profitable. Alongside, and that creates with it some opportunities, right, to choose how much profitability we draw through in the year and how much of that will reinvest back into future growth.
And on the next page, you’re able to take a look at how our share has developed in that key American markets. You can see that there’s been a little bit of year-to-year variation, but there’s a pretty steady progression through to having built around a 13.5%, 14% volume share in 2019. We then had a one-off rebasing step changes up to 20% through the pandemic, and we’ve been able to maintain that 20% volume share in the U.S. market. And that makes us by far and away by volume, the largest participant in our U.S. D2C space, and that has a number of important advantages, especially in a world where increasingly, like a lot of the businesses, we are having to deal with cost pressure in areas like logistics and distribution. Fundamentally, that scale advantage is important.
So turning to the next page, I thought it would be helpful to share a little bit of data about our supply base. And whilst we work with over 250 winemakers around the world, we have a number of incredibly important relationships with our top suppliers. And what we’re highlighting here is the first — the sales by unit volume in the first half of the year compared to the first half of the year in fiscal ’20 for the financial year before pandemic. And you can see for our top 10 suppliers, all of them have seen material volume growth over that period. I think when you average this out — on average supply we’re seeing 18% higher volumes than they were pre-pandemic. And you can also see that this is a group of suppliers that have built and developed their businesses in partnership with Naked on average, for nearly a decade. And this is really important when you think about questions of, what is the impact of us having to make volume commitment reductions or purchase reductions on our long-term relationship.
I think the proof here is that Naked is delivering on its premise. We’re helping talented independent winemakers build businesses of their own of real substance, scale and profitability. And the truth is, in a tough environment, we continue to offer much better opportunities for independent winemakers than traditional distribution, when times get tough, you increasingly see access to markets being cut off and distributors focusing on inventory efficiency, cash utilization actually often unwilling to take on any new clients or offer distribution to anyone outside of large producers.
I think in the next couple of pages, I wanted to expand on a couple of the things that James talked to in the financials. Now James gave an overview of the evolution of our contribution per order in the period. And I think it’s helpful to expand on one of the levers behind that, which has been some of the work that we have taken in the first half of the year around pricing. Now the benefit of working with independent producers to help them build their own businesses and their own brands of value, is that Naked as a business that 95% of what we sell is exclusive to Naked.
These are brands we have developed in collaboration with winemakers that are available nowhere else. It also means we have a lot of deep involvement in that production model we’re able to help in terms of the product, the packaging design and able to manage the cost in that product, and we have full ownership of how that goes to market, the sales channels, the mix and the promotional structure. All of that gives us a lot of levers to enable us to balance, providing great value to consumers, in a time when consumers are being squeezed, but also being able to have really good margin delivery.
Now so turning to the next page. I think it’s helpful to maybe illustrate the extent to which we have built real value and equity into these brands, but also how that has enabled Naked to have a good degree of pricing power, by focusing in on one of our top brands that we sell in our American market, actually also available in the U.K. and I had to look the other day, it’s GBP23 in the U.K. So if anyone hasn’t done their Christmas shopping, I highly recommend, some Matt Parish Napa Cab, get it while we can.
Getting off sales note, right? If you look at this as an illustration, over the course of the last 4 years, this is a brand that we’ve been able to travel in terms of sales value, $2.5 million worth of sales to members just purely on — stripping out any mix case promotion we do on this brand. Through that period of time, you’ve seen average selling price move from $22 through to an average in 2022 of $27. I think it’s actually selling at around $29 at the end of the year. And you can see against that, the Buy It Again rating has actually increased, and part of this reflects the fact that Matt — the winemaking heir has done a fantastic job. We’ve been able to put in place long-term sourcing arrangements, drawing great fruit from some of the top suppliers in Rutherford, in the heart of the Napa Valley. So I think the product is better than it was 4, 5 years ago. But it’s showing all the hallmarks of a real brand. We’ve been able to grow volume at the same time as taking price and customers are telling us that they’re more satisfied with this product than ever.
So turning to the next page, if that’s an example of a single product, what we’re illustrating on the next page is just again, highlighting our U.S. business. We’re showing what’s happened in terms of the gray line on here, which is the average change on a basket of like-for-like products this year versus prior year. And you can see that at the end of the period, we’re looking at average prices up sort of 7% to 8% year-over-year. And the blue line reflects that our average price of a bottle of wine sold, is pretty much tracking close to that, up around 6% year-over-year. And underpinning that, what we’re seeing is that, customers are sticking to the brands that they know and love and they’re broadly accepting the price increases that we’ve got through. And that means that, flowing through obviously the higher gross margin.
We have also looked at our shipping threshold and policy in the U.S., and we’re seeing a net increase in shipping income as a result of that. So if you take those 2 things together, you’re probably looking at around about a 7% like-for-like price increase and maybe the equivalent of further 3% through shipping, which has put the economics of the business, I think, on a very strong and sustainable footing, has enabled us to address some of the cost pressure that we’ve seen in distribution and logistics. And it means that improving contribution margins are one of the elements that are strengthening our lifetime value of members acquired in the period.
Turning to the next page; the lifetime value story though is by no means purely a price-led story. We continue to deliver improvements to the overall range and customer experience and proposition. So highlighting on the left here, we’re showing the trend in terms of repeat revenue, so sales to our Angel members per active Angel, and how that’s evolved over the course of the last 6 years.
Now I think when you look at this on a full year basis, actually, the pandemic FY ’21 wasn’t our high point, but just in a first half perspective, it was. I mean, if we remember back that period from April 2020 onwards, things could go absolutely crazy in the business. But if you compare the first half of ’23 to any other period, so you look at H1 ’20, ’19, ’18, you’ve seen a material step up in terms of that revenue measure. And ultimately, that reflects, I think, a combination of us having a stronger range than we ever have before.
And I think in all our markets, we’ve expanded the number of products available to consumers, improved availability. In the U.S., in particular, there’s been a focus on offering more choice at luxury price points. In Australia, we’ve seen some of that as well. In the U.K., there’s been a real push to add diversity to the range, both things like launching our first Georgian winemakers, giving customers a chance to off the beaten path and experiment. But also substantially increasing the range from traditional wine-making heartland. So they’ve been a smaller part of the Naked mix. So that means more wines from Burgundy, from Bordeaux, from Spain, from Italy, and consumers have really responded well to that.
Equally, we continue to enhance the digital proposition and experience. In the first half of the year, we rolled out a new payments platform powered by Braintree, which saw a fall in card decline rates. We have added for consumers, the ability to self-serve additions to their subscription products. That’s auto recurring shipments for their favorite wines. And we see double-digit percentage of consumers using those to double those orders, which obviously is both driving revenue and favorable contribution economics. We rolled out our Fine Wine Club proposition, which we debuted in the U.K. and are now recruiting members in both Australia and the USA.
And honestly, whilst it’s not the number one thing we look to, it’s always lovely to have a bit of industry recognition. And in the period, we continue to see a combination of Naked producers winning very large numbers of awards of the biggest, most important industry wine shows. Alongside recognition for the work we’re doing, things like winning the Decanter Sustainable Green Choice Award in the U.K. and being voted to kind of people’s #1 wine in the U.K. and even in the USA [today] awards in the U.S. So all of that being recognized by not just our consumers, but also people externally.
So if you take all that together, I think you see that Naked’s business comes through the course of the last 3 years, which reflecting back, having been 3 years in the job, and there haven’t been a lot of normal years in that period of time. But it’s a period of time for us as a business, which has been very important. We have consolidated our leadership position in the markets we operate in. We’ve continued to invest in improving the quality of the customer proposition experience. And most importantly, in partnership with our winemakers delivering the best wine proposition that Naked has ever had. And I think that sets us up very well to look to the future.
I think finally, it’s worth then reflecting on Page 29 on what the next couple of years are likely to look like for this business. And I think here, it’s important that we are clear, that there are a couple of different ways in which the next 2 years may play out. I think some things we can commit to under any scenario. We intend to run the business profitably, not just this year, but in FY ’24 and ’25. And as James has outlined, we have made substantial progress to put in place the conditions to deleverage and destock the business, which means that, that profitability will translate into material cash generation, in both financial ’24 and ’25.
And I think then that leads to choice being, the balance between growth and profitability that we deliver as a business. Our intent will be to look to return Naked — from financial ’24 to a level of growth accompanied by some profitability, but therefore likely a more moderate level of profitability. We will look to do that, as long as there are sufficient attractive investment opportunities available. However, we do want to be clear, we’re not going to pursue a course of investment at any cost. And if the case is, it makes sense for us to wait a little longer to return the business to growth, then we’re willing to be patient and we’re willing to wait. Ultimately, we believe that we have a business that is differentiated, that in terms of long-term trends, plays to a likely consumer desire to buy more wine online, is really aligned to consumer preference to understand provenance, understand where their products are coming from to buy from small independent producers.
So we’re very confident, that long-term growth exists. If the consumer environment and market environment means, they are not particularly attractive opportunities to scale investment in F ’24, then we would look to deliver a higher level of profitability and wait to deliver a return to growth.
I think that ends the presentation for us, and James that may be a record for us being a little snappier, which means we’ve got time to move on and take some Q&A.
Question-and-Answer Session
A – Unidentified Company Representative
Okay, guys. So our first question is from Wayne Brown at Liberum. He has two questions. First one is, what is the price and volume mix with regards to revenue growth in the period? And the second question is — sorry, if I can…
Nicholas Devlin
Well, let’s do one question…
Unidentified Company Representative
Yes, one at a time. Perfect. Super guys.
James Crawford
Yes. I’ll say that. Well, I don’t have the precise numbers to hand. I think there’s actually 3 elements in there. There’s a little bit of market mix, a little bit of shift towards the U.S., which supports those numbers. The U.S. has slightly higher order values on average. There’s not going to be a massive degree of product mix in there. The underlying number will be strongly influenced by price. So you can probably kind of safely infer that, of the 6% average order value increase, there’s a bit of market mix. There’s probably a fraction of an extra bottle per order, where some of our upsell mechanics have held that. There is a solid kind of mid-single-digit price impact, set at the core of that movement.
Unidentified Company Representative
Great. And the next question is, looking at the standstill EBIT chart, the fact, SS EBIT fell negative so quickly due to one cohort, what does that infer about the underlying rate of customer attrition?
James Crawford
Yes. If you look at — I think in the RNS, and I think on the presentation page, let me just flick to it. All right. I’ll point you to the RNS somewhere in the appendix of the presentation. We’ve bridged out the drivers of the standstill EBIT reduction. Actually, the — from 21.2% down to negative 5%, you get 2.5% net increase due to having more repeat contribution. You had GBP3 million reduction due to lower aggregate retention. You get GBP14 million reduction due to lower year 1 payback, and you get just under GBP12 million reduction due to G&A. The single cohort is what impacts the lower year 1 payback. The way that metric is calculated and taken into that calculation is, of the FY ’22 or the rolling 12 months of investments, the year 1 payback we realized on what — I think we have to be honest, was not a good year in terms of investment performance, is only 46%. That’s down from 68%.
That single movement is responsible for the majority of that reduction in standstill EBIT reduction. And we could argue that’s a flaw in the calculation. I think I’d argue it’s a truth in the calculation. It looks at what are the latest 12 months of investment performance have been. It doesn’t speak to the retention across the overall base. That speaks to only that GBP3 million reduction, which is the difference between a kind of 80% and 78% in the last 12 months sales retention number. And in the appendix of the presentation, and we can pick it up individually later, we’ve got a chart that shows how actually sales retention per cohort based on their tenure has actually improved for all but the most recent cohorts. So if you’ve been with us for 7 years, we have shown slightly better sales retention year-on-year. Did so for 6 years, did so for 4 years, et cetera, et cetera. It’s all about last year’s investment returns and the way that they factor into that calculation.
Unidentified Company Representative
Great. And the next question is from Ben Hunt with Investec. How can you ensure that the destocking of your inventory will not affect your sales channels and gross margins going forward? And how promotional is the market currently?
Nicholas Devlin
Yes. Happy to respond to that one Ben. I think the first one is, the way in which we are looking to manage our destocking is very much looking to deliver an orderly destocking process, and that is to try and do a few things. One that enables us to do that collaboratively in partnership with our suppliers and winemakers and ensure that we preserve their business viability, which is ultimately a key part of our competitive differentiation. But it also does a second thing, and it means we are not flooding any of our own sales channels with heavily discounted offers and incentives, which will be compromising the long-term value of brands, things like the Matt Parish Napa Cab that I spoke to earlier.
One of the mechanics then that we are using alongside collaborative negotiation with winemakers, is looking to have some of that — a decent part of that inventory disposal happen in bulk, i.e., prior to bottling. And that typically involves you signing a confidential agreement to sell wine on to a third party and the juice — high-quality wine goes into additional different brands. And so you don’t get an impact of consumers seeing brands you created, being sold in alternative channels at lower prices. So that’s one of the key mechanics that we’re using, in order to make sure we don’t have that [indiscernible].
Unidentified Company Representative
Okay. Another question from Ben. LFL ASP seemed modest, given sales retention in older cohorts, remains at healthy levels, and you have good value quality credentials. Could you recover more margin via price hikes?
Nicholas Devlin
I think Ben the — this is one where the market environment is probably a shade different in different parts of the business. So as you’ll recall, we started experimenting and looking at our ability to drive margin through pricing in Australia in the prior year. We saw some good results. And as those results have bedded in, we haven’t seen net impact to retention rates. So we’ve moved to take price in the U.K. and the U.S. in the first half of this year. Again, we will take time to look at the data and look at the impact of that and make an assessment as to whether there is any further opportunity.
I think from what we’re seeing at the moment, it is likely that we may have more pricing headroom than we previously understood in our U.S. markets. I think the consumer outlook and conditions are probably a little tougher in the U.K., so there may be a little less headroom in the U.K. market. But we’re very much taking the approach we normally would or being iterative to a degree here, and giving ourselves an opportunity to create some natural experimentation and then look at the impact that’s having on consumer behavior, in light of that, we will take a view as to what’s possible going forward.
Unidentified Company Representative
Next question is from Claire Shaw with [Wickery]. There’s been a lot of press recently that wine suppliers are expecting glass prices to increase 45% to 70% next spring. How are you planning to mitigate this significant increase?
Nicholas Devlin
Well Claire, It’s important not to believe everything in the press. But I think underpinning this, you’ve got actually some quite big regional differences in terms of the glass market. So I think a lot of that press will relate to a European market, where you’ve got glass producers feeling the pain of increasing energy prices, with the war in Ukraine. If you remember, for our business, the largest part of our business is in the U.S., where actually we’re seeing glass pricing fall as we get international trade opening back up and supply into the U.S. market from places like Taiwan, Chile, China starts to flow again.
So I don’t know that we’re going to be seeing that kind of pressure overall in our business. However, I mean, it’s a good opportunity to talk about something that we have been focusing on, which is an opportunity to do both the right thing from a sustainability perspective, and for us to take some costs out of the proposition, which has been focusing on program of lightweighting glass and working in collaboration with partnership with our winemakers, to deliver lighter products that are easier to transport, have lower environmental impact. And ultimately, obviously, having exactly the same taste, there is no impact to the juice inside. So we will continue to do that, which I think is the right thing for us to do both commercially and from a sustainable perspective.
Unidentified Company Representative
We have 3 questions from Thomas Tang from MediumInvest. First is, how much money do you use to fund winemakers and where is it visible in your balance sheet?
James Crawford
Yes, it’s James, I’ll take that one. So essentially, the funding that we provide to winemakers is in terms of advanced payments to inventory. So it sits within the inventory line that we have. That inventory line is a combination of finished goods in the warehouse and ready to ship, wine in the tank, as Nick suggests. Payments that we’ve made to winemakers, so they have secured grapes or maybe they’ve crushed the wine and they hold the wine and tank on their site. It all sits within that inventory balance. In the funding side of it is a combination of the company’s funds, but also the angel funding balance, which sits at the customer liability on the balance sheet.
Unidentified Company Representative
Great. And the next is how much of your wine is made with grapes that are bought versus grown by the winemakers themselves?
Nicholas Devlin
Yes. Happy to take that one, Thomas. I mean I think the reality of the wine trade, especially thinking about our largest business in the U.S. is that actually there’s relatively limited number of the real dramatic vision of someone who owns a vineyard, grows their own grapes and makes all of their own wine there. So we typically tend to have long-term contracts for fruit. You’ll have grape growers with different people to winemakers. Will have long-term contracts with winemakers, who they make wine for us. What’s important in the business, sometimes we’re contracting grapes, sometimes we’re contracting for a finished wine from a winemaker.
The thing that’s in common, is we look to have continuous sourcing from the same location, which gives winemakers the opportunity to progressively iterate, based on the feedback that we give them, both quantitative feedback and qualitative feedback, the direct commentary they get through the website and the app from customers. And that’s what fundamentally lets them deliver and create a better product year-over-year-over-year. It’s that consistent sourcing model with clear line of sight to where the grape is originally grown.
Ultimately, kind of the legal arrangement and who’s growing what and who owns what, less important. But to give you a little bit of insight on how the business works. And I guess that will be a contrast versus a business out there, something like a [wink], which is kind of have more of a view of taking wine as a commodity and saying, hey, we will go and buy whatever juice is available on a spot market and put that into a brand that we have created and we own. Fundamentally, we believe that to have long-term differentiation in our proposition, we need to work with great winemakers, and we need to give them the tools and the ability to source consistent high-quality products.
Unidentified Company Representative
Next question is, to what degree are you positively impacted by selling wine now, that was bought at lower price levels before inflation surge?
James Crawford
Hey Thomas. Nick, maybe who is going to take one? So I’ll take. I think the answer is partly, I think it’s worth being aware that very different in different markets. U.S. has a slightly longer stock position than the U.K., for example. The underlying cost of the juice is more impacted by near-term things like climatic events than it is inflation.
Glass, as you’ve heard, is impacted not just by kind of inflation, energy costs, demand side economics, et cetera. In the U.K., duty is a big component of our selling costs, anyone looking at the chart that had COGS on, you won’t marry it back nicely to the P&L because there’s such a big chunk of duty in there. Duty moves with its own cadence based on the exchequer.
There is some benefit. It’s hard to unpick. I don’t think it’s particularly substantial in the bigger picture.
Unidentified Company Representative
And there’s 2 other questions from Thomas. What is driving the increase in trade and other payables?
James Crawford
Yes. I’ll take that one. It’s a combination of some timing differences, in particular, there are some things like timing of U.K. duty payments relating to large packages that we’re building ready for Christmas. There’s also a recognition in there, that as we’ve worked with our winemakers to work out how we manage the stock commitments, the route through stock, we found the cheapest viable option, so we might take some stock, but agree with the winemaker that we will pay for it later. So there’s a combination of factors in there. It has been, I think, reflective of the fact that, to some degree, our winemakers have helped us, as we have managed the stock levels through the system and continue to take stock from them, so they don’t have to incur cost of holding it.
Unidentified Company Representative
The final question from Thomas is, do you see any new one-off costs in the foreseeable future?
James Crawford
We’ve guided to one-off cost up to GBP12 million for the year. That implies that there could be further costs in the second half, as we bring in more wine, this is committed that may be excess to the demand, we can’t provide for that until it sits on the balance sheet. So there is some timing in terms of how we’re thinking about stock provisioning in particular. And there is leeway in the second half for us to incur potentially another GBP3 million to GBP4 million of onetime costs related to stock movement.
Unidentified Company Representative
The next question is from Dan Curtis with Navat Capital. What was the total staff headcount at the end of the period and how does that compare versus ’21 and ’20?
James Crawford
Dan, I don’t have these exact numbers to hand, if I’m perfectly honest. What we did do is, as we’ve indicated, we removed 32 roles in the period. We also did not fill a series of roles that we had originally planned. I think if we were to look across the group versus pre-pandemic, say, end of FY ’20, we’re probably 60%, 70% up on total numbers, including customer-facing staff, a little bit lower than that in terms of the administrative roles, which I think are the ones we generally break out reporting. Happy to get a number back to you there offline if you want to drop us an e-mail, [indiscernible].
Unidentified Company Representative
Great. And the last question on the webcast so far, is from Stefan Winterling from Isar Holding GMBH. What is the current churn rate and how will it most likely develop?
James Crawford
Yes. The churn rate we report Stefan, is a sales retention rate. So sales made to repeat customers in the comparable period. What was the level in this period? That was 76% for this half. As we alluded to, we’re seeing very kind of stable retention rates comparable to how people performed pre-pandemic based on their tenure with the business. When you look at those and projecting forward, I would expect us to see high 70% sales retention rates in the future.
Unidentified Company Representative
Great. And we have one question via the conference call. So I am going to pass across to our operator, Diana, who will open the line.
Operator
The question is coming from Grace Gilberg with Jefferies.
Grace Gilberg
The first point or first question I have is on sales per new customer, because you guys have it up about 24%, and you’re still giving a lower discount on joining, plus those new cohorts are still becoming more loyal. So my question is, why is your long-term value only 0.1% year-on-year? Surely, there’s more upside to that.
James Crawford
That could be Grace. I think the model we have used is something like 20 to 30 different predictive data points. Only one of those is kind of near-term purchasing behavior and retention. So we’ll see how that ages out. I would love to think with my optimistic cut out, that the history we have with cohorts being upgraded in value over time will play out with this latest cohort. But right now, we’re seeing those kind of numbers, but it’s only translating into a 0.1x improvement due to LTV. I mean to be clear, LTVs are up by more than 10%, for example. But I think the model is genuinely quite cautious — at most times, but it got back by some of the short-term trends we saw during the pandemic.
Nicholas Devlin
I think maybe the only other thing I’d add to that, James, I guess on Page 14, which shows the bridge from Q1 to Q2. If we thought about that on a prior year to this year basis, you would see a greater increase in lifetime value than that. And you can start to infer some of that from the data we’re showing on Page 15. I think we may also show a little bit more in the appendix that starts to highlight that — year-over-year, we are driving some pretty substantial increases in lifetime value. And I think that’s important, right? Because ultimately, over the long term, perhaps to have a good set of quality opportunities to return the business to growth, we need to be generating higher — value per member. That ultimately gives us the foundation to go and compete with, not just other wine businesses, but other D2C businesses and frankly, other people who are interested in people’s attention, in different marketing channels for customers. So the year-over-year trend will be more positive compared to [indiscernible].
Grace Gilberg
Got you. No, no, very clear. And then just one more, if I may, and I apologize if potentially, you’ve already touched on this a little bit. But in regards to payback metrics, if it reached actually the 2.5x that we thought pre pandemic levels, what could that actually add to your standstill EBIT, or maybe even just more relevant to the EBIT margin itself?
James Crawford
Nick and I are looking at each other, trying to do some difficult math in our heads and so…
Nicholas Devlin
I’ll give quick something, and that will let James do a bit of his magic math in his head. I mean a couple of things are important. I mean number one, long term, we typically try to operate the business at around 2x payback. And actually, if you go back before the pandemic, that’s roughly what we normally reported. Now over a period of time, we have done some things like consistently expand contribution margins. And that has tended to mean that, now when you look back, it looks like all our cohorts for the pandemic were delivering an average 2.5x. So actually, there’s a little bit of — over time, we have operated well as a business and the past looks better now than it did at the time. So I think getting back to around 2, really reflects delivering a similar level of performance against our investment goals that we have over the long term.
In terms of quantifying what the half term of payback were, in terms of maybe kind of sustainable long-term profitability. I’m looking to the man on the right now and seeing whether he’s willing to give you an answer on the slide?
James Crawford
Yes. I mean, Grace, I think indicatively, the number that’s driving below standstill EBIT is a 46% year 1 payback that we’re seeing from last year’s recruitment. Historically, that’s been more like a kind of 66%, 67%, which is what I believe we will revert to during FY ’24. For what it’s worth, just doing a quick calculation on the slide, the difference between a 65% and a 70% year 1 payback is about GBP2 million to GBP2.5 million substantially. But I think that kind of gives you an indication of the magnitude that it will change by — based on that, but I’d be unwilling to try and do anything more certain than that on the fly.
Okay. I think that’s down back to Nick. I think any closing words?
Nicholas Devlin
Very good. Okay. So I think overall, the message here is that we are very much delivering in line with the update that we gave in October. It’s been really pleasing to see trading through the first half of the year, supporting the strong balance sheet we have now. Pleased to see resolution — issues around growing concern, and pleased to see that we are on track for delivery of our profitability goals through the first half of the year. And as we’ve indicated, continue to trade profitably in the months subsequent to the end of the interim reporting period.
And that sets us up well, looking to the long term. I think we’ve got a business that is clearly differentiated in the space. I mean, you can see from the information we shared today that, that differentiation is very much intact. We continue to have a loyal customer base that is valuing the quality of wine and product we’re offering, the differentiated experience, the direct connection to winemakers. And that sets us up well looking to the longer term.
The bit we remain sanguine about, is that there remains quite a lot of uncertainty and unknown in the outlook, both from an inflationary cost perspective but also from a consumer perspective. And in that context, we’re very much focused on giving ourselves a series of choices. And at their heart, those good choices come from having strong liquidity, a business that is profitable, therefore, is not reliant on any funding from elsewhere. And that gives us a chance to choose at what point we return this business to growth and make sure we do that alongside continued delivery of profitability. And James and I and the team are very focused on delivering against that.
Thank you all very much for your time this morning. I’m sure we’ll get a chance to talk to you — a few of you one-on-one over the course of the days to come. Thank you very much.
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