Fevertree Drinks PLC

LSE:FEVR

Earnings Call Analysis

Company Lowers 2023 Revenue Guidance, Maintains Growth Outlook

The company has adjusted its 2023 revenue expectations, now forecasting £380-390 million, acknowledging challenges in the U.K. market and distributor transitions affecting Australian operations. However, gross margin guidance remains at 31-33%, and despite decreased revenues, a confident outlook for improved EBITDA at £30-36 million is upheld, reflecting internal levers to maintain control. Additionally, there is optimism for a stronger second half, fueled by initiatives in cocktail mixers and adult soft drinks. Looking into 2024, the company has aligned with a consensus revenue growth prediction of 10%.

Stabilizing U.S. Operations and Commitment to Growth

Despite a frustrating issue which temporarily halted production, the company has swiftly reacted, ensuring no impact on U.S. customer relationships or demand fulfillment. Remedial actions are complete and production is restarting with contingency plans. Their commitment to expanding the U.S. production footprint is unwavering, forecasting margin improvements in 2024.

Strategic Efficiency and Global Profit Enhancement

Across the company's global operations, significant strides are being made in efficiency and profit enhancement. From progressing discussions with an Australian bottler to improving U.K. manufacturing efficiency, the company is on a clear path to optimize production. The rollout of technology advances is set to further enhance forecasting, procurement, and inventory management, which solidifies expectations of strong growth and higher profitability starting in 2024.

Optimistic Second Half Based on Margins and Working Capital

While the first half experienced operating expenses rising to 24.9% of revenue, this is attributed to expense phasing and is expected to decrease. The company projects an EBITDA margin improvement in the latter half of the year. Working capital was driven up by higher U.S. inventory levels to match demand, resulting in negative cash flow conversion initially. Nevertheless, the company expects a return to positive cash flow conversion, underpinned by confidence in improved margins and working capital management, as evidenced by a 2% year-on-year increase in their interim dividend.

Revising 2023 Revenue Guidance and EBITDA Projections

Amid more cautious trading conditions in the U.K. due to poor summer weather and a challenging economic environment, the company has adjusted its full year revenue guidance to £380-390 million. The transition and establishment of operations in Australia are poised for future growth, albeit contributing to the revised 2023 revenue outlook. Nevertheless, gross margin projections remain steady at 31-33%, with operating expenses forecasted at £88-92 million, translating to an adjusted EBITDA guidance range of £30-36 million.

Confident Outlook for 2024 with Enhanced Margins

Looking ahead, the company is comfortable predicting a 10% consensus revenue growth for 2024, bolstered by growth in the U.K., momentum in the U.S. and Europe, and a resurgence in other world regions. The company plans to exploit its self-run operation in Australia. With savvy improvements and investments, an anticipated 600 basis point improvement in gross margin is on the horizon, driven by favorable costs on glass and freight. This positions the brand to achieve an impressive EBITDA margin of around 15% for 2024, surpassing current market expectations.

Earnings Call Transcript 2023-Q2

[Operator]

Hello everyone and welcome to the Fever-Tree full year 2023 interim results conference call. My name is Bruno and I’ll be your moderator for today.

During the presentation, you can register to ask a question by pressing star followed by one on your telephone keypad.

I will now hand over to your host, Tim Warrillow. Please go ahead.

[Tim Warrillow, Chief Executive Officer]

Thank you and good morning everyone, and thank you for joining us to hear about Fever-Tree’s performance during the first half of 2023. My name is Tim Warrillow, co-Founder and CEO of Fever-Tree, and I’m joined on the call by Andy Branchflower, CFO, Charles Gibb, our North American CEO, and Ann Hyams, our Director of Investor Relations.

Over the page, Slide 2, this morning I’d like to start by highlighting some of the key points that I hope you’ll take away from the presentation before reminding you of the significant global opportunity for the brand and how we will take advantage of this in the most responsible way through our comprehensive ESG agenda. Following this, Andy will take you through the financial view before Charles and I present the regional strategic update.

Slide 3, the group has delivered good revenue growth during the first half of the year, especially in the U.S. where the brand grew by 40% to become our number one revenue generating region for the group. We have successfully driven share gains in each of our regions and with it further extended our premium mixer category leadership globally. In addition, our new products have contributed meaningfully to top line growth as we expand our portfolio to a greater number of drinking occasions.

We continue to experience macro cost headwinds resulting in gross margin pressure on the business, and our team remains focused on mitigating these through a range of projects covering glass supply, how we work with our bottling partners, as well as the implementations of new technology to optimize our global operations. Specifically relating to glass, we’re now in the contracting phase for our U.K. European glass tender process, which will give us better security of supply, a more transparent approach to energy hedging, and crucially better glass pricing. Our progress on glass alongside more advantageous trans-Atlantic freight rates makes us very confident in delivering a meaningful improvement in gross margin next year.

Slide 4, before we go into detail about how the group has performed over the first half of the year, I wanted to briefly remind you of the strategic blueprint we laid out in March. Our focus on innovation allows us to tap into ever more occasions and with it the most popular drinking trends in each one of our markets, whether it’s the growth of tequila in the U.S., the popularity of the spritzer across Europe, or of course the gin and tonic around the world. Our unwavering pursuit of product quality and our significant first mover advantage has enabled us to build an unrivalled reputation with the trading consumer, and our premium but accessible price point allows us to appeal to a broad customer base but also deliver superior margins for all our customers throughout the chain.

Each of the elements on this slide have propelled us to become by far the largest premium mixer brand globally, and our continued investment in the brand is driving further share gains that underpin our confidence in the future opportunity. Moreover, as the only mixer brand premium or mainstream with a global footprint and singular initiative, we have become the partner of choice for global spirit brands, giving us a further significant advantage against the competition.

Over the page, while we have made great progress so far, Fever-Tree still has a significant growth journey with an ever-lengthening runway ahead. Over and above our stronghold markets, such as the U.K. where the brand has premiumized and significantly expanded the mix category to become the largest mixer brand by some margin, a substantial [indiscernible] over the next few years will come from our next wave markets, such as the U.S. and Australia. In these markets, we are investing behind the brand to increase trial, awareness and distribution, as well as building relationships with customers across the on and off-trade. Beyond this, we have a number of white space markets particularly in Asia, where we’re focused on ensuring we’re working with the right partner for the right age and stage of development, such as our new partnership with Asahi in Japan.

Not only does the volume growth opportunity look compelling, but Fever-Tree has a unique position at the center of a number of strong global trends, from the premiumization of spirits and their growth ahead of wine or beer to consumer preferences for quality ingredients and easy-to-make cocktails. This is why we also see opportunities across many of our markets beyond our core carbonated mixers and will continue to develop products to cater to trending categories such as cocktail mixers and sophisticated adult soft drinks, leveraging the power of the brand.

Slide 6, before I hand over to Andy for the financial review, I’d like to update you on our progress under three of our five branches as part of our ESG agenda. Firstly climate, where we continue to focus on our carbon footprint and strategies to promote emission reduction, including switching to renewable energy where it’s feasible and ensuring that we’re producing as close to our end markets as possible. Secondly, we have several ongoing programs in place to support our communities both to home and where we source our ingredients. As part of this, we are proud to be in our tenth year of our partnership with Malaria No More, where we’ve raised money in support of projects that directly help the people impacted by the disease. Finally, we make sure we’re supporting the most important part of our business, our people. Over the last year, we have made great progress on our diversity, equity and inclusion agenda, where our committee has been working on a broad range of initiatives to foster engagement, education and training with a focus on collecting feedback and reflecting this in staff policies and ongoing event programming.

I’ll now hand over to Andy to take you through the financial review.

[Andy Branchflower, Chief Financial Officer]

Thank you Tim, and good morning everyone. We’ve set out here the key financial metrics for the first half of 2023. I will talk to the detail in the following slides and I’ll also set out why we expect this to be the turning point in profitability going forward with upside in gross margin and overhead phasing to drive an improved EBITDA margin in the second half of the year, before we expect a significant improvement in gross margin next year due to a combination of softening inflationary headwinds and the benefit of the proactive steps we’re taking, setting up the group for strong profitable growth going forward.

Turning the page, talking to the main moving parts of the H1 gross margin, we drove 190 basis points of margin improvement through pricing and we expect further upside in the second half as we enjoy a full six months with the increases in place. This was supplemented by a further 150 basis points of improvement from increased U.S. bottling, with recalibrating trans-Atlantic freight rates to provide a further benefit in the second half of this year. But as we explained at the start of the year, we are facing significant inflationary pressures across categories, with glass as expected driving 600 basis points of margin dilution alone, and so despite the mitigating actions we have taken as a result of these extraordinary cost headwinds, gross margin reduced to 30.7% in the first half. This was in line with our expectations and with tailwinds from pricing and trans-Atlantic freight to come in the second half, we remain comfortable with the guidance range of 31% to 33% gross margin for the full year.

Moving to Slide 10, we’re confident in driving gross margin improvement in 2024 with three key levers, firstly driving improvement in glass pricing. We’ve seen a relative stabilization in energy costs following the volatility and extraordinary increases we saw in 2022. U.K. gas forwards for 2024 currently sit at circa 130p per therm, which is significantly below our glass suppliers’ hedged levels for this year, although not back to their historic 50p per therm levels. We are at the contracting phase of our tender process, which is initially focused on U.K. and Europe, and we are confident that this will underpin greater security of supply, a partnership approach, and full transparency with regard to energy hedging. As part of the tender process, we have agreed to hedged energy levels with our primary supplier for 2024.

Meanwhile in the U.S., glass will be fully locally supplied going forward, removing the freight costs of previously imported glass bottles into the U.S. Following the impact this year of extraordinary levels of glass cost inflation, we’re confident in driving a significant year-on-year reduction in glass cost in 2024.

Secondly, driving improvement in U.S. cost, we flagged in the R&S this morning an issue impacting certain U.S. production batches towards the end of the first half. We subsequently took the decision to not sell the affected stock and have therefore recognized a £3.3 million provision in the first half results as an exceptional item due to its material and one-off nature. We’re currently exploring all options for compensation for this cost, including insurance, and we’ll recognize any sums received as an offset on the exceptional item line in due course. This issue, whilst extremely frustrating, did not affect customer relationships or our ability to continue to fulfill U.S. demand. We’ve identified the root cause, remedial action has been taken, and we’re now restarting production with contingencies in place, if required.

It’s important to state that we remain committed to building our local U.S. production footprint, whilst the recalibration of trans-Atlantic freight rates also allows us to supplement U.S. production with U.K. production and still drive margin improvement in 2024.

Finally, we’re making good progress on a wide range of efficiency and profit enhancement projects across our global operations. Discussions are well progressed with a local Australian bottler. We are working with our anchor bottler here in the U.K. to improve manufacturing efficiency and are delivering a program of cost reduction and technical optimizations across our raw materials and packaging. The rollout of our technology program is also progressing well, which will drive further improvements across forecasting and production scheduling and will allow for more efficient procurement and optimized inventory levels.

Subsequently, while the first half of 2023 represented the peak impact of the inflationary and operational challenges we have faced in recent years, the multiple proactive steps we have taken alongside a softening of inflationary impacts means we are confident we are entering a period from 2024 in which we’ll drive strong growth and profitability as we realize the benefit of these improvements going forward.

Moving on, as a reflection of our confidence in these gross margin improvements going forward, we continue to invest behind the opportunity. The phasing overheads, which is typically more evenly spread between H1 and H2 compared to revenue resulted in operating expenses increasing to 24.9% of revenue in the first half. This percentage will reduce as this phasing unwinds, which will allow for EBITDA margin improvement in the second half.

Turning the page, working capital has been driven by increased inventory levels, largely in the U.S. where we’re holding sufficient product to service the strong demand in that region. Increased working capital alongside the reduction in EBITDA margin has meant that operating cash flow conversion was negative in the first half. Despite this, cash remained strong at £76 million and we expect to return to positive cash flow conversion in the second half as both margins and working capital improve, and as a reflection of the confidence we have in the business and its prospects for continued cash generation, our interim dividend is increasing by 2% year-on-year.

Finally as flagged in this morning’s R&S, we’re reducing our full year revenue guidance range to £380 million to £390 million for 2023. In the U.K., we’re seeing more subdued trading than expected over summer, where poor weather impacted across the category, and so we’re bringing full year U.K. revenue guidance down, reflecting that impact and recognizing that the continued soft economic backdrop will make it challenging to offset this in the remainder of the year.

In the rest of world region, we’re working through a distributor transition and the establishment of our own subsidiary operation in Australia. Whilst these steps set us up for strong revenue growth in 2024, we are reducing our 2023 revenue guidance to reflect the one-off impact of this transition and associated inventory buyback.

Below revenue, as I said earlier, we are reiterating our gross margin guidance range of 31% to 33% and we expect operating expenses in the range of £88 million to £92 million, so the decrease in revenue guidance drops through to an EBITDA guidance range of £30 million to £36 million.

Looking forward to 2024, we’re comfortable with consensus revenue growth of 10%. We expect the U.K. to return to growth aided by our cocktail mixer and adult soft innovation. We expect momentum to continue in the U.S. and Europe and that this will be accompanied by a return to good growth in the rest of world region as we realize the benefits of running our own operation in Australia whilst lapping the effects of the transition this year.

I’ve explained why we have confidence in driving gross margin improvement in 2024 and we’d expect a circa 600 basis points improvement in gross margin, driven by improved glass and freight pricing. Alongside an intention to continue investing behind the opportunity, this would result in an EBITDA margin of circa 15% for 2024, which is ahead of current market expectations.

So whilst it is disappointing to revise our 2023 guidance this morning, we are confident that we are turning the corner on the impact of the unprecedented challenges in the operating environment we’ve faced over recent years, and we look forward to a period of strong sustainable profitable growth in 2024 and beyond.

With that, I’ll pass back to Tim.

[Tim Warrillow, Chief Executive Officer]

Thanks Andy.

Charles and I will now take you through some of our regional specific highlights as we continue to make great strides across the world. But in a change from the normal proceedings, we will start with the U.S. in recognition that for the first time ever, this is now the group’s largest revenue generating market.

Over to Charles.

[Charles Gibb, Chief Executive Officer, North America]

Thank you Tim, and good morning.

Fever-Tree delivered £36.1 million of revenue in the first half of 2023, a strong increase of over 40% year-on-year and plus-32% on a U.S. constant currency basis, which included a 5% net price increase as we extend our presence and popularity amongst U.S. consumers and the trade. We continue to grow strongly in the off-trade with significant sales increases across all our mixer categories over the last four years, with particularly strong growth in our sparkling mixers through our new innovative flavors, including pink grapefruit, lime and yuzu, and Sicilian lemonade, all of which cater to the demand for longer, lighter serves with tequila, vodka and bourbon.

In addition, we’re extending our market leading position in ginger beer and became the clear market leader in tonic water, a significant achievement in a market with the largest premium spirit category in the world, which is a real testament to the strength of the brand and our multiple drink strategy.

Moving onto Slide 17, the brand is building a considerable competitive advantage at retail, enabling us to drive growth well ahead of the category. As a result of this success, we’ve become the clear leader and advisor with some of the largest retailers across the country, which puts us at the center of the decision-making progress around the mixer category in these grocery stores. Fever-Tree is also expanding into white space with new accounts added across both channels during the first half of the year. In addition, we’ve added considerable new distribution points with existing customers, including large off-trade customers such as Total Wine and Target, led by our canned business which is driving this incremental expansion.

In the on-trade, we’re also working closely with our customers to increase the numbers of SKUs per account by educating them about the breadth of our portfolio, providing merchandising, and writing more cocktails to excite the consumer at the point of purchase. These conversations are supported by our activations, pop-up bars and spirit partnerships, which showcase the brand and drive trial and awareness.

Moving to Slide 18, our five drink strategy remains the cornerstone of our innovation pipeline and enables us to target a wide variety of spirits occasions, thus meeting the diverse needs of the U.S. consumer across all trade channels throughout the entire year. We launched our blood orange ginger beer, our first flavored ginger beer in the U.S., with the aim of replicating the success we’ve had with adding flavors to our tonic range and recruiting new consumers and exciting those already loyal to the brand. We’ve already won a significant amount of new distribution with this product, including around 2,500 new points of distribution at major retailers as well as significant wins in the on-trade, contributing to its initial success as now our fastest ever new product launch in the U.S. market, far exceeding the growth of our previous additions.

In addition, we’ve now entered the significant non-carbonated mixer category, noting that this category is larger than either tonic water or ginger beer and has a significant long term opportunity for the brand. Following our acquisition last year of Powell & Mahoney and the transition to Fever-Tree branding and Fever-Tree Liquids, we now have a classic margarita, a light margarita, and a Bloody Mary mixer to attract new and existing Fever-Tree consumers as well as leveraging our strong distribution network. We’re excited to build on a good platform of distribution, Fever-Tree’s brand credentials and our strong relationships with the trade to drive growth, and have already seen a meaningful uplift in rate of sale with the Fever-Tree branding and Fever-Tree Liquids on shelf.

As I hope you can see from the last few slides, the U.S. remains an incredibly exciting marketplace for the group with significant runway ahead. We’re growing across all categories, opening up new opportunities through innovation, and continue to increase our distribution and brand presence enabled by the quality of our ingredients and strong relationships within the trade.

I’ll hand you back to Tim to talk about the U.K., Europe, and rest of world.

[Tim Warrillow, Chief Executive Officer]

Thank you Charles.

Slide 19, turning now to the U.K. where sales for the first half of the year were in line with our expectations and slightly ahead of 2022 at £53.8 million. Fever-Tree remains the mixer brand of choice in the U.K. by a substantial margin with around 45% value share of the total mixer market across both the on and off-trade, materially higher than the next largest competitor, Schweppes, and over 20 times larger than the next largest premium brand. In the on-trade, we continue to increase our value share, which has grown by just over 5% since 2019, as well as the number of accounts we are present in, and on the off-trade, the brand is not only the largest mixer brand in the U.K. but we now make up over 90% of premium mixer sales as we continue to lead the absolute growth of this segment of the market.

Slide 20, the spirit category has been growing well in the U.K. over the last two years, with rum and vodka the best performers, and although gin has been softer, it still remains a significant and highly premium part of the total spirits category. Fever-Tree has built an unrivalled portfolio to cater to a broad range of mixing occasions across a growing number of spirit categories, which is demonstrated on the right-hand side of this slide. We hold a strong market share across all major mixer categories, and while we remain a tonic-led business, our ginger ale and flavored sodas have been growing particularly well in recent years, pairing well with rum and vodka respectively, two categories that are in good growth.

We are also incredibly encouraged about our latest additions to the portfolio, adult soft drinks and cocktail mixers, which has shown positive early signs of consumer traction and growth, and I’ll talk more about this on the next slide.

Slide 21, investing in the brand both in terms of new product development and marketing is a vitally important aspect of our strategy and future growth. When it comes to new product development, we have been focused on cocktail mixers and adult soft drinks over the last year, which we believe had significant potential to grow and expand their respective categories. We launched our cocktail mixer range during the first half of 2023 and have seen extremely positive interest from our customers across the on and off-trade, winning distribution at three of the U.K.’s leading retailers as well as in a number of the largest U.K. on-trade chains.

We believe we’ve been able to revolutionize the simplicity making these popular cocktails, opening up a whole new portfolio of drinks for people to make at home as well as enabling the wider on-trade channel to offer high quality margaritas, mojitos and espresso martinis, serves that were previously limited to high end bars.

Our adult soft drink range is also gaining traction as our quality ingredients, sophisticated flavor profiles and low calorie options have added something new and exciting to this sizeable category. Our initial success following trials has encouraged us to invest further in adult soft drinks, increasing our distribution in new slightly larger [indiscernible] packs as well as launching a new 275 ml glass bottle format for the on-trade and adding a new flavor to the range.

Finally, the right-hand side of this slide gives you a small insight into the fantastic work our team has done across multiple channels to showcase the brand’s credentials and ensure we remain front of mind for customers when they’re making purchasing decisions, with a focus in the first half of this year on showcasing our new cocktail mixers both at retail and at pop-up bars across the summer.

As I hope you have seen from these last few slides, we continue to make good progress in the U.K., remaining the market-leading mixer brand and ensuring our portfolio continues to cater to the most popular drinking trends.

Over the page, Slide 22, turning to Europe, the Fever-Tree brand delivered £50.5 million in revenue, an increase of 9% year-on-year and 5% at constant currency, with our total European revenue including GDP portfolio brands at £56.1 million. [No audio] each year for the next few years, with premium vodka and tequila the drivers of this growth. In a similar way to the U.K., we are ensuring that Fever-Tree has the right mixers for the most popular serves in each European market. As you can see from the right-hand side of the slide, whilst we’re growing well across all categories, our sparkling category has been growing most strongly over the last few years. These versatile mixers, including products like our pink grapefruit and Mexican lime soda, pair well with a range of spirits but principally with vodka and tequila, with spritzers and cocktails like Paloma becoming more popular in recent years.

As well as making sure we have the right product in each market, we continue to focus on marketing campaigns to promote our mixers across each of our markets to ensure we’re staying front-of-mind for consumers. During the first half of the year, we have had three main focuses: tonics, ginger beer and sparkling pink grapefruit, which all cater to different popular drinking occasions. For tonics and ginger beer, where we have dominant market share and good consumer awareness in growing categories, we have used bold, far reaching and popular line campaigns such as billboards in Paris along with TV investments in several markets, all of which showcase our ingredient quality. For sparkling pink grapefruit, one of our most recent innovations, we’re focused on launch events, engaging with trade press, using influencer campaigns and on-trade activations to build consumer awareness of the mixer and encourage trial using popular serves, such as the Paloma.

As you can see, we’re making really good progress in our European market, where we aim to maintain our lead in tonic and ginger beer categories and continue to extend our portfolio to a range of sparkling mixers to expand the number of occasions our portfolio caters to.

Slide 25, our final region is the rest of the world, where Fever-Tree delivered £9.6 million revenue. This result was impacted by the transition to a new subsidiary set-up and new distribution partner in Australia. The decision is an exciting step that has been encouraged by our strong growth in a market which we believe has a long runway of opportunity ahead. Fever-Tree already leads the premium mixer market in Australia with over 80% premium value share at retail, but still has a lot of white space to grow into across the wider mixer category in both channels as the trend towards higher quality experience, craft and provenance is well [indiscernible]. Therefore, Fever-Tree is focused on driving momentum in the premium mix segment in Australia and has made significant steps this year to set the brand up for future growth with a dedicated sales and marketing team, more advantageous distribution set-up, and more resources to service customers and gain synergies as we scale.

We’ve also been encouraged by the progress that’s being made in Japan and Canada following the step changes we have made to our route to market over the last year, reflecting the potential we see across our wider rest of the world region. We therefore remain confident of a stronger second half performance and remain buoyant about the growth the brand can achieve in future years.

Turning to the final slide, Page 26, I’d like to finish by once again reminding you of the strategic progress we have made in the first half of the year and why we remain so invigorated by the future opportunity. In short, in Fever-Tree’s top 15 markets, IWSR forecasts for the next five years shows global spirits to keep growing strongly at 13.5% and for this growth to be driven by premium categories with premium value growing from 43% to almost 50% by ’27, so the trends remain very supportive.

The brand continues to grow and gain share well ahead of the completion all around the world, with especially strong growth in the biggest global premium spirit market in the U.S. Our innovation continues to successfully broaden and deepen our addressable market size and opportunity, and along with top line growth, the business is very focused on driving margin improvement and has worked hard during the first half of the year to set the stage for meaningful margin benefit for next year.

While it’s frustrating that in recent months our sales have temporarily been impacted by [indiscernible] in the U.K. and the set-up of our subsidiary in Australia, these are very short term impacts and do nothing to change the long term prospects and velocity of the brand and business.

Thank you for listening this morning. Andy and I, along with Charles in the U.S., are now happy to answer your questions.

[Operator]

[Operator instructions]

Our first question comes from Edward Mundy from Jefferies. Edward, your line is now open, please go ahead.

[Edward Mundy, Jefferies]

Morning guys. I’ve got three, please. The first is on the 15% margin target for 2024. Given that you’re a grace business, appreciate there is opportunity for [indiscernible] to be materially better, but how do you think about the opportunity to reinvest to drive accelerated growth? Are you really wedded to that 15% margin target, is the first question.

The second question is for Charles - you know, good momentum in the U.S. and certainly my trips [indiscernible] the Fever-Tree brand is much more visible within the on-trade than historically, but my sense is that a lot of the mixing is done with the 500 ml certainly behind the bar, relative to having the perfect serve on the bar when you get the bottle alongside your drink. Is there more that could be done to boost brand visibility in the on-trade?

Then a third question is around innovation - appreciate you’ve got a lot on your plate at the moment with the adult soft drinks and also the cocktail mixers, but I wanted to come back to ready-to-drink, which you launched back in 2019 ahead of the pandemic, so not a great time for it. But philosophically, is there any reason why ready-to-drink couldn’t be successful over the medium term, given the strength of the brand not just within tonics but within the gingers and the grapefruits and some of your other variants?

[Tim Warrillow, Chief Executive Officer]

Okay, should we split that between us? Do you want to take the margin, Andy and Charles, and then I’ll take the last one on innovation?

[Andy Branchflower, Chief Financial Officer]

Yes, good morning Ed. From a--talking to the 15% margin guidance, as I said, our focus is on driving margin improvements at gross margin level. We spoke about 600 basis points improvement, and that’s based on good confidence and visibility on glass pricing, where freight rates are, not to mention the benefit of the wide range of projects we’ve been running internally to drive margin improvements.

I think sort of implied in that guidance therefore is the overheads, which remain relatively elevated as a percentage of revenue compared to recent years, so about 23% of revenue, so alongside an increase in top line, that does allow us to continue to invest behind growth, so we’re allowing for that in our guidance, to continue to invest behind the opportunity. As I say, the margin improvement is really focused on the gross margin line.

[Charles Gibb, Chief Executive Officer, North America]

Sure, then taking your point regarding the U.S. and the perfect serve, Ed, you’re absolutely right - we are focused on trying to get more and more bars to do the perfect serve, but it’s changing a sort of cultural norm here, where the bartender makes the drink and gives you the drink, you don’t pour your drink yourself in a bar. It also relates quite a lot to table service, where a lot of bars, you actually go to a table and you get served at your table, so you don’t actually get served at the bar. In particular, interestingly we were making a lot of strides pre-pandemic, post-pandemic with lack of staffing, lack of people. They’ve reverted to sort of norm much, much more.

That said, the best way of us ensuring visibility in a bar is in fact through the cocktail list, and when we’re on the cocktail list, not only do we see sort of obviously the brand an awful lot more, but our rate of sale in those bars, it goes up exponentially, sort of five or six-fold simply because we’re integrated into the bartenders cocktails and integrated on the cocktail list there, so that cocktail list and improving visibility on the cocktail list with proper Fever-Tree names, etc. is the core driver for us, and they use the 500 ml because of the ease of serving and because they’re serving multiple drinks a night, and again tight spaces and ease of recycling is much, much greater with that. That’s the rationale.

But absolutely, we are focused on trying to change the way people serve their drinks in the U.S.

[Tim Warrillow, Chief Executive Officer]

I will add that I think the U.S. team have been doing a brilliant job of getting the bottles served where they can. These tend to be more in sort of hotels, more sort of premium, slower adrenalin on-trade accounts, so what I conclude from that, Ed, is that you’ve obviously been spending quite a lot of time in the high adrenalin, fast-paced accounts as well, which is good news for you.

On the subject of innovation, RTDs, absolutely they’re in our thinking, but as you rightly said, we’ve got a lot on our plate in terms of our new innovation, which we’re really excited about. The cocktail mixer that we recently launched this year has been very quickly and very well received, and that opens up a whole new interesting category and opportunity for us, not just here in the U.K. but all around the world, so that is a real focus of ours at the moment and we see significant potential and opportunity for that going forward, and of course alongside the adult soft drinks.

But there’s no question that the RTDs are something that we’ve given quite a lot of thought to over the years. We’ve been approached, as you can well imagine, a lot and increasingly, so don’t be surprised if you hear us talking about that in the future. But just at the moment, we’ve got a lot on our plate that we’re excited about.

[Edward Mundy, Jefferies]

Okay, thanks guys.

[Operator]

Our next question comes from Andrew Ford from Peel Hunt. Andrew, your line is now open. Please go ahead.

[Andrew Ford, Peel Hunt]

Morning Tim, Andy and Charles. Thanks for taking the questions. A couple from me.

On the U.S. sales [indiscernible], I wonder if you could give an indication of how much of that was price; and just on the cash flow, it was sort of--you know, the negative was mainly through working capital build in the U.S, and Andy, you mentioned an improvement in the second half. I just wonder, if demand continues to build, would we not expect further outflows here?

Lastly, you’ve given a fairly wide range on EBITDA guidance for this year, so on £10 million of revenue, there’s £6 million of EBITDA range, and then a fairly precise percentage guidance for FY24. I understand that the quantum of the increase sort of expected on margins, but I wondered what was driving the uncertainty this year and why there’s so much confidence next year. Thanks.

[Charles Gibb, Chief Executive Officer, North America]

I’m happy to take the one on U.S. price to start with. Look, we achieved approximately net about 5% price increase across the market, obviously with slight variations in different trade channels. I think most importantly, we were able to do so without losing any distribution, without losing any momentum, and with in fact increased retailer support in and around the brand, and really that whole thing becoming this category leader and taking this role with a number of key retailers has really helped us do and shape the way the category is being viewed by them and making sure that they’re organizing it in the best way. That 5% price increase net was what we achieved, and--yes, it went through seamlessly, which is, I think, the most positive thing.

[Andy Branchflower, Chief Financial Officer]

Yes, just picking up the other two questions, Andrew, on the cash flow, in the first half you see the effect of increasing working capital driven by inventory, and that’s driven by U.S. inventory, holding more U.S. inventory, particularly if we compare to this time last year where we had clearly lower levels of U.S. inventory. Alongside that, we made a low level of EBITDA for the reasons I set out, so just over £10 million of EBITDA, so the combination of increase in working cap and lower absolute level of EBITDA means we went into negative operating cash flow conversion.

If you look at the second half, you’ll see implied in our guidance is more than a doubling in absolute EBITDA in the second half to get to that midpoint, let’s say, of £33 million EBITDA, so more EBITDA generated. We don’t expect to increase the working capital profile; in fact, we’re going to be focused on bringing it back from the 25% of revenue you see in the first half. If you look historically, we’ve always held heavy working capital at the half year compared to the full year, so when you model that through, it means you should get a good return to strong positive operating cash flow conversion in the second half. It’s really this negative one in the first half is the impact of that crunch on absolute EBITDA alongside increased working capital behind what is very good momentum in the U.S. market.

From an EBITDA perspective in terms of the range, this year what we’re doing, obviously we’re bringing down the revenue range, we’re maintaining our gross margin range but we’re giving a relatively narrow opex range, and the result of that is that slightly wider range on EBITDA guidance for this year, which is similar to the range we had at the beginning of the year. Clearly there are levers we can pull to make sure we land within that range.

I think when we look forward to next year, at this point we’re not giving a range on revenue, we’re saying we’re comfortable on revenue growth at 10%, and so because of that, we’re not giving sort of absolute EBITDA numbers. But what we’re saying is we’re comfortable with circa 600 basis point increase in gross margins, so if you take 31% to 33% gross margin range, that gives you a range for next year’s gross margin, and then dropping down from that, it gives you that circa 15% EBITDA, which we’re comfortable we can deliver against.

[Andrew Ford, Peel Hunt]

That’s great, thank you.

[Operator]

Our next question comes from Matthew Ford from BNP Paribas. Matthew, your line is now open, please go ahead.

[Matthew Ford, BNP Paribas]

Morning Tim, morning Andy, morning Charles. Just a couple from me.

Just firstly on the gross margin development in 2024, the 600 basis points, would you be able to kind of break that down loosely between the constituent parts around glass and freight and increased U.S. production? Then the second question is just around pricing, how do you think about pricing in H2 ’23 and then into 2024 across your markets? Are there any markets where you’re looking to take price, or how do you think about that in terms of outlook for next year? Thank you.

[Andy Branchflower, Chief Financial Officer]

Morning Matthew. Yes, in terms of that gross margin breakdown, we’re not giving a bridge in terms of how the constituent parts of the 600 basis points, but as I said, the key drivers of it will be glass in particular. This year, we’ve got 600 basis points of dilution on our gross margin driven by glass costs. If you look back to last year as well, we had a lot of surcharges hitting our P&L in the second half, and we had 300 basis points of dilution on glass last year, so glass has driven a lot of dilution in gross margin over the last 18 months. On the basis of where we’re hedged out on energy for next year and on the basis of the pricing we’ve agreed as part of our tender, we’re confident we can recoup a good proportion of that.

Then on top of that, as we’ve spoken about a lot, the trans-Atlantic freight rates, which remember peaked almost four times historic levels last year, have been a significant headwind to our overall gross margins, and the mitigation whilst those freights have been so high has been to increase on-shored U.S. production. With the recalibration in our trans-Atlantic freight rate, that exposure goes away almost independent of how we build that local U.S. production footprint, so both of those factors give us good visibility and certainly on the extent of margin improvement we can drive next year, not to mention there’s obviously other levers we’re pulling in terms of efficiency programs and the benefit of the technology program that’s in the implementation phase at the moment.

I hope that helps, but I think glass and the removal of that--the final removal of that U.S. freight headwind are the main components of that 600 basis point improvement for next year.

[Tim Warrillow, Chief Executive Officer]

This is Tim. Then on the subject of pricing, look - I mean, we’ve got--we’re planning on not changing our pricing strategy. We will continue to plan on putting moderate price through across our regions, as we have done consistently and successfully over the years, so no change in pricing strategy. It’s working well for us and we will continue to do, and plan to do as we have done previously.

[Matthew Ford, BNP Paribas]

Great, thank you.

[Operator]

As a reminder, if you’d like to ask a question, please press star, one on your telephone keypad. That’s star, one on your telephone keypad.

Our next question comes from Damian Mcneela from Numis. Damian, your line is now open, please proceed.

[Damian Mcneela, Numis]

Okay, thank you. Morning everybody. I’ve got a couple of questions for Charles, I think.

Last year, clearly the supply chain issues meant that you were sort of capacity constrained in the U.S., and you weren’t really able to run any promotional activities. I’m wondering whether you could give us a sense of what level of promotional activities you’ve been able to run in the first half and how that’s shaping up for the second half, is the first question.

Then just also on the sort of--what are the strategic priorities? It sort of feels from the presentation that you’re sort of pushing on a lot of fronts. What is the order of things that are most important? Is it driving point of sale in existing distribution or is it more distribution points in either channel? I’ll leave it there for now.

[Charles Gibb, Chief Executive Officer, North America]

Sure, thanks. Look, in terms of promotional activity, we’ve been in full inventory position throughout the whole of the first half of this year, and as a result of that, we are on a normalized promotional program and normalized promotional schedule, which obviously we were not for the first half of last year, nor really until towards the end of the year, and so we’re planning, if you like, a normal promotional calendar which obviously focuses on key holidays, key holiday periods, summer being obviously a peak period for us and then clearly from Thanksgiving through to Christmas being the second. I think normalized promotion, back to a normal cadence there.

In terms of your second question, we approach the market in a number of different ways. One is I think it’s critical that we establish this multiple drink strategy, and where we do, we find that that’s where we get the best growth from because we can appeal to the vodka drinker, the gin drinker, the tequila drinker, the bourbon drinker, the scotch drinker, the mescal drinker - whatever it is, and so making sure that we’ve got tonics, ginger beers, sparklings all present in the count is really important. Now that we’ve got all of those, also adding cocktail mixes in there, noting that the margarita is in fact the number one cocktail in the U.S., which is why entering that category has been so significant and so critical for us.

So yes, we’re expanding into more and more doors and expanding into more accounts, but particularly in the off-trade, and I’ll just talk on the off-trade for a second, we’re in just about every single major grocery chain that you want to be in, so our focus switches then from just getting in the door to now having multiple offerings, establishing that five-drink strategy in all those accounts.

Secondarily, in those accounts what we’re finding is that we need to have multiple SKUs, so at the moment we lead with our 4x200 ml glass, but the biggest growth is coming from our canned pack, because once the consumer loves the image, has adopted the brand through the four-pack of glass, when they are looking for convenience, when they’re looking for easy recyclability, when they’re looking for simplicity of storage in their fridges, this is where the canned pack plays such a critical volume--a critical role, and that’s why our canned growth is way ahead of our total business growth at the moment as we expand distribution, but we also see a faster rate of sale on that.

If we go into the on-trade, we are still--we’ve still got a long way to go in terms of achieving peak penetration in the on-trade, and so there, yes, it is about knocking down new doors but also it’s about turning these one and two points of distribution accounts, where they may have the grapefruit and the ginger beer, neither of which you can do on a gun, and then expanding into getting in more sparklings, more tonic waters into those accounts, so there the depth of distribution is really important for us.

Frankly, the answer is it’s a combination of all of the above. A lot of that depends on the trade channel, it depends on the state, and we’ve got different states at different levels of maturity, so when we get down to more kind of precise, if you like, localized strategies, we look at what we need to do in that market to achieve the success. If I took California, where we’re more developed in the on-trade, it’s more about get the distribution per account, whereas if you’re like some other states, let’s just say Chicago for a second, we’re looking to get into more accounts there in the first place.

I hope that makes sense.

[Damian Mcneela, Numis]

Yes, that makes sense, it’s very clear. Thank you very much, Charles.

[Operator]

We currently have no further questions. This concludes our call. Ladies and gentlemen, thank you for joining. You may now disconnect your lines. Thank you.

[Tim Warrillow, Chief Executive Officer]

Thank you.

[Andy Branchflower, Chief Financial Officer]

Thank you.