Naked Wines PLC

LSE:WINE

Earnings Call Transcript 2023-Q2

[Nicholas Devlin, executive]

Hello. Thank you very much. Good morning, everyone. Thank you for joining us.

I'm going to start off and just give a little bit of housekeeping for today's presentation and then take you through a quick introduction. And then James is going to walk through some of the detail to expand on some of the themes that we've announced today in our financial and operational update.

Two bits of housekeeping. First one is, please do expect a short presentation. We're not intending to do a long run through here. The biggest focus for us was wanting to make sure we had an opportunity for analysts and investors to ask some questions off the back of the announcements we've made today. So we'll get pretty quickly to that.

And the second one is just a reminder, I'm sure you all know this, but this is not our interim results update, so we'll not be going into detailed disclosure around operational metrics in the call today beyond the disclosure that we've provided in the RNS announcement earlier.

So I think, firstly, just to set the theme for the updated plan that we've announced today. And I think this is very much the right plan for Naked to adopt right now in the context of the market and consumer environment we see. I think we're clearly acknowledging a couple of things. Like a lot of online businesses, we have made some mistakes in the pursuit of growth over the course of the last year. And I think in particular, common to a lot of people, we made some planning assumptions in 2021 about the likely rate of growth the business would deliver over the near term that have turned out not to be true. We didn't call or anticipate the level of cost inflation that we have seen, both operating costs, cost of doing business, but in particular, supply chain cost pressures the business has experienced and some marketing cost inflation. And as a result of that, again, like a lot of businesses, we're sitting on an excess of inventory that we need to address and work through.

I think the second thing that we acknowledge and we've been -- we've addressed directly today was that while we rightly put in place a funding facility to support our liquidity, we didn't get the structure of that facility right, and we had a facility that was orientated towards the requirements of a high-growth, low no-profit business as opposed to one that was orientated around the situation we find ourselves in today. And that's something, with James coming back in and leading the negotiations, that we've directly addressed.

So I think what we seek to do today is lay out the plan that we've been working on over the course of the past couple of months, which I think does 3 really important things. First of all, we have liquidity in the business that is substantially reinforced. The business had a net cash position at the end of the reporting period in September of GBP 22 million with a further GBP 42 million readily available in our asset-backed lending facility. James will walk you through the details, but we have substantially improved that facility by renegotiation of the covenant structure, by giving ourselves much more surety of access to that funding.

We've also directly looked to face into the challenge we have of excess inventory in the business, and we've got a plan in place for an orderly reduction of those inventory levels over the course of the next 18 months, which alongside the cash generation from EBIT in the revised plan that we're projecting will enable the business to deliver material cash generation as we move into financial year '24.

We will be announcing today that there are some onetime costs to access that, and James will take you through those as well. Beyond that, we've got a business that will be showing profitability. And that's not just a plan for profitability. The numbers we're announcing today include the fact that we made adjusted EBIT of GBP 4 million in the first half of the year. So very quickly, we've been able to pivot the performance at Naked. And I think that reveals something we've always said: we've got a fundamentally better way of doing business here by connecting talented independent winemakers to wine lovers. We have a better alternative to the traditional wine model, and that's enabled us to reveal that profitable core.

I think the third leg of the story is that we've taken necessary action to reduce our costs versus the guidance we've given, both pulling back marketing costs to somewhere in the region of our level of investment prepandemic and reducing our SG&A cost base. And those things taken together will enable us to reveal the underlying profitability of the business.

Sorry, it's a little late in California, and I'm not quite at 100% health, but hopefully the voice will get me through the presentation.

So they're the kind of key messages we're going to talk through today. I'm going to hand over to James, who's going to take us through a few of the supporting materials, and then we'll move on to Q&A. Thank you.

[James Crawford, executive]

Thank you, Nick. Have a glass of water. If we could roll on to Slide 3, please. I just want to outline here how we have renegotiated the credit facility to give a significant improvement in covenant headroom.

I think also worth reflecting on why we have this facility, not sure the context was ever fully explained. But this is a facility that was the genesis of which actually happened on my previous stint as CFO and we started looking at the intra-year working capital cycle and felt it wasn't a good allocation of equity capital to finance an intra-year peak in working capital -- generally happens around now as we prepare for peak trading. And we are repacking wine, paying duty, paying warehouse costs for the wine to set in.

But having a facility also brought some other benefits. It brings the benefit to align supply and demand with what I'd call a soft landing when demand outlook changes and the supply chain has to respond behind that. It also provides access to capital that would fund inventory for growth initiatives prior to recruiting Angels as Angels at best only fund their own wine, not wine for future Angels.

So the idea behind the facility was threefold. The facility is very much operating at the moment. And the second of those reasons, the flexibility to align supply and demand as the growth curve changes. But the issue with the facility was that the covenant structure, there are 3 covenants, one of which related to our repeat contribution profit delivery.

And that covenant was set very close to the expected forecast at the time the facility had been negotiated 6 to 9 months ago. The world has changed since then. And as was disclosed in our accounts for the full year, the proximity of that covenant to the repeat contribution outlook did not leave significant downside space in the event of a variance to plan. And as a result of that, there was a risk that we could not access this facility in a downside scenario.

We have agreed with the banking group that we would amend that repeat contribution covenant to one that is based on adjusted EBITDA. It's a slightly different definition of adjusted EBITDA to that, that we would normally report. It actually also adds back share-based payment charges. But with that in place, we now have a covenant that we have good headroom, much improved headroom to.

The facility covenant is set at GBP 1 million of EBITDA to be delivered each quarter for the first 3 quarters of our financial year. And in the fourth quarter, we have to have delivered GBP 4 million of EBITDA across the trailing 12 months. So that gives us room for the quiet post-Christmas quarter. Worth noting, we have delivered GBP 5 million to GBP 6 million worth of this facility adjusted EBITDA just in the first half versus those covenant requirements of GBP 1 million per quarter and GBP 4 million for the year. So I think there's a good demonstration there of the headroom that we have.

And as such, we have a good level of confidence that we have access to this facility, which when combined with cash at the reporting date means there's GBP 64 million of available liquidity within the business.

Moving on to the next slide. Nick has also mentioned the high stock level that we are sitting on at the moment as a result of growth flowing. I think useful to show us some history here and put the statements we've made today around stock peaking now expected to gently destock over the next 12 to 18 months into context. So this chart shows the group inventory balance over a period of history. You can see during FY '21, that's a period where sales were growing very quickly. 68% was the sales growth that we've delivered during that financial year. Inventory was flat. And as a result of that, stock cover was actually significantly reduced during that period. We started seeing availability gaps. Within the U.K. business I was running, we were down to 6, 7 weeks of warehouse stock.

We were in a position where we had to start making commitments to buy stock for the future. And in particular, in the U.S. market, we make those commitments ahead of vintage and then the stock has to age. So there's a long supply chain that's behind some of those stock commitments.

And then during FY '22 growth began to slow. Availability started to recover as we started to bring more wine in, but the increased purchases started to land in the warehouse. And that results in FY '23 as we pivot towards profitability and through the actions we're taking, in particular, around reduced marketing investment, expecting growth to slow further. That is leading to an overstock position today. We are at probably peak stock right now at the end of October as we run into peak trading season. And we will steadily destock over the course of the next year, 12 to 18 months.

I think there's an important question to ask, which is why wouldn't you do this quicker? And it is a balance that we're trying to strike between the liquidity we have, the winemaker relationships that we have, which we wish to be enduring and are a critical component of our proposition. And actually, customer value. It would be a decision we could take to aggressively discount the stock we have, but we sell a range of brands which we have built exclusively to Naked over the course of many years. We don't wish to devalue those. And therefore, doing this in an orderly and measured fashion is the highest value outcome, we believe, for the business. And we'll see stock levels reduced from an estimate of around GBP 185 million at the end of this fiscal year to about GBP 40 million less than that by the end of fiscal year '24.

Moving on to the next slide. We've also given an update -- a very brief update on H1 trading today. I think it was important to give you this to put the plan in context and demonstrate how quickly we can deliver the changes to the shape of this P&L and how that has shaped up. In tough conditions, I don't think anyone would be surprised for us to say that consumer confidence is low. Inflation and costs are high. We have driven revenue growth at reported currency of 4% in the half. That is flattered by the translation of our U.S. dollar revenues in our biggest market into pounds. On a constant currency basis, the revenue growth was 3% for the half.

Interesting to note that in Q2, we saw better trends than in Q1. Q1 was still lapping some months where customer purchasing rates were elevated due to COVID. I think I said to one analyst last night or this morning, I don't remember which wave of which variant we were in. But certainly, in April and May of last year, we were seeing higher sales per Angel trends than we would have seen historically. But we think the revenue trajectory that we're on does demonstrate the resilience of the market and especially in the U.S. where the trends are better. The addressable market is higher. The U.K. is a more competitive and lower margin market, but still return to growth in Q2.

At the profit line, adjusted EBITDA for the half is expected to be GBP 4 million, still closing the books on that. But yes, certainly, you could see versus GBP 1.2 million of adjusted EBIT delivered last year, that is a threefold increase. And remembering that we pivoted towards this profit strategy during the half, I think it really demonstrates our ability to drive profitability out of this business and from our engaged customer base.

Nick mentioned some onetime charges. I expect to see onetime charges this year, predominantly in H1, that could be as high as GBP 12 million. We're still refining those calculations, and we'll have to work through the review process. Those reflect a combination of exiting bulk wine, exiting commitment to wine, but managing winemaker relationships and also the changes that we have made to the SG&A base and severance costs.

That will be offset to some degree by a profit we've made on disposal of the Majestic property that we retained post the transaction that was in the midst of a conditional sale process, and we have now completed the sale process on that freehold.

And so overall, that gives us a significant available liquidity. We've mentioned these numbers, but between the closing net cash and the credit facility, there's GBP 64 million of available liquidity as of the half year close date. We do expect to see some further outflows of cash in H2, reflecting the mix of inventory, payables and customer funds movements offset by the profitability in the second half. But expect FY '24 to start being strongly cash generative as inventory comes off the balance sheet and converts back into cash.

And that begins to speak to the outlook, which we've laid out on Page 6. We've given significant more detail on the outlook for FY '23, very mindful of the number of moving parts. Don't plan to talk through this line by line, but should enable people to update models and understand how we derive the level of profitability we're expecting.

Some changes in there in terms of adding in the RNS things like depreciation so you can get a sense of what the covenant position looks like. And FY '24 guidance has been kept high level, and around the cost lines, you'll see we are targeting flat G&A costs. There are different ways that we could see the top line evolving in FY '24, and we're not going to be drawn on which of those we think is most likely at this point. I think the overarching message to take from here is that with a full year of the operating changes we have made, we would expect adjusted EBIT in FY '24 to be stronger than FY '23. But the balance of which that comes through a revenue line supported by higher -- the high end of new customer acquisition or the lower end dropping through to enhance margins is still to be seen. But certainly, this is a business that can deliver profitability higher than that we're guiding to in FY '23 and FY '24. And that's an indication of the sustainability of the profitability that we're building in with the configuration of the P&L that we're operating in.

We'll obviously give more details in December with the full half year results around how that is developing and some of the facts behind how the H1 numbers have been delivered, which should answer additional questions regarding H1 at that point.

That is all we are planning to talk to in terms of the formal presentation part of this call. If we could flip over to the next slide, we're then ready to start Q&A. Please, operator.

[Operator]

[Operator Instructions] The first question comes from the line of Wayne Brown from Liberum.

[Wayne Brown, analyst]

Just a couple of questions from me. Firstly, just on inventory, maybe it would be helpful if you could break out inventory between finished goods and work in progress because, inherently, GBP 145 million still feels like a lot of inventory. And I know the U.S. is a winery, but maybe if you can just give a little bit more color as to maybe why that is the right level of inventory just to clarify that. And then on...

[Nicholas Devlin, executive]

Shall I take that one first and then we...

[Wayne Brown, analyst]

Yes. Yes, sure. Go for it.

[Nicholas Devlin, executive]

I think the important point here, as James emphasized, is that we believe an orderly reduction of our inventory levels from their current overstock position is the thing that's going to maximize value to the business when we balance off a consideration of, first and foremost, we have to make sure that we have sufficient liquidity.

And that needs to take into account the fact we're operating in a tough consumer environment. And so we need to look hard at plausible severe downsides. But beyond that, we want to maintain the value of our brand and the value of our winemaker relationships.

The second thing to draw out is the challenge we have here is very similar to a lot of other online businesses. We bought too much wine in 2021 when we thought we would grow faster. And so the balance of our overstock problem today sits in case goods that we have. Practically speaking, bottles of vintage '20 and '21 wine, primarily in our U.S. business, although we have some overstock in other locations.

In terms of the -- what does the right number look like, I think there's always a little bit of a range you could apply to this. It's hard when you're a manufacturing business that's selling product 2 or 3 years after you make a decision to ever land on a pin for your inventory number. But I think you'd say it probably is still a lower number than GBP 145 million. And from that, I think we would expect to see a further year of material cash generation from destocking of the business in FY '25.

We have though also been able to strengthen our business through some of the investments we've made into that inventory position. It's the best range we've ever had. You see our business in the U.K., winning a number of accolades and awards at Decanter recently. You see our business in the U.S. having its best ever range of premium luxury price point lines getting great traction in the market. So I mean there's a lot of things we've done there that are good, but we do have -- we have too much stock, and we need to manage an orderly reduction of that stock.

[Wayne Brown, analyst]

Okay. My second question is around the size of the customer base. If I'm not mistaken, you had about 900,000 odd customers across the group, end of FY '22 [ or at the end of September, ] right now? Or how big do you think the customer base will be at the end of FY '23?

[Nicholas Devlin, executive]

And so we're not guiding today to a specific customer number, although we will provide disclosure of the interim position with our results announcement when we get there. I think as James has highlighted, one of the things that we do expect as a consequence of this plan is that in the near term, sales will fall and active member numbers will fall, but we will have overall a business which is profitable and sustainably profitable.

[James Crawford, executive]

And Nick, if I may, I think I'd answer that, Wayne. The -- we're flagging that we expect active Angels numbers to drop. They will drop because the active Angels we will be losing will be those that we were recruiting through low returning activity. And therefore, it would be a sensible assumption to assume active Angels are likely to drop quicker than sales because we will be retaining the higher sales per Angel -- Angels. And that's a consequence of good investment.

[Wayne Brown, analyst]

Yes. No, absolutely. I was just trying -- obviously, the back end of that is just trying to figure out how big that business can be in the next 2 to 3 years after the reconfiguring.

I just wanted to ask another question on debt. Clearly, you're going to have an extra GBP 40 million of inventory this year. You got cash exceptionals coming through and you've got one-off costs, et cetera. Is it fair to assume that you're going to end up in a debt position at the end of FY '23? And if so, can you just give a little bit of guidance around that?

[James Crawford, executive]

Not providing specific guidance, but I think important to recognize that we are at peak stock now. We've ended H1 with GBP 22 million of net cash. And therefore, you need to draw your conclusions from that. But I don't believe that supports a net debt conclusion.

[Operator]

The next question comes from the line of Andy Wade from Jefferies.

[Andrew Wade, analyst]

Just 2 from me. The first one, Nick, you sort of talked about this being the right plan for right now. So just sort of interested in -- although there's obviously a lot to execute in this pivot to profit. It sort of sounds like you're leaving the door open to a shift back to growth one day. Sort of interested in your thoughts -- say, your thoughts on is the TAM still the TAM? And if the proposition is as good as you thought it was.

[Nicholas Devlin, executive]

Yes, Andy, absolutely. I think the reality is we've built the world's largest direct-to-consumer wine business for a reason, and that's what our model of connecting passionate, independent winemakers making great wine directly to consumers, delivers real benefit for both winemaker and consumer. We have wine makers doing what they love, making great product, not doing the stuff they're bad at, selling it, and building sustainable businesses. And you have consumers who are able to get better quality wine from a real person with a real story at better value.

And I think if you take a long-term view, whilst we called some of the growth rates wrong in 2021, I still believe that more wine will be bought online in 5 and 10 years from today than is today and that we're a beneficiary of a long-term secular trend of consumers wanting to understand where their products come from. Wanting to buy from people with a real story behind them.

So still very much believe that we have that opportunity. I think the business we've built in the U.S. remains a real differentiating asset for us. There, we do address the world's largest wine market and our vertically integrated production model delivers really high margins and makes our business exceptionally differentiated.

I think in terms of what that looks like, now is not the right time to be definitive about what growth rate and what time horizon with a lot of uncertainty in the world. But I think there are kind of 2 outcomes you could envisage. We believe that we should be able to return as conditions normalize to a level of growth which is sustainable and balanced with achieving still a degree of profitability. If that is not the case, for whatever reason, then we would seek to make sure that the business is to remain at this scale that it is a more profitable business, i.e., a higher EBIT margin business than we have today. And so they are the 2 kind of longer-term outcomes I would envisage.

[Andrew Wade, analyst]

Yes. Okay. All right. And then I guess, somewhat linked to that. There's some sort of -- if you could just talk around some of the key factors that over time will be reversing out of your repeat contribution? Because I mean we've got things like the elevated logistics costs, excess warehousing and so on. And if you're going to be running the business at sort of 2, 2.5x 5-year payback and then some of those reverse out, you will end up sort of mathematically ahead of those levels, won't you?

[Nicholas Devlin, executive]

You're right to say that there are some things weighing on our contribution margin today that we think are not necessarily enduring. In particular, where we have excess inventory levels, that directly leads to elevated storage costs and that weighs on variable costs.

And certainly, we have seen some cost inflation, particularly in logistics, getting wine from its point of production to our warehouses and then getting it from warehouses to customers. Now I'm mindful of the airline industry where fuel charges got introduced and never went away. So I don't want to promise or commit that those are onetime and transitory in nature, but we'll certainly be working hard to see if we can unwind some of that.

I think the other side of that equation is that we believe our business remains very differentiated. And especially if you look to our business in the U.S., where we operate as a producer, working hand in glove with talented winemakers to make wine. I think those -- we've seen that there's a lot of value and equity in those brands, and that gives us a degree of pricing power. So there are -- I think we can look at both sides of that to look for some medium-term margin expansion.

And you're right, to the extent we can do that, which is what traditionally we have been able to do. If we strip out FY '22 and look over the long term, that expansion of contribution margin has been something we've done consistently, and it has been one of the reasons why we have tended to progressively upgrade paybacks over time.

[Operator]

The next question comes from the line of David Reynolds from Davy.

[David Reynolds, analyst]

I just have a couple of quick questions for you. First one, just hark back to the 18th of August RNS and your new LTIP scheme. There was a name there, Lucy Devlin, which was a person closely associated with you, Nick. Could you just explain what the relationship between Lucy and yourself is?

[Nicholas Devlin, executive]

Lucy is my wife.

[David Reynolds, analyst]

Got you. Wicked. Thank you. So we got another RNS, I think, in September with regard to the joining then the relatively rapid departure from the Board of the guy from Punch Card. What happened there?

[James Crawford, executive]

Happy to take that one. Look, ultimately, the decisions Pratham made are kind of questions for you to ask Pratham and I'm not going to seek to speak on his behalf. But I think what I can say is that I believe the plan we've outlined today is very much the right plan for Naked in the current consumer and economic environment and that in taking measures to reinforce our liquidity, address the issues that have been raised around the previous structure of our funding facility in particular and deliver a pivot to profitability and a reduction in our costs, we're addressing a number of issues that we have discussed with Pratham in his capacity as a Board member and issues we've discussed with shareholders. So I believe we've got a plan that addresses issues that he has raised.

[David Reynolds, analyst]

Super helpful. And then just last one for me. So just looking at net cash and liquidity going forward. I think at the end of fiscal year '22, you disclosed, I think, GBP 72.2 million of Angel funds as a liability on the balance sheet. How critical will Angel funds continue to be in terms of working capital management going forward?

[Nicholas Devlin, executive]

I'll take that one. Fundamentally, our business model is that we take Angels who support winemakers and use the money they subscribe to their accounts to fund winemakers, which means buying inventory from them, which sits on the books. So Angel funds will always be a part of the working capital cycle in this business if we're going to undertake the mission that we tell our Angels we're undertaking.

I think quite often, these questions are triggered by what does it mean in terms of redemption rates. I think it's worth saying versus long-term averages, Angel fund redemption rates are currently low. In fact, they've been some of the kind of lowest weekly rates as a percentage of the balance that we've ever seen. And therefore, we remain confident that it is right for us to do what we say we do for Angels, which is to take their subscriptions and use them to fund winemaking.

[Operator]

Our next question comes from the line of Anubhav Malhotra from Liberum.

[Anubhav Malhotra, analyst]

I've got 3 questions, I think. Can I ask you, firstly, you have been investing in brand marketing, particularly in Australia as an experiment. What does the reduction in the marketing spend mean for the brand marketing investment? Are you going to continue that in Australia and try it in other markets? Or has that project been shelved for now?

[Nicholas Devlin, executive]

So we're not going to get into detail around the investment mix by channel for today. We will talk a little bit more about the operational impact of how we'll be delivering the overall marketing expense when we get to the interim results. What we can say is in terms of how we've guided, we don't intend to have a separate R&D marketing line moving forward into FY '24. So to the extent we continue any of that activity, it will be reflected and included with our other new customer investment expense.

[Anubhav Malhotra, analyst]

All right. And then secondly, can I ask on the FX contribution, you gave a good view on what it means for the sales line. But what would it mean for the adjusted EBIT guidance of GBP 9 million to GBP 13 million, how much is contribution from FX translation from the U.S. pound -- U.S. dollar to pound?

[Nicholas Devlin, executive]

I don't think I have that number to hand. I'm not going to try and do it with mental arithmetic. It's not that straightforward, but very happy to get back to you one-on-one and see what I can -- see what I can share with you on that. Sorry.

[Anubhav Malhotra, analyst]

All right. Great. And then just one last one. The strategy that you are putting out today for -- especially for FY '24 sounds very similar to what you gave out when you tell us about your standstill EBIT number for FY '22, for instance, where you said it could be as high as GBP 27 million. So is GBP 27 million right kind of number when I think of [ FY '24? ]

[James Crawford, executive]

The way that I would think about that, I think we gave 2 presentations with standstill EBIT at the end of the financial year. There was a kind of 3-year average, and there was a kind of current trends. I think on the current trends, there was a 6.1% EBIT margin. I think we'd certainly say that the guidance we've given, which is a 2% to 4% adjusted EBIT margin in '23 and only improvement into '24 would support that, that standstill EBIT margin is entirely viable.

[Operator]

Our next question comes from the line of Wayne Brown from Liberum.

[Wayne Brown, analyst]

Just with regards to an article that I read that, I think from one of your buying directors that there are gaps in your ranges and that you're typically going to be going into old world wines and buying some wines in the normal fashion of buying inventory outside of the realms of the Naked Wines model.

And I was just wondering if that's going to be -- how big that's going to be and how important that is for the strategy going forward. And then if you don't mind, just for my benefit and Anubhav's, could you repeat the question with regard to the standstill EBIT? Because I also kind of missed it.

[James Crawford, executive]

Okay. Let me repeat the standstill EBIT. So FY '22 results, there were 2 standstill EBIT counts in either the presentation or RNS -- I don't remember which. One was a kind of 3-year average metric, which, if I'm honest, includes kind of COVID quirks in those metrics, one was in the last 12 months. The last 12-month calculation came out to standstill EBIT margin, I think a fraction over 6%. If you take our FY '24 guidance, which is to say that margins will improve versus FY '23 and the FY '23 guidance of 2% to 4%, I think you can certainly see at the top end of that range, that the margin guidance and the standstill number for FY '22 begin to converge. Nick, do you want me to maybe talk about the range, given it's kind of U.K.-centric or do you want to do it?

[Nicholas Devlin, executive]

You go for it, James.

[James Crawford, executive]

Yes. So I think you're referring to some comments from the U.K. buying team in particular that we have been broadening the range. That is work that remains kind of a test in the U.K. What our research has told us is that because Naked has historically focused on, I guess, less traditional wine areas, there are a set of addressable customers who believe that the range can't be reflective of their tests. So we are buying small quantities of stock from some more traditional areas in a supportive Naked way with relationships with winemakers to test whether or not that breaks down some of the barriers to what we would see as more traditional customers engaging with Naked and discovering a better way to buy wine. It's not a material outlay in terms of stock at this point, and it is a hypothesis we are testing to see whether it makes a difference to wider access and recruitment.

[Operator]

The audio questions are now concluded. We will now take questions from the webcast line.

[Unknown Attendee]

Our first question is from [ Edward Gordon ]. How large will the U.S. business need to be to have its inventory fully funded by suppliers and Angels versus equity as the U.K. and Australia business are now? And what would it take to get there?

[Nicholas Devlin, executive]

Thank you, I'll be happy to talk to that. First of all, it's not primarily a question of size, it's a question of ratio. And ultimately, in the U.S., we typically would expect to have a degree of funding requirement beyond the amount of money we hold from our members and the working capital benefit we have of payments due to suppliers. It's important to put that in context. I think if we have a right-sized level of inventory in the U.S., that still looks like a fairly moderate amount of funding requirements, and so still a pretty efficient balance sheet there.

And I think it is not a certainty that, that needs to be funded by equity. I think as James talked through, one of the roles that we would see good asset-backed financing playing over the medium term for the company is giving us a more attractive alternative to equity financing, in particular, for in-year movements in our working capital cycle or to the extent we need to provide for additional working capital at points where the business is growing faster and [ menthol ] stock requirements grow.

I think the other thing that's important is to remember that the benefits we get to having that differentiated production model in the U.S. is we're able to capture multiple tiers of margin, and that's at the root of why we're able to see repeat contribution margins approaching 40% in our U.S. division. That's the core of why we have a particularly valuable asset in our American business.

[Unknown Attendee]

Our next question is from [ Nick at Local Cap ]. When do you think Naked Wines will focus on 20% plus growth rate again?

[Nicholas Devlin, executive]

And look, I think there are a couple of important things to say here. Right now, our focus is very clear. It's on making sure, number one, that we restore and rebuild liquidity in the business to make sure we are absolutely resilient to any potential scenario in terms of consumer behavior.

Beyond that, we're very much focused on delivering profitability and sustainable profitability over the course of the next 2 years. I think beyond that, we very much believe that the Naked model connecting independent winemakers to customers is a better approach than "business as usual" in the wine industry, and we believe there's a large addressable market out there that we can grow into.

I think what is not helpful and I think something that with the benefit of going through the last 12 months we concluded is anchoring on a specific growth number is not helpful. It doesn't support us making good capital allocation decisions. And so we don't intend to be particularly focused on getting back to a certain level of top line growth. But what we can say is we're committed to 1 of 2 things. Either as the environment normalizes, we'll have a business making a moderate amount of profit and delivering growth or if we're not able to do that, then we'll have a business delivering much higher EBIT margins than we're seeing today. Either way, that should be a business that's growing its intrinsic value.

[Unknown Attendee]

Our next question from [ Patrick Smith. ] Could you talk a little bit about your inventory and what it means by qualifying inventory in terms of your credit facility? And how is inventory impacted by price increases, if at all?

[James Crawford, executive]

Yes, I'll take that. So our qualifying inventory is just a description of the way the facility agreement works. The facility is secured on inventory. Understandably, the bank don't say, well, your books tell us the inventory is worth 100, so here's 100. They look at that inventory and they do a calculation about where is the inventory? Is it stuck in transit? Is it in a site where a site operator has offered the right paperwork, which demonstrates the banker could come and seize it if they needed to? It does a calculation about the age of the inventory and applies different discounts to Reds and Whites based on that.

There's a whole bunch of factors that they factor in where they kind of go from a gross inventory number on the books to a net borrowing base based on those qualification criteria. I can't explain all of them. It's a big calculation we do every month for them. But hopefully, that gives some flavor as to how they think about inventory qualifying towards the borrowing base.

In terms of how inventory is impacted by price increases, I'm not sure whether this means on the kind of cost side and the borrowing base. So the borrowing base calculation starts with what we've paid for the inventory. So to the extent to which there are cost price increases on inventory, it will provide a bigger borrowing base before those qualification calculations are done. To the extent to which you're talking about consumer price increases, we're not a fully inelastic business. That would be the dream.

So to the extent to which we put up prices and that will slow volumes of sales but generate higher revenues, obviously, it means the inventory outflows reduce slightly. Hopefully that answers the question.

[Unknown Attendee]

Our next question is from Andreas Aaen. Q2 constant currency growth of 4% improved a lot, but full year constant currency growth is set to be a lot worse in H2. Where does the deceleration come from? Is it mainly lower new sales or also worsening revenue retention from repeat customers?

[James Crawford, executive]

So let me take this. I think, yes, important to probably kind of stress Q1 has some COVID behavior in the baseline. Q2 is a little bit of bounce back from that. I think as you kind of head into Q3 and Q4, you begin to see lower revenues really showing in the P&L that come from both slower new customer recruitment, right? We don't yet have a full quarter where the revised strategy of lower growth investment is seen. And then over time, you get the compounding effect of that, whereby the low payback Angels that you were generating would still have been generating some repeat customer sales. So you begin to see the, what I'll call, the impact of the bad investment dropping out of the revenue line over time.

[Unknown Attendee]

Another question from Andreas. Should we see any risk on this elevated inventory, bad wine, bad grades, et cetera, that would lead to further write-downs of inventory?

[James Crawford, executive]

I would like to think I am one and done on inventory provisioning.

[Unknown Attendee]

Final question from Andreas. While the cost reduction is in progress and the right direction, G&A as a percentage of revenue is still elevated in FY '23 and '24 compared to FY '19 to '22 levels. Does not seem there is any real cost reduction.

[James Crawford, executive]

Nick, do you want to take that one in terms of the mix of the cost base and where reductions have come from and what we think the right position is?

[Nicholas Devlin, executive]

Yes, absolutely. So Andreas, I think in our mind, we've been looking to get the cost base to the right position to support the business we're operating today at substantially larger scale post pandemic and in a much more expensive operating environment than we were in before the pandemic. We have -- in the context of that, faced in common with a lot of other businesses, a lot of costs have increased for us -- the cost of employing people, some of the other parts of our cost base. So I think in real terms, actually, the progress looks a little more than it does in nominal terms.

What I can be kind of clear about is that the cost base we've got to gives us space in our plan to deliver both meaningful profitability and the scope to invest enough money to see if we can grow the business again. And I've been pretty clear on the fact that there are 2 possible longer-term outcomes. Either we can have a business that has some profitability and some growth, or if not, we need to have a business with higher margins. And in that second example, we would definitely need to look again at how we operate, and we would need to deliver a lower cost base than we have today.

So that's the approach that we have as a team and that's the way we are working. I think the other thing I'd say is having James back in the chair, I think it's given us a good opportunity to look at some of our operating principles, and we're very much committed to making sure that any future cost growth, whether that's inflationary or otherwise, has to be delivered after increase in revenue as opposed to in anticipation of it.

[Unknown Attendee]

Our next question comes from Thiago at Granular Capital.

Given the long lead time needed for local winemakers to produce for Naked, wouldn't you say that the business model will always face imbalances as by definition you cannot predict when the market will pick up again? Shouldn't it be the case that the Naked portfolio should also adapt to a more volatile customer backdrop?

[Nicholas Devlin, executive]

With respect, Thiago, I disagree on this one. I think the model we have is the true point of differentiation for Naked Wines. It not only delivers benefits for producers, it gives us a point of difference in the market and it delivers for consumers better wine at better value. And in particular, looking at the U.S., it's the reason why we can build a business with contribution margins approaching 40%. If we moved to a more retail sourcing model, we would also see margins in common with a retail type business, probably in the 15% to 20% range. I think that would be a much less attractive business.

So from our point of view, the focus is on how we manage the risk that you highlight, which is it will always be difficult to have exactly the right level of inventory when you're making commitment a degree in advance of when we sell.

And there, I think the work we're doing is actually developing some better levers to control that. So whilst it wasn't our intent, we've developed capability around bulk wine sales, often selling bulk wine at a profit, reflecting the fact that we have good sourcing and add value to our products. As James pointed out, over the medium term, asset-backed lending is a great way to manage some volatility in your level of stockholding. So I think the solution here is making sure we manage that effectively as opposed to giving up our differentiation.

[Unknown Attendee]

Next question from Ben Hunt at Investec. Sales have recovered in Q2. Are there signs of payback starting to improve as well?

[Nicholas Devlin, executive]

Ben, yes, we've pointed in the materials to an improving trend on payback in Q2, and we'll give more details when we report our interim results.

[Unknown Attendee]

Next question from James Gilbert at Argon. Can you please talk a little bit about how you're going about promoting the value of the Naked Wines offered to the consumer and how you're leveraging the star power of your stable winemakers in terms of the broader brand recognition?

[Nicholas Devlin, executive]

James, I think today, we're going to keep this fairly focused on the overall plan that we're delivering. A good opportunity when we go into the interim results to dig a little bit deeper into some of the marketing tactics.

[Unknown Attendee]

Another question from Thiago at Granular. If Naked goes through a 3-year plus period of destocking, how can you keep the relationship with the local winemakers if you arguably buy materially less marginal wines from them?

[Nicholas Devlin, executive]

I think here the answer, Thiago, is that Naked remains a powerfully differentiated proposition for winemakers. Even at lower volumes, there are not alternatives out there that are offering the combination of security, an opportunity to do what you're truly passionate about -- making wine as opposed to selling the wine and doing the business side. A chance to build a brand and make the products that you really want to make and a chance to earn a good income alongside doing that. And actually, whilst these conversations are always tough, the way you build and solidify good long-term relationships is showing your character and your approach in the way you engage with and deal with people in difficult times.

Everyone can be a great business partner when everything is going right. So I firmly believe that while yes, will have challenging conversations with wine makers, we'll come out of this with those relationships strengthened. And I think in an environment -- consumer environment, which is likely to be tough, the reality is normally what happens is routes to market access and opportunities for small independent brands get squeezed. And I think in that context, Naked becomes more vital than ever.

[Unknown Attendee]

Another question from Ben Hunt. Beyond the near term, with new customer investment at circa GBP 20 million, can that actually grow the active customer base? Or does it merely replace those churning?

[James Crawford, executive]

I'll take that one, Ben. So the range we've guided to for '23 is GBP 20 million to GBP 24 million. I'll try to explain this, maybe it's a nuanced point, but kind of within that range is probably a range of outcomes from FY '24 seeing stable sales to some growth versus potentially a bit of decline, but higher profitability into '24. So the answer is, you can within the range we've given, grow the sales base -- at the very least, hold it flat. Whether or not we're able to do that because of the investment economics we can achieve with that money is the question and the reason that we're staying rather coy about how we're guiding to the kind of top line in '24.

[Unknown Attendee]

Next question from [ Claire Shaw ]. How are you managing the impact of duty changes expected in the U.K. this February?

[James Crawford, executive]

[ Claire, ] historically, in the U.K., duty has been passed through pretty quickly to the consumer. So we will, as always, watch what's happening across the market and do what we can to protect margins whilst continuing to offer good value to customers.

[Unknown Attendee]

Next question from [ Jack Ailing. ] There have been a number of changes in the Board composition, both today and over the last few months. Nick, as the person that oversaw the strategy and ultimately the taking out of the original facility, why are you still the right person to run the business?

[Nicholas Devlin, executive]

[ Jack, ] happy to talk to that. I think I've been clear that as a team and personally, I take responsibility, we did get some things wrong through the course of 2021. I think today, what we've unveiled is a clear plan to directly address those issues and put Naked on a really secure footing with very strong funding and a clear plan to deliver meaningful profitability.

I strongly believe that I'm the right person to work with James and the rest of the Board to deliver that plan. And also if you look to the long-term future of this business, the position we've built in the U.S.A., which is a business that I've been directly involved in running since 2017 as the leading direct-to-consumer wine business, I think, is a massive strategic asset for the company, and I'm really committed to sticking around and seeing that through.

So we've had to make some hard decisions over the course of the last 6 months. And certainly, that kind of weighs on you personally -- it weighs on me personally. But I come out of that very resolved that we've got a great business, and it's delivering real value for consumers and winemakers, and I'm committed to delivering on its potential.

[Unknown Attendee]

Our next question from [ Simon Corfield. ] Thinking about the bigger picture, something is a bit odd. In the U.S., Naked can deliver wines to consumers at a big discount to the market price, given the inefficient industry supply chain. Yet you say that you can't grow the business in the next 2 years or so. Are you sure that the Angel subscription business model isn't constraining potential growth?

[Nicholas Devlin, executive]

I think it's important here to set a few things in context. What we're guiding to today is that we cannot definitively promise a level of growth over that time horizon. And I think we do need to be realistic about the environment we're operating in, consumer confidence at 20-, 30-year lows, inflation rates hitting double digits at a high level of cost price inflation. All of that means it's a tough environment for all online sellers, and it's a tougher environment for online sellers in the wine category. And you look to the largest online wine retail pure play, wine.com it looks like it's seeing revenue decline 20% to 30% from its pandemic peak.

So I think Naked's performance needs to be seen in that context. What we are clearly saying is we will be disciplined about the choices we make in pursuit of growth. And to the extent that there are good investment opportunities there that allow us to return to growth sooner, absolutely, we'll take them. But I don't think it will be appropriate or responsible for us to make a specific promise at this time.

[Unknown Attendee]

Time for our final question from . What has been the operating impact of higher glass recycling costs in the U.K.? And what are your thoughts on the U.K. alcohol duty review to be implemented in February?

[James Crawford, executive]

I'll take that one with my U.K. MD hat on. Higher glass recycling costs are one of many inflationary factors in us getting our products to market. We've done a lot of work in the U.K. light-weighting bottles. We've taken significant weight of glass out of our supply chain by doing that. Quick plug: the Decanter green award a couple of weeks ago is a result of some of the work we've done doing that. But it is another cost driver that is weighing on margin and LTV that we are using our own strategies to overcome.

In terms of the U.K. alcohol duty review, I think there's 2 things. There's the duty increase, which has now been put kind of back on the table, but a bit of a hokey cokey, which I think I've already addressed in an earlier question, there is a broader review of how alcohol is taxed and duty rates for wine that we've been working with the WSTA Trade Association on. It is, in our opinion, overly complex and difficult to implement and does not need to be so. However, we're still awaiting the final reckoning on how that will go live. It will add complexity and in all likelihood, cost to the consumer if it goes through in the way that it is currently configured by the government.

[Operator]

That's all the time we have for questions today. Time for closing remarks. Go ahead.

[Nicholas Devlin, executive]

Thank you very much. And just to acknowledge, I think there were a couple of individual questions that we've not gone through solely from the fact that we feel like we've covered those remarks in other questions either through the teleconference line or submitted here.

I just want to close by restating that, as a team, we're very excited to get this revised operating plan out into the market. I think the work delivered, and in particular, some of the work that James has helped us deliver over the course of the last 3 months, sets Naked up very well in an uncertain environment.

We have really strong funding position for the business with about GBP 64 million of liquidity available. We've got a clear plan to profit, which is evidenced in the results that we've highlighted from the first half with delivery of real profitability. And we've taken tough but necessary decisions to get our cost base under control and to put in place a managed orderly reduction of our inventory levels. I want to thank everyone for their engagement and their questions. And we look forward to getting a chance to talk to many of you again over the course of the coming months. Thank you very much.