Earnings Transcript for HFG.DE - Q3 Fiscal Year 2024

Operator: Good morning, ladies and gentleman, and welcome to the HelloFresh SE Q3 2024 results. At this time, all participants have been placed on a listen-only mode. The floor will be open to questions, following the presentation. Let me now turn the floor over to Dominik Richter, CEO of HelloFresh.

Dominik Richter: Good morning, and welcome, ladies and gentleman to our Q3 earnings call. After we've pre-released our headline numbers last week already, we would like to focus today on giving some additional color on our recent marketing strategy changes and share some more details on the respective performance of our two largest product groups, meal kits and RTE. For all direct-to-consumer companies, marketing and advertising constitute a large investment area with both near-term and long-term impact to both growth and profitability. This is because direct-to-consumer companies like us cannot rely on foot traffic to their stores nor halo third-party brands driving customers to the site. After we've talked a little bit about our drive to lower cost in our fulfillment network and through operational streamlining in the most recent calls, we would like today to spend a few minutes to share some thoughts on the fundamental shift in our marketing strategy we have initiated over the last six months. These tend to work their way somewhat quicker through the P&L than, for example, site rationalization or operating model changes, and we did see some early signs of success in Q3 already. In the last few years, we have perfected the marketing playbook to penetrate early-stage growing markets that are early in their adoption curves in a very effective manner in different industries, from meal kits to RTE to most recently pets or premium butchery. However, given that we expect no strong near-term growth in the meal kit category, we set out to build the muscles to optimize our marketing budget for long-term brand strength and a different market maturity as we want to consolidate the meal kit market around a new size and drive higher profitability and cash flow generation as a result of it. This has led to a number of fundamental changes to our approach. Whereas we have tried to maximize growth in under-penetrated markets at low ROI thresholds before, we are now focusing increasingly on maximizing the overall marketing ROI. It is important to note that our marketing budget has always been successfully spent to generate positive future ROI in aggregate. However, in a world where the future category might be somewhat smaller than initially expected, it is important to generate strong ROIs today. We have adapted by prioritizing to win over high-value customers with strong customer lifetimes over considering market share versus competitors as a primary input metric to our marketing mix. Further, rather than focusing on generating the largest pool of first-time buyers, we will increasingly focus on improving overall brand metrics and brand strength to the benefit of the whole customer base. That means focusing our marketing efforts to simultaneously drive first-time purchase of high-value customers, drive usage of existing customers and re-engage formers. One important avenue to do so is pivoting our incentive strategy from primarily using monetary incentives to relying more on product incentives which benefit the whole customer base and are beneficial toward long-term customer tenure. We aim to bring this strategy to life in a data-driven and disciplined approach across the whole funnel from awareness to consideration, trial, usage and reconnecting formers with the product. We have started to shift some of our overall budget into brand and content investments in the recent back-to-school period and saw a positive impact on brand recall and brand desirability. As we continue to drive an ambitious product innovation roadmap, we plan to talk more about new and recently launched product features. In a category where brand awareness is high, we will benefit by showcasing our product to both prospects and existing customers and make them aware of news to our product portfolio. Our direct-to-consumer platform, which has been developed and optimized over many years and constitutes one of our strongest assets, will help us to convert prospects into buyers at favorable and industry-leading customer acquisition costs. Recently, we have tweaked our ROI thresholds and started to turn away low-intent audiences through cutting back on incentives and taking a much harder stance toward borderline fraudulent customers' behavior, such as multiple accounts per household. Finally, we want to have a strong focus on our tenured customer base to increase their retention and order frequency and as a result, improve overall marketing ROI. This entails improving the service levels we provide through real-time information of where the order currently sits in our supply chain, proactively informing customers of any potential issues with an order, and providing better customer service through self-serve tooling and Gen AI. In addition, we've upped the pace on product innovation and will meaningfully increase the number of meals on the menu, the cuisines featured every week, and the options to customize your order. While we have driven significant change already in ’24, ’25 will see acceleration on our product innovation efforts unlocked by new manufacturing solutions and increased productivity. Finally, we have started to test into our loyalty program Hello Fresh PLUS, which will roll out to the majority of our meal kit customer base globally over the course of 2025. While it's too early to share quantitative results, test user cohorts have shown high customer satisfaction with the program and we're eager to expose more of our base to Hello Fresh PLUS. The combination of all of those factors should lead to higher customer satisfaction, ultimately better customer retention and a clearer understanding of the value we provide. This should result in a more loyal and more profitable customer base and will increase the returns on our marketing ROI. As it remains early days, we have grown confident that we're on the right track and will add the muscles of marketing in a mature market environment to our playbook going forward, benefiting the group and all its entities as a whole. With that, I'd like to point your attention back to our most recent quarter where we could see some of these developments already play out. I'll start with the highlights. Q3 turned out to be a robust quarter against the lowered expectations we provided earlier in the year. We're early in our quest to meaningfully expand EBITDA, EBIT and free cash flow but have seen some promising signs in Q3 that we're on the right track. We did generate revenues of over €1.8 billion in line with expectations and constituting a year-over-year growth rate of about 2% in constant currency. Revenue growth has been primarily driven by an increase in AOV to €66.2, a 3.8% year-over-year growth rate. We saw good marketing efficiency following our shift in strategy that I just elaborated to focus on high-value customers and brought marketing expenses down both on a relative and absolute basis for the group and more forcefully for our meal kits product group. As a result, we expanded absolute EBITDA to over €72 million for Q3 with an EBITDA margin of 8.5% for meal kits and 1.3% for RTE. As a result, we have also generated free cash flow of about €30 million in the nine months year-to-date and expect to increase free cash flow for the year further based on improving marketing efficiencies and lowering our cap expense for the remainder of the year. Taking a look at orders. And our existing customer base has shown quite robust trends here as well, with order rates and customer retention up year-over-year. That was, however, not enough to offset the considerably smaller number of new customers we saw in meal kits, and as a result, total orders for the group shrank by 1.9% year-over-year, from 28 million orders in Q3 ’23 to 27.5 million orders in Q3 ’24. AOV, on the other hand, had continued to improve in the most recent quarter, increasing by 3.8% in constant currency. This was driven by both regional segments, North America and International. North America increased by 4.3% year-over-year, International by 3% year-over-year. The difference between the two mainly stemming from a higher contribution year-over-year from RTE to the overall mix in North America. Both segments, however, continued to see favorable trends in AOV through the uptake of larger baskets following our menu choice expansion and the introduction of new product concepts that come at an extra price tag. Putting that all together, our overall group revenue is expanded by 1.9% in constant currency versus the prior period one year earlier with our regional segment, North America, contributing 2% and International at 1.7%. More interestingly, when looking at product groups, you notice a very different trend for meal kits and RTE. While RTE continued on its strong growth trajectory and posted growth of just shy of 40% year-over-year in Q3. The meal kit product group was down by 9% in the same period, following the strategy change in meal kits marketing, a shift of our budgets more forcefully into the RTE product group and consequently, a much lower number of new customers joining our meal kit brands in Q3. With that, I'll hand over to Christian to walk you through our cost lines.

Christian Gartner: Thank you, Dominik. So let me turn now to our contribution margin. Our contribution margin is still down year-on-year in Q3 by 1.3 percentage points. However, the delta to last year is sequentially reducing due to, number one, a gradual improvement of productivity in ready-to-eat, which we are quite confident will continue in Q4. And secondly, continuous productivity improvements in meal kits, especially in our North America business. This positive trend is somewhat offset by the ramp up expenses of new meal kit fulfillment centers in Germany and the UK, as we had discussed on prior calls. From a seasonal perspective, we expect a normal sequential expansion in contribution margin as we go into Q4. Let me now turn to our marketing expenses. Marketing spend is for the first time down this year, both in relative as well in absolute terms. This is a continuation of the trend, which I described on the last two calls. We apply strong ROI discipline on our marketing spend, and Dominik had gone through the details a few minutes ago, which means that we acquire fewer, but on average, higher value customers. When you look at our underlying product groups, we continue to acquire a lot of new customers in ready-to-eat, where revenue in Q3 is up by 40%. This means for that product group, absolute and relative marketing spend is up year-on-year. In meal kits, where overall new customer acquisition activity is going through a normalization phase, absolute euro spent on marketing, as well as marketing as percentage of revenue is down year-on-year. And then the sum of those two means down for the group, both in absolute and relative terms. For Q4, we target to maintain our marketing efficiency, and other than last year, we’ve not spent against the seasonally weaker trend in the second half of the quarter. By year, we are okay to accept slightly lower revenue compared to last year, but at a sustainably higher profitability level. Let's now have a look at our Q3 EBITDA. We have delivered an AEBITDA of €72 million in Q3, slightly higher than last year, and also higher than our initial expectations. This was effectively driven by both good ops performance and therefore a decent contribution margin, and secondly, good marketing efficiency as we have just gone through. After the first nine months, adjusted EBITDA for the group stands at €235 million, which sits well from our perspective versus our EBITDA guidance. Let me now dive into our two product categories, starting with meal kits. We achieved a higher EBITDA margin and a higher absolute EBITDA in this product group. This is primarily driven by the focus on our marketing ROI. Contribution margin is a touch lower for meal kits than last year, driven by the factors discussed on prior calls, i.e. the temporary impact of volume deleveraging and initial ramp-up costs of more automated trials in Germany and the UK. However, we are taking active steps to offset these effects, and therefore, while at the beginning of the year, we were targeting actually a one percentage point compression in AEBITDA margin and meal kits this year from 9% to 8%. At the moment, we are more trending towards maintaining that 9% margin for the full year. Let's now also talk about our ready-to-eat product group. Ready-to-eat in Q3 ended up slightly better than break-even, a touch better than what I indicative envisaged on our last earnings call. Keep in mind that the comparative last year period does not yet include the impact of the new production capacity ramp-up, which started in Q4 last year. We therefore feel pretty confident to deliver a mid to a higher single-digit AEBITDA margin in Q4 in ready-to-eat already, versus a negative AEBITDA margin in Q4 last year, i.e. from Q4, you should see the profitability pattern switch, i.e. this year's period then better than last year's period. Before we talk about our cash flows, I would like to briefly also discuss adjusted EBIT. Other than adjusted EBITDA, our adjusted EBIT in Q3 is actually down year-on-year from €14 million to around about €7 million. This is driven by higher depreciation and amortization this year, which increased by roughly €10 million year-on-year, excluding the effect of impairment. Going forward, we want to actually put more emphasis on adjusted EBIT. As adjusted EBIT is a better KPI to take our capital efficiency into account. So, given that adjusted EBIT and free cash flow are the KPIs we want to maximize in the long run, we will also more regularly guide and comment on these metrics from 2025 onwards. Let's now have a look at our free cash flow. Our free cash flow in Q3 was negative by around about €20 million, which results in a year-to-date free cash flow of positive €30 million. This is approximately €50 million lower than last year, driven by, on the one hand, lower AEBITDA by roughly €100 million year-to-date and less favorable working capital movements, which is largely offset then by lower CapEx. In the first nine months of 2024, we have spent €130 million on CapEx. For the full year, we have trimmed our CapEx plans further and also shifted some into 2025, which means that we're targeting now for 2024 overall, come in at low €200 million of CapEx versus the €230 million to €240 million that we had discussed before. I would now like to talk about our narrow guidance for the full year. After the first nine months of this year, our constant currency revenue growth stands at 2%. As we discussed a number of times on this call, we want to maintain our strong focus on disciplined marketing spend also in Q4. This means that we intend to spend less on marketing than in the same quarter of last year, especially in the latter half of Q4, when customer acquisition environment is typically seasonally less attractive. As a consequence, we reduce our revenue growth outlook for 2024 on a constant currency basis from previously 2% to 8% to now 1% to 1.7%, i.e., we're indicative planning with a slightly negative constant currency revenue growth in Q4 for the group. Also, please keep in mind that the US dollar so far has been weaker in Q4 compared to Q4 last year. Q4 last year, the average dollar was, dollar to euro was 1.075 versus in October, we've seen a dollar fluctuating between 1.085 and 1.12, i.e., if that pattern continues, a softer FX rate that would impact euro-reported revenue growth for Q4 as well. Now let's talk about AEBITDA. Given our strong AEBITDA in the third quarter of 2024 and our continuous focus on marketing efficiency, we raised the lower end of our AEBITDA outlook by €10 million, i.e., the narrow range is now €360 million to €400 million compared to an analyst consensus of €361 million before we pre-released our Q3 results. After the first nine months, we sit at an AEBITDA of €235 million. This implies an indicative AEBITDA range of €125 million to €160 million for Q4 compared to €114 million in Q4 last year. Lastly, I would like to conclude with a qualitative midterm outlook. We will only provide a quantitative outlook for 2025 together with our full year numbers on March 13. However, I would like to already give you a qualitative picture of the key levers through which we are confident to drive both profitability and cash flows into next year and beyond. From a contribution margin perspective, we are targeting an expanding contribution margin driven by labor productivity increases across both of our product groups, meal kit and ready-to-eat, supported by further production side rationalization within meal kit. In marketing, we are targeting to maintain strong ROI discipline on our marketing spend as you've seen come through in our Q3 numbers already. On top of that, we are starting to benefit from a bigger existing customer base on the ready-to-eat side. On G&A, we are targeting to achieve further overhead and G&A savings, which should bring absolute G&A expenses down further next year. Then lastly, on CapEx, we at maximum are targeting CapEx of around €200 million before 2025 and see the opportunity to bring this down further thereafter as we are overall well-prepared in both product groups to largely address future demand out of our existing infrastructure. I'm looking forward to provide you more, also more quantitative detail on our earnings call in March. Also, we want to dive into some of these levers here, in more detail at our Capital Market Day, which we are planning for the end of March. But for now, we look forward to your Q3 related questions.

Operator: [Operator Instructions] And the first question comes from Luke Holbrook, Morgan Stanley. Please go ahead with your question.

Luke Holbrook: Good morning, everyone. Thank you for being clear on the marketing strategy shift. I just wondered, how should we think about the normalization here in the meal kits? In other words, when should we expect it to have stabilized revenue trends? Thank you.

Christian Gartner : Luke, its Christian here. So there are no changes to what we had discussed in the past, i.e., we still are planning for negative growth in meal kits next year, and we'll see a greater stabilization thereafter.

Luke Holbrook: Understood. Thank you.

Operator: And the next question comes from Sven Sauer, Kepler Cheuvreux. Please go ahead with your question.

Sven Sauer: Yes, hello. Good morning. Thanks. My question is on the customers. You mentioned that you now acquire fewer, but on average, higher value customers. And I was wondering, how long does it take for you to know that it will be a good customer? And when you acquire them at the beginning, you do not know that, right? It takes a while. So just wondering, how we should understand that? Thanks.

Dominik Richter: Great question. So given that we've been operating now the business for about 13 years, we have a lot of data points that we can feed into the different prediction and machine learning models that we have. And so usually, it takes us about three to four weeks until we have very, very high predictive power, how a group of customers will do over the next six, 12, 18, and 24 months. So the big advantage in our model is that you generate data points of a customer every week rather than every month or every couple of months. And that means that you can understand quite quickly whether you're actually acquiring customers that are exhibiting better behavior than the ones that you acquired before. So in short, usually about three to four weeks until we have very high predictive power on the quality of customers.

Operator: Okay, then the next question comes from Jo Barnet-Lamb, UBS. Please go ahead with your question.

Jo Barnet-Lamb: Excellent. Thank you very much. I was just going to push a little further basically on Luke's question. So obviously, clearly seeing a very significant strategic shift here away from a sort of more growth-oriented mindset to retention and free cash flow. We've seen from your historic cohort work that you have very sticky core customers. And I think there was a comment in one of the written releases from Dominik implying that remains the case. So as such, the reductions we're seeing in meal kit revenues, is that presumably you’re just sort of churning through the lower quality customers acquired over the last couple of years? And as such, now to sort of the punch line as Luke asked, can we assume that you'll get sort of sequential improvements in meal kit from about a year after when you started the shift approach? And as such, in sort of H1’25, can we expect the declines to moderate fairly materially? Just a little bit more information around sort of the churn, what's driving that churn and how you're getting through those customers off the platform? Thank you.

Dominik Richter: So I think what we referred to or referenced in one of our earlier calls was that really the main effect that you see playing out right now is the right sizing of the overall size of the new customer cohorts that comes in. So once you start lapping numbers that were much higher the previous or the previous two years, then you're actually getting back into an environment where you can basically show at least stabilization or at some point moderate growth again. We've obviously started taking some more rigid measures on acquiring fewer customers over the last six months. So I would expect, and in line with what Christian has said before, that over the course of ’25 you actually see some of that moderating. And then ’26 and beyond, let's see, with a much better product that we have and hopefully with a better customer quality, I'm generally optimistic on the long-term potential of the meal kit market. But the most important thing is that once you start lapping much, much bigger cohorts, then you get much, much closer again to actually showing stabilization or moderate growth in the category.

Jo Barnet-Lamb: Excellent, thank you.

Operator: And the next question comes from Nizla Naizer from Deutsche Bank. Please go ahead with your question.

Nizla Naizer : Great. Thank you. Could you kindly remind us what the one-off costs were in absolute numbers, last year Q4 and linked to that, I think in the last call, you mentioned that Q4 absolute EBITDA could be higher than what we saw in Q2 already, if I remember right. Is this still the thinking going into Q4 with this revised revenue outlook in mind? If you could give us some color, that would be great. Thank you.

Christian Gartner : And Nizla, it's Christian. So, for both what you see in Q3 this year in terms of one-off or special items, as well as Q4 last year, this was primarily around severance costs for some of the efficiency measures that we've taken, plus some costs around the rationalization of our production footprint. I can follow up with a more detailed breakdown, but that effectively is substantially all of what you see for Q3 this year, as well as for what should be a large part of Q4 last year. Now, in terms of absolute EBITDA expectations for Q4, I would encourage you to stick to effectively what's implied by our guidance. So, the €360 million to €400 million implies for Q4 €125 million to €165 million and that's effectively what you should take as the yard stick and some of them, if you anchor yourself around the midpoint of that, I think that's the best place to be at this point in time.

Nizla Naizer : Understood. Thank you.

Operator: And the next question is from Andrew Ross, Barclays. Please go ahead with your question.

Andrew Ross : Great. Good morning, guys. I wanted to ask about the margins in meal kits. You're kind of guiding to hold margins broadly flat this year despite quite significant top line declines, which is impressive. When we think about margins into 2025, what are the puts and takes in terms of how we should think about the drop through to margin for meal kits? So, okay, you're going to get some benefits of more marketing efficiency gains, there's some fulfillment cost efficiency to run through as dual line costs drop away, maybe other cost items you're working on. Just help us understand the puts and takes and how to think about meal kit margins next year. Thanks.

Christian Gartner : Yeah, Andrew and it's a good point. In terms of the key levers are really the ones that I tried to plot for you on this last page that we had put into the presentation. These are primarily the levers which will also impact our meal kit business itself. So, higher level of productivity, more fulfillment center rationalization, being focused on higher ROI on the marketing side, or making sure that we keep a tight control on overhead and G&A cost. All of that basically will pay into what we are targeting for next year in terms of EBITDA development and free cash flow development for our meal kit business. In terms of quantitative guidance, again, please have patience and we'll give that in March together with our overall guidance for 2025, but these are really the levers that we are focused on.

Andrew Ross : Cool. So, it sounds like as you see a moderation in declines of meal kit business, it's also logical to think we could start to see margins clearly increasing next year, although you're not quantifying that.

Christian Gartner : Yeah. Let's discuss in March.

Andrew Ross : Yeah. Cool. Thanks.

Operator: And the next question comes from Marcus Diebel, J.P. Morgan. Please go ahead with your question.

Marcus Diebel : Hi, everyone. Just on the cohorts again, could you at least give us an indication sort of like about the size of your loyal customer base, ideally in meal kits US, to have it clear. So, for example, an indication roughly what's the share of orders from customers that have been in the 2022 cohort? I understand you won't give specific numbers, but if you can give us an indication, that would be very helpful to assess the size of the so-called loyal customer base. Thank you.

Dominik Richter: Yeah. Marcus, we don't disclose those numbers. I think we generally have like a good set of disclosures around both product groups. Obviously, like with fewer new customers, the maturity, the average maturity of our customer base has gone up and will go up slightly further over the next couple of quarters, but those are not numbers that we're disclosing on a frequent basis or even on a one-off basis.

Marcus Diebel : Okay. Thank you.

Operator: And then no more questions from the audience.

Dominik Richter: Thanks a lot for attending our Q3 earnings. We hope this was informative and look forward to connecting with you over the next couple of weeks. Thanks, everyone.