HELFY - HelloFresh SE (HLFFF) Q2 2023 Earnings Call Transcript

2023-08-10 14:54:09 ET

HelloFresh SE (HLFFF)

Q2 2023 Earnings Conference Call

August 10 2023 2:30 AM ET

Company Participants

Dominik Richter - Chief Executive Officer

Christian Gartner - Chief Financial Officer

Conference Call Participants

Luke Holbrook - Morgan Stanley

Andrew Gwynn - BNP Paribas

Joseph Barnet Lamb - Credit Suisse

Emily Johnson - Barclays

Nizla Naizer - Deutsche Bank

Nick Coulter - Citigroup

William Woods - Bernstein

Sebastian Patulea - Jefferies

Presentation

Operator

Good morning, and a warm welcome to the HelloFresh SE Q2 2023 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 your host, Dominik Richter.

Dominik Richter

Hi, good morning. Welcome all to our Q2 2023 earnings presentation. We would like to confirm the numbers that we've already pre-released a couple of weeks ago and use the opportunity to shed some additional light on how Q2 turned out for us, but also how we see ourselves performing against our long term ambitions.

Our mission is to change the way people eat forever. And home cooking has obviously been around for hundreds of years, and will most likely continue to be the most popular way to eat dinner for the next 100 years. More than 50% of dinners in our target markets are cooked and consumed at home, a figure that's also incredibly sticky throughout economic cycles, and always apply.

In the almost 12 years since HelloFresh was started, we grew HelloFresh to a meals run rate of over 1 billion meals per year, which is on the one hand an incredible achievement, on the other hand, this also just constitutes a little over 1% of all dinners that our prime target group consumes.

We've more recently disrupted another food category successfully, and grown into the largest direct-to-consumer ready-to-eat player in the US. The plan is to also bring that to Europe and other places around the world. Changing the way people eat forever, not only for people cooking at home but also for those being a little bit shorter on time.

These two scale verticals and the number of newer verticals and which are in the early stages and as a meaningful step closer to our vision, to grow into the world's leading food solutions group. And while we have achieved some amazing wins, and despite being the biggest disruptors in these two huge consumer categories of home cooking and ready-to-eat in the last decade, we still feel very early in our trajectory and are excited about the days ahead of us.

And while it's always nicer to have everything go smoothly up into the ride in an extremely consistent fashion, the reality is that it's usually a little bit more messy and we continue to be to be faced with many things that we cannot control. Whether that's a pandemic, which in hindsight, was a big accelerator to our market penetration, an inflationary shock, or war mongering, just to name a few.

Others such as capacity constraints are to a certain degree in our own control but we cannot always time them without any impact to our growth journey were actually in line with a financial quarter, making the numbers sometimes seem a little bit more volatile than they are if you assume where they should be headed in the mid and long term.

In the long term, these are all completely negligible things, if you think about the size of the opportunity that we go after. But in the short term, they often causes a lot of hard work and long nights. What we have done in all these phases is to really focus on the long term, and work backwards to actually understand what the best strategy is to deal with the shorter term opportunities and challenges of today.

And so for the first half of 2023, for us, this really meant shifting our focus to exercising strong cost discipline across the board, and improving our underlying unit economics significantly, but also making our customer experience better. This puts us now in a position to take the next step in our growth journey with a more profitable model, and a lot more modes against current and potential future competitors.

After the massive scale up over the last three years and we more than tripled the business, these past six months have certainly felt a little bit more like a transition period. But it hasn't been healthy and made us the strongest version of HelloFresh that we've ever been. In terms of talent, technology but also our unit economics, I think will pave the way for strong profitable growth and predictable, sustainable free cash flow generation.

In the end, it's quite simple, as a company, we strive to maximize the long term free cash flow per share for our shareholders by building the customer base, technology, talent, and brand to become a category defining company in our own right. With the many modes and the strong market share gains that we have achieved, we are on a clear path to build a lasting winner in one of the largest consumer categories, and also on track for very material free cash flow generation.

With these opening remarks in mind, I'd like to walk you through some of the highlights specifically of Q2, bearing in mind, the overall H1 development. First of all, we've grown constant currency by about 1% year-over-year, as a decrease in active customers is more than offset by an increase in AOV of 8% and continued strong average order rates close to record levels of 4.1 orders per customer per quarter.

We've seen very strong operational efficiencies on both procurement and fulfilment expenses, which drove a very substantial contribution margin uplift by about three points to 28.4% contribution margin that is very reminiscent of some of the contribution margin that we've actually seen pre-COVID, or in the early days of COVID.

We've had a very disciplined spend approach against a relatively soft consumer environment, which translates into broadly flat relative marketing expenses, and which also gives us some additional discretionary growth budget for the second half of the year.

Most notably, we achieved our highest ever quarterly adjusted AEBITDA of €192 million at a margin of about 10%. Importantly, we also generated very significant free cash flow again. Our free cash flow from operation is among the highest it has ever been in Q2. And so also, Q2 and Q1 combined, made us to achieve not only record operational free cash flow but also returned to generating free cash flow after the investments that we've taken in fulfilment centers, and the build out of our infrastructure.

We’ve narrowed our top line guidance to 2% to 8% of constant currency growth. And we've upped the range of adjusted AEBITDA, we expect to land then to €470 million to €540 million, taking into account the additional discretionary growth budget that we've taken the site for H2.

Why do we think or why are we positive for the developments in H2? Number one, because we've worked hard on actually improving our unit economics and can go for very profitable growth in the second half of the year. Our Factor production capacity will be de-bottlenecked, the comparative period benchmarks become easier, and a number of product enhancements such as the increase from 35 meals to 45 meals on the menu in the US market, will start to hit. This in combination with our better contribution margin will guide us the way to continued profitable growth and then also free cash flow generation.

In addition to improving our unit economics in the short run, we also continue to invest in new business verticals, such as pet food for our Factor, Europe launch, and a number of capabilities in the first half of the year to drive mid to long term growth, profitability, and ultimately free cash flow per share.

For the last six years, we've been investing into establishing artificial intelligence and machine learning as key components of our technology platforms. Many use case is live and providing real monetary benefits. And now we have a group of about 70 data scientists and machine learning engineers who work exclusively on training, refining and deploying around 1500 models per week, across a multitude of different use cases all along the HelloFresh value chain.

Most of our models are powered by the unique and proprietary datasets that we’ve accumulated over the last few years, such as customer order patterns, meal preferences, menu browsing behavior, and other rich customer preference training sets. Examples of AI/ML driven apps locations that are used daily in our operations include, for example, menu creation algorithms, new real term customer lifetime modeling, incentive individualization, customer service automation, or the load balancing of picks along our picking lines in near real time.

And most of these scaled use cases rest on predictive AI. We also continue to be excited about our forays into generative AI as well. For both types, value of our own proprietary datasets is immense. For both types, the infrastructure demands, to structure your own data, to store your data, compute, to make it consumable for the different application cases, follow very similar principles that we have gained strong experience in over the past six years.

Outside of the AI/ML use cases, we already have live today and that I just shared, we see lots of opportunity across all P&L line items to benefit from the advances of AI and specifically GenAI. Over the last six months, we started experimenting with some use cases and become increasingly excited for the midterm potential. I don't want to read out each and every one here.

But if you focus on some of the ones that we have in green here, those are ones that we’re experimenting live with today, already. And so if I pick out one example from each of the G&A line items, for example, on the revenue side, we've seen good initial results, to better leverage AI to understand fraudulent customer behavior, and better crack down on it and actually identify that earlier and be more efficient in turning these customers away.

In procurement and fulfilment, we've started to leverage computer vision to enhance the quality of our picking processes. And we aim to introduce this more widely for quality control purposes around our fulfilment centers around the world. In marketing, for example, we've seen tremendous opportunities for creative asset generation such as simple copywriting, image generation or video generation, something that is done at the moment by many, many talented people inside of HelloFresh at agencies today at varying quality levels and where generative AI can play a big role in the midterm.

It's also, I think, a really interesting use case to leverage real-time weather data and forecasts to dynamically adjust and configure our packaging solutions, which allow us to reduce packaging, which benefits the environment and helps us save on cost plus provides a better user experience to customer.

And then finally, with regard to employee productivity and G&A, I think especially with regard to our engineering population, for establishing code assistance tooling to make the coding process less error prone, of higher quality and achieve higher productivity in the process. So ultimately, in the mid-to-long term, a lot of these opportunities will eventually materialize and make us a better and more efficient business.

It's hard to say what timeline we're exactly looking at to bring many of these opportunities into production, so into the daily usage versus simply test cases where we've already seen good results. But given our experiences, given our talents, and the investments that we've done over the last six years into structuring, cataloging and storing our own proprietary datasets, we feel pretty well equipped to leverage the opportunities that are provided by this new technology.

Let me return quickly to some of the numbers from the second quarter. So first, starting with meals, we delivered around 254 million meals in the second quarter of 2023. So after the unparalleled growth over the last three years, that's actually been the first year where we've been down in meals about 6% versus last year, as we’ve rode off the final pandemic comparable quarter, but we remain well on track to deliver more than 1 billion meals to our customers in 2023.

While existing customers continue to show some stickiness, and actually ordered on average more meals per order than ever before, we pulled back on some of our marketing investments given a softer consumer environment, elevated travel levels, and anticipated improvements of our unit economics into the second half of the year. We plan to shift a part of these budgets to H2. And we will have de-bottlenecked Factor US capacity and can drive more profitable growth as a result.

In terms of average order rates, we increased that by yet another 2% year-over-year to 4.1 orders per quarter per customer. That's a new record level for HelloFresh in the second quarter, and more than 14% higher than the last pre-pandemic level that we have. Major drivers for this improvement were the enhancement of our product, and recipe quality, better service levels, and a significant strengthening of the relative affordability against grocery and food delivery, which has been exposing their customers to a lot more inflation than we have in the process gaining relative affordability.

With that I'd like to come to the Average Order Value we have observed during the second quarter. AOV has been trending 8.4% higher than last year, and has reached €63.6 per order. This was the single biggest driver to our year-over-year positive net revenue growth. And if you look at our two segments, AOV increased actually 9.7% year-over-year in North America and about 6.5% in our international markets.

Three factors contributed to that growth in Average Order Value, number one, a higher contribution of RTE specifically impacting the North American number, price increases, and then very importantly, also bigger basket by our customers on the one hand side, with a larger menu, they've taken on more meals per order on average. And with the roll out of HelloFresh market into the UK, into France and into Germany, we’ve also had a lot more customers exposed to our HelloFresh market and that contributes positively to increasing AOV.

Last two should really continue to be growth contributors going forward as we roll out to HelloFresh market and scale RTEs even as inflation is rolling off, this will contribute to better a AOVs, going forward. Now, taking together reduction in the number of meals sent with higher average order values, led to a constant currency revenue growth of about 1% for Q2 to €1.92 billion. It’s not that the euro lost against most other currencies, so euro denominated figures are slightly down or as in constant currency they are actually up.

Q2 should have been the low point for growth with reacceleration of customers and number of meals expected for H2. Outside of easier comps, we see the scaling potential of factor US into H2 as very significant. And we see a number of product enhancements hitting in the second half of the year, such as the expansion from 35 meals to 45 meals on our US menu, as well as the rollout of HelloFresh markets into more and more geographies.

Overall, much improved unit economics and an improved customer experience should make our growth in H2 more profitable, which is why we have shifted some of our budgets into these periods.

With that, as always, I hand over to Christian to walk you through our cost line items and our free cash flow generation.

Christian Gartner

Thanks, Dominik. And I would like to start with the development of our procurement expenses. Despite an overall still inflationary ingredient pricing environment, we achieved a year-on-year margin improvement of 0.6 percentage points by lowering our procurement expenses to 33.8%.

Structurally, as you've seen consistently from us in the past, our AI driven menu planning helps us to achieve consistently higher customer satisfaction scores in recipe writing and also hitting consistently our margin targets. In Q2, specifically from a geographic perspective, our US meal kit brands contributed meaningfully to this margin expansion as well as certain key international markets such as Germany and the UK.

Looking into the second half, you should expect a modest year-on-year increase of our relative procurement expenses as we, number one, ramp up our new Factor ready-to-eat production facility in Arizona and secondly, have a strong pipeline of new products and experiments coming through as Dominik had alluded to.

Okay, next, I would like to discuss the development of our fulfilment expenses. Similar to Q1, we have very meaningfully decreased our fulfilment expenses year-on-year by 2.3 percentage points. This is a continuation of the strong improvements that we've seen from us very consistently since mid last year. Especially all of America segments continues to contribute significantly to this positive trend.

As we have discussed in detail in our Capital Markets Day at the beginning of the year, we are meaningfully reducing our relative fulfilment expenses by, number one, optimizing our fulfilment center footprint. Secondly, by driving process, standardization, and thirdly, by ramping up the use of technology and automation. Besides these like-for-like ongoing improvements, a higher share of ready-to-eat and a higher overall average order value also helped to deliver lower relative fulfilment expenses.

And the combination of both, relative improvement on procurement expenses and a meaningful increase in fulfilment efficiencies, we've expanded our contribution margin almost three percentage points to 28.4%. And this is the fourth quarter in a row that we consistently deliver meaningful contribution margin expansion. Both of our operating segments contributed well to this positive trend, especially our North America segment achieved a contribution margin of 31% in the quarter.

We had promised that our Capital Markets Day that we would expand our contribution margin for the full year, this year by at least 100 basis points. So far, we've delivered meaningfully north of that in each of the first two quarters and also expect for the second half to at least 100 basis points above last year's level.

Now, I would like to discuss the development of our marketing expenses in Q2. We have spent somewhat less on marketing in Q2 than originally planned based on the factors that Dominik had outlined. This meant that both absolute and relative market expenses in Q2 2023 were largely on par with the same period last year. In the reasonably soft consumer environment, we decided, based on our AI driven proprietary marketing tools to stay disciplined in the way we're deploying our capital and rather deferred some budget to the back-to-school period in autumn.

This period will then also coincides with the ramp up of our new Factor facility in Goodyear Arizona, which will go live towards the end of Q3. And when we put all of this together, this means we have achieved the highest ever quarterly AEBITDA in Q2. We achieved an AEBITDA of €192 million, higher than during any pre-COVID period. We achieved this through strong contribution margin expansion, disciplined marketing spend, and very healthy retention and ordering behavior from existing customers.

As a result, we delivered an AEBITDA margin of 10%. In that sense, our Q2 profitability is already a template of how we see our 2025 full year margin target. Contribution margin of around 29%, marketing at circa 16% of revenue and AEBITDA margin of circa 10%, all in line with what we had discussed in our Capital Markets Day, a couple of months ago.

Our strong Q2 AEBITDA margin performance also means that we are up for the full year, for a full H1 versus the same period last year. This hopefully also provides some comfort to those of you who feared at the beginning of the year that our AEBITDA performance would be too backend weighted and therefore would put our guidance at risk.

Before we come to our guidance, I would like to also discuss the development of our free cash flows in Q2 and thus end the first half. At our Capital Markets Day at the beginning of the year, we promised to get back to at least free cash flow break-even this year after quite extensive multi-year CapEx program. In H1, we've increased our cash flow from operating activities to €207 million versus CapEx of €169 million. This means we already in H1 delivered a positive free cash flow of €38 million.

Dominik had mentioned earlier today already, long term growth of our free cash flow per diluted share is from our perspective, one of the most important drivers of value creation for our shareholders. Therefore, we will continue to be focused to drive the nominator of this ratio, free cash flow growth over long periods of time, but also continue to be disciplined to avoid the growth of the denominator.

We've also started to report the free cash flow per diluted share as a key KPI. Some of you will have noticed that this morning already at the front of our quarterly report, we reported in addition to reporting our absolute free cash flow so that you can easily track our progress on this metric. Our strong business profile and our financial position has also been recognized through the investment grade BBB- rating, which we recently received from S&P. It’s a good illustration of our robustness and put us several notches ahead of most other international e-commerce companies.

Let me now conclude with our narrowed outlook for the full year 2023 which is effectively repeating what we had published earlier on July 19, already. We’ve narrowed constant currency revenue growth from previously 2% to 10% to now 2% to 8%. Illustratively this would result at the midpoint of this range i.e. the 5% constant currency growth rate in a full year revenue of circa €7.7 billion, assuming FX rates as of mid-July, the time when we narrowed this guidance, which would mainly include a US dollar to euro rate of round about 1.10, so roughly what is still today.

Versus H1, we are expecting a year-on-year reacceleration of revenue growth from autumn onwards as our Factor US is not any more capacity constrained from Q3 onwards, and COVID comparables were largely washed out by Q3, Q4 2023. From an AEBITDA perspective, given the strong Q2 performance, we have lifted the lower end of our previous range and therefore currently expect €470 to € 540 million of AEBITDA for the full year.

For Q3, just keep our normal seasonality in mind, i.e., somewhat lower contribution margin due to less fixed cost utilization during the summer holiday period and increased the packaging and cooling material costs due to peak temperatures in most of our markets. Then secondly, seasonally higher marketing spent in the back-to-school period. So we in addition have carried over some extra budget from Q2 to take advantage of attractive opportunities when they arise, as discussed earlier.

With that, we look forward to your questions.

Question-and-Answer Session

Operator

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

Luke Holbrook

Good morning everyone. Just a question really on if you can share more color on actives improving in North America and this is, do you think due to increased competition? Is it the demographics that’s turning? Just any more color there would be very helpful. Thank you

Christian Gartner

Luke, its Christian here. So the first point. So no, it's not increased competition. When you look at whichever third party data you have access to, market share database and credit cards for example, you will see that we continuously increase our market share across our meal kit brands in the US, and certainly also on the ready-to-eat side. And this applies to both the second quarter, but frankly, any period you want to look at over the last five years in that market.

In terms of the year-on-year development, this is driven by two things, one, reasonably soft consumer environment in North America that you probably have heard from some other companies in the period as well and the fact that we effectively since the first half of Q1, at max capacity in our ready-to-eat business. Now the latter, as discussed will be addressed as of the end of Q3. So we de-bottlenecked capacity constraints there. And on the first one, we've good hopes that that is going to clear up over time as well.

Luke Holbrook

Okay, understood. And just on the capacity in North America, if your orders are down, I guess 8%, is there a way that you can optimize warehouse capacity even further or change on the distribution footprint going forward?

Christian Gartner

Yeah, that's an ongoing process. But overall, we feel quite good with the steps that we've taken. You see that shining through in our contribution margin, obviously, as well. As on rationalization of our fulfilment center footprint and optimizing, that is certainly one of the factors that helps to expand contribution model.

Luke Holbrook

Thank you.

Operator

The next question comes from Andrew Quinn, BNP Paribas Exane. Please go ahead.

Andrew Gwynn

Hi, there, good morning. Yes, apologies, it’s very short term, but Q3 trading, or sort of guidance would be very useful. And presume there's significant seasonality even more pronounced than last year, so appreciate an improvement from September onwards. But as we say, in July and August, presumably trends are pretty subdued?

Christian Gartner

Yeah, so obviously reasonably early in that quarter and keep in mind, we just let our turnout in back half of peak holiday season for us. So, there's not a lot we can tell you about Q3 trading other than that, it's fully aligned with our plan on a base to which we've given our guidance.

Andrew Gwynn

And Dominik said earlier that you expected growth to trough, the year-on-year growth had troughed in Q2. So Q3 presumably expected to be better and then much better in Q4, is that the right sort of shape?

Christian Gartner

That's ballpark the right shape. So sequentially, more or less move up in Q3 and then more pronounced in Q4, correct?

Andrew Gwynn

Yeah, perfect. Thanks very much.

Operator

The next question comes from Joseph Barnet Lamb, Credit Suisse. Please go ahead.

Joseph Barnet Lamb

Excellent, thank you, [indiscernible]. And when you talk about shifting budgets into 2H, that'll be more profitable, I imagine you mean from a sort of CAC versus LTV perspective. In the remarks, you sort of gave some reasons to believe that LTV would be better, but can we talk a little bit about CAC? I think CAC was sort of rising through last year. And then you saw, I think, you said at 1Q that it had been sort of flat from 4Q into 1Q. And has CAC remained flat in Q2, or have you seen a bit of a movement upwards? And what are your thoughts on CAC into 2H? Thank you.

Dominik Richter

Yeah, sure. What we did see is, as the pandemic ended, sort of like in late ’21, ’22, or early ’22, we saw some sort of like increased, slightly increased customer acquisition costs, but it's really been broadly flat to slightly down since. So we haven't seen sort of like additional inflation and customer acquisition costs. And as we outlined during the Capital Markets Day, at the same time, we've actually grown our LTV more. So our LTV to CAC, these days, is at the same or better levels for most of the markets that we operate in. There are always some regional differences but high level and company-wide it looks like we have increased LTV more than CAC has increased since the pandemic ended.

Joseph Barnet Lamb

Thanks Dominik. So there was a sort of movement up in CAC in Q2, which is sort of one of the drivers for you, pushing the spending into H2?

Dominik Richter

In Q2 ’22, there was a move up and ever since, it’s kept broadly stable. We used Q2 ’23 this year to really work on our contribution margin, to work on our product enhancements to make sure that we get the capacity de-bottlenecked in Factor so that we can drive profitable growth, now on the back-to-school season, and all the way through Q4.

Joseph Barnet Lamb

Excellent, thank you. Yeah, and I mean, Q2 ’23 versus Q1 ’23, there have been no incremental increase, it sounds like you're saying there has not been an increase? Thank you.

Dominik Richter

That's correct.

Operator

Next question comes from Emily Johnson, Barclays.

Emily Johnson

Morning, and can you please walk us through what your expectations are for the market and as well, your kind of meal kits versus ready-to-eat mix to get to the bottom and the top end of your revenue growth guidance? For example, with Factor growth is planned in H2, what would need to happen to the rest of the business for you to only achieve the 2% revenue growth, given recent comps?

And a kind of follow-on from that, in terms of Factor growth in the second half, what gives you confidence in not just when that capacity comes through, but I guess the consumer kind of subscribing to it, given the weakness you've seen in Q2? And to what extent do you think you've benefited in the second half last year, in the first half of this year, from the closure of Freshly? Thanks.

Christian Gartner

If I can answer that, so on the first one is, no, we are not giving granular guidance on a per brand basis. If we change that, I’ll definitely make sure you will know but we're not giving that. Qualitatively what makes us confident that we can further step up growth at Factor, once we've got the production capacity is really the latent demand that we are seeing. So right now we have to be reasonably -- our marketing teams have to be reasonably constrained in terms of the campaigns that they run, not to generate more demand as much we can serve and that’s a ongoing fight on a week-by-week basis, so to pare back there. So we think we're quite confident that once capacity is de-bottlenecked, there will be quite healthy demand for that.

Operator

Well, the next question comes from Nizla Naizer, Deutsche Bank. Please go ahead, your line is open.

Nizla Naizer

That's okay. Hi, just two questions from my end. Firstly, you mentioned that there was some marketing from Q2 now being pushed back to sort of Q3 to Q4. Just on the back of that, how should we think of the customer base evolving in Q3? Could it be sort of a typical seasonality quarter where there could be sequential declines? Or could it even be flat with the incremental marketing that you're now spending after the declines we saw in Q2. So some color there would be great on maybe how, the base case of your -- of the customer base evolution?

And the second question is on your 2025 outlook, to get to the €10 billion of revenue, you would now need sort of double digit growth from 2024 to ’25? How confident are you that growth could accelerate from these levels, and in fact that is [indiscernible], we'd love to get some color on the scale of back to growth that you anticipate to get to those targets? Thank you.

Christian Gartner

On the first point on customer growth, so if you assume for Q3, broadly stable customers, but again, there's some variance, some potential events left or right from that, especially given when you think about Q3 where if the customer acquisition is somewhat back-end loaded. And we're only going to embark on a back-to-school in most of our key geographies in September onwards. So even people we bring onboard then may not have received first delivery still in that quarter and therefore would not count as an active customer. So there is some variance in that. But sequentially, this is the same point for you. In Q2, if you assume broadly stable with a little bit in for variance left or right.

On your second question, so confidence on our mid-term growth to say north of 10%, we remain confident that the drivers really are unchanged from what we discussed in detail at our Capital Markets Day at the beginning for year.

Nizla Naizer

Thanks.

Operator

Next question comes from Nick Coulter, Citi. Please go ahead.

Nick Coulter

Hi, good morning, Nick Coulter from Citi. And I have three quick ones, if I may, please. Firstly, for the NA segment, could you update us on the underlying level of pricing going through? Like the underlying price per meal increase year-over-year? I guess by default, that will kind of give us the impact of RTE market base and surcharges?

And secondly, could you update us on the custom number over that between Factor and the other brands in the NA segment, please? I know it's a small percentage, but it'd be helpful to have an update, please. And then thirdly, just to clarify, I think Christian, you mentioned a modest move up for the third quarter, which incomes line were you referring to with that piece? Thank you.

Christian Gartner

Nick, on the impacts of pricing, so the pressure of the 8.5% AOV increase that you've seen from us, year-on-year, roughly 5% to 6% are both of that combined. So price and mix combined. And then 2%, 2.5% is basically for the expansion of the take up in surcharge, as well as basically HelloFresh market. And then sorry, there was some noise. Would you like to remind us of your second and third question.

Nick Coulter

Yes, sure. It was just on the customer number overlap between Factor and the other brands in NA, and I think you've given it previously as being a small percentage, but just to kind of get a sense of how that's trending?

Christian Gartner

Yeah, for Factor and North America, I couldn't tell you from -- here spontaneously, what we've also shown in the report is basically for the group overall. So, if you take all brands together that overlap is somewhere on 150-ish, for 150 key customers but the fraction in the US is even smaller. So the bottom line is its de minimis, frankly.

Nick Coulter

Okay. Thank you. And then, on the modest move up for the third quarter that you mentioned earlier, which Income Statement line does that refer to or which statistic does that refer to, please?

Christian Gartner

So that was on our procurement expenses. And so, year-on-year procurement expenses as percentage of revenue, given that basically, we will start in the second half to -- so from end September onwards to use that new Factor capacity. And as you know, Factor comes with a with somewhat high procurement expenses, and then a number of quite exciting product enhancements and experiments that we want to pursue, basically, in the second half and that has a certain impact as well. So the combination of both means year-on-year, modest procurement expense on relative basis, expansion in the second half. Having said that, contribution margin overall, we are still targeting to increase also in the second half by north of 100 digit, so expanding margin despite of that also in both Q3 and Q4.

Nick Coulter

Thank you, that does help. But I was referring, I think, Dominik mentioned an inflection or great bottoming in the second quarter. And I think Andrew asked you a question on clarifying that. And you said there'll be a modest move up for the third quarter with respect to growth, I was trying to understand, I think is obviously some sort of sales line was declining?

Christian Gartner

I see. Sorry, yes. So a modest sequential step up in revenue growth, so versus around about 1% year-over-year growth that you've seen from us in the second quarter, and then a more pronounced step up in Q4.

Nick Coulter

Thank you, that's helpful.

Operator

The next question comes from William Woods, Bernstein.

William Woods

Hi, good morning, thanks for taking the question. Just on active customers in terms of the kind of 9% drop, are you able to break, give us a rough breakdown between losing existing customers and the newer customers or any kind of guidance there? And how does that impact your AOV? Are you seeing the mix of customer types help your AOV? Thank you

Christian Gartner

Hey, William, it's Christian, here. So as you know from the shape of our retention petal, typically, we see very little churn basically from customers, the more and the longer they are with our service or therefore any reduction in customers would them more be related to what more recently acquired customers.

William Woods

Got you, thank you, and does that -- I suppose that helps you AOV, right? Because you shift to a full price paying existing customer versus a newer, maybe discounted customer, is that a factor in the AOV move?

Christian Gartner

This is overall beneficiary towards average order value as well. Correct.

William Woods

Thank you.

Operator

The next question comes from Muskaan Kedia, Goldman Sachs. Please go ahead, your line is open. Okay, so I'd like to repeat, the next question would be Muskaan Kedia.

Lisa Yang

Can you hear me?

Operator

Yes, I can.

Lisa Yang

Hi, sorry. I was on mute, sorry. So it's actually Lisa Yang from Goldman. And so the first question I had is just in terms of how you think about marketing versus customer acquisitions. Meaning the second quarter initially guides to €7.7 million. And that’s a bit lower than that, and historically you’ve been quite good at predicting the number of new customer additions based on the marketing spend that you were planning. So just wondering, has anything changed in terms of the visibility?

And just wondering, like, what basically happened for you not to be able to achieve your guidance that you initially gave? And obviously, I think that's important given, obviously, that will give us maybe some more confidence in terms of the second half and the longer term guide. That's the first question. And secondly, it's just on the capital allocation, you used have periodic [€400 million] of net cash. So just wondering, I mean, obviously, with your share price is attractive in terms of how you think about the buyback and the potential timing of that? Thank you.

Christian Gartner

Yeah, it's Christian here, so to your first question, I would really repeat what Dominik had mentioned earlier. We decided that in a reasonably soft consumer environment, it would be more beneficial for us if some of that went into the back-to-school period in autumn rather than spend relatively aggressively ahead of or into the summer period. It's really it was the driver of the near term, active customer development. And then on your second point, that's noted. So in case we take a decision on capital allocation, for example, to something like a share buyback, we will communicate that at that point in time.

Lisa Yang

Okay. Thank you.

Operator

Okay. Then the last question comes from Sebastian Patulea, Jeffries. Please go ahead.

Sebastian Patulea

Thank you very much. Good morning, everyone. Thank you for the presentation. May I please ask, what makes it confident that after the Arizona facility gets launched at the end of Q3, that demand is there? Can it be the case that you launch it and grow for Factor75 is not accelerating? What are you seeing that gives you confidence that demand is there please? Maybe you're canceling some orders or you cannot fulfill some orders, you tell me, please?

Dominik Richter

What makes us long term confident that in RTE but as well new kits, we're very early days and the growth trajectory is the incredibly low penetration number that we have today? So obviously, if I talk about meal kits here first, when you triple a business in three years, it's very, very hard to just continue kind of like growing each and every year and each and every quarter. We will be growing each and every year, we will be returning to double digit growth in the near future. The timing of some of that growth is not always entirely in our controller, that's for the meal kit business. For Factor specifically, for an even lower penetration that we are in the meal kit business. And if you just look at the category that has been established in the US, that's about €12 billion to €15 billion of ready meals actually sent in retail, we do believe that our product is much, much higher quality, what you can find there.

So we're at very low penetration levels at the moment. And even if we double from the current run rate, we're still at very low penetration levels. What we did see since the beginning of the year, is that even running at sort of like half of the marketing budget that we actually wanted to ideally run on, we had to pull back in a lot of weeks, and actually use some of the COVID playbook that we have developed in switching off certain channels, in introducing like a third shift in on-boarding 3PLs to basically manage some of that demand. So there's a lot of anecdotes around here that make us quite confident that we will be able to capture significant demand.

But once again, I think the long term opportunity is incredibly intact. There's very few other categories, which in a short span of a decade, have actually scaled to around €8 billion in revenue run rate shipping a billion in meals, and that not every single quarter is always up and to the right, as we manage through multiple, multiple crises at the same time, I think that's pretty clear. But in the midterm, I think there's no way around that this business will be a lot bigger in two years and three years and in 10 years than what it is today.

Sebastian Patulea

Thank you very much, Dominik. And if I may ask a second question, please? Are there any countries in which customers started to sign up to HelloFresh due to the affordability factor? The reason why I'm asking this is because in the group's history, there were a few times when HelloFresh decreased prices and growth has meaningfully accelerated. So were there any countries in which the specific factor why people signed up was because it was becoming more affordable? Thank you.

Dominik Richter

So I'm not sure if 100% understood your question. If it is around pricing, then I think generally, like our philosophy has been we want to increase prices less than overall inflation, and strengthen our relative affordability against grocery and food delivery. We think we can do that, because we have more levers to mitigate price increases that we see in the market than those companies have, because we're fully vertically integrated. That's why both in terms of and in times of inflation, also, in terms of more minor inflation, we should always be able to strengthen our relative affordability as we gain scale and as we move through the powerful flywheel of giving back, sort of like excess margin to consumers to enlarge our overall target market.

Sebastian Patulea

Thank you for that. I was asking more if customers became aware or if they are aware that you guys are more affordable than you were two years ago, for example, from that perspective?

Dominik Richter

From some of the surveys that we actually take, we have seen that there is a modest increase in customers who feel that HomeFresh is actually like a great, affordable alternative. I think the numbers are -- some of those numbers and we poll on a quarterly basis, customers all around the world. So at least we have seen that despite the fact that we've increased prices on an absolute level, we have not seen that customers actually think we're more expensive than grocery or more expensive than food delivery. The relative affordability, I think we have proof points, that customers understand that they continue to find better and better deals at HelloFresh.

Sebastian Patulea

Thank you, Dominik. That was it, cheers.

Operator

So there are no further questions at this point. This concludes the Q&A session. Thank you all for participating and I'd like to hand it back to the speakers for some closing remarks.

Dominik Richter

Thank you for attending our Q1 earnings call. I think overall, I see big focus on some small margin movements or excess customer numbers here and there. I do think the long term opportunity is more than intact. You will see us kind of like reaccelerating growth in Q3 already. And I do think there is many, many growth opportunities and many, many growth vectors where we've already laid the foundations for within the group. Plus, we will be maintaining sustainable free cash flow generation for the next years to come.

So overall, I think the risk is here very much skewed to the upward. And we're obviously hoping to prove that out over the next quarters to come to take advantage of the massive, long term opportunity that we're going after.

Thanks for your attention, and I'll speak to you all soon.

For further details see:

HelloFresh SE (HLFFF) Q2 2023 Earnings Call Transcript