Blue Apron Holdings, Inc.
Q3 2017 Earnings Call Transcript

Published: 2 Nov 2017

[Operator:]

Ladies and gentlemen, good morning and welcome to the Blue Apron Holdings' Third Quarter 2017 Earnings Conference Call and Webcast. All participants will be listen-only mode. [Operator Instructions] This call is being recorded. Following the conclusion of today's remarks, the Blue Apron team will be taking your questions. With that, I would like to turn the call over to Miss Felise Kissell, Vice President of Investor Relations. Miss Kissell, please go ahead.

[Felise Kissell:]

Good morning everyone and thank you for joining us. On this morning's call, we have Matt Salzberg, Chief Executive Officer of Blue Apron and Brad Dickerson, Chief Financial Officer. Various remarks that we make during this call about the company's future expectations, plans, and prospects constitute forward-looking statements for the purpose of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important risks and other factors, including those described in our earnings release and the company's SEC filings. In addition, any forward-looking statements represent our views only as of today and should not be relied upon as representing our views as of any subsequent date. We specifically disclaim any obligation to update these statements. During this call, we will be referring to non-GAAP financial measures, which are not prepared in accordance with Generally Accepted Accounting Principles. You are encouraged to refer to the earnings release and SEC filings where we have described these measures in more detail and to review the reconciliation of these non-GAAP financial measures to the most directly comparable GAAP results. With that I would now like to turn the call over to Matt Salzberg, Blue Apron's CEO. Matt?

[Matt Salzberg:]

Thank you, Felise. And thank you to everyone for joining our third quarter earnings call. Today, I will briefly review the quarter's financial results and then provide an update on progress toward our top strategic priorities. Afterward, Brad will provide additional detail on our financial performance before we take your questions. In the third quarter, we grew revenue 3%, while reducing our marketing costs 31% year-over-year reflecting an improvement in marketing as a percentage of net revenue from 24% to 16%. Our average revenue per customer increased 8% year-over-year from $227 to $245. This was partly driven by a mixed shift to more tenured customers as we deliberately scaled back our new customer acquisition activity, as well as improvements in monetization that we made throughout the year, by optimizing our menu assortment and launching more flexible choices to our customers. An important part of our strategy is to continue to increase our revenue per customer metric through product innovations and improvements in our on-time in-full, or OTIF, rates across our fulfillment center network. Our adjusted EBITDA loss of $48 million was largely driven by heightened costs related to the launch of our Linden fulfillment center, expanded product offering infrastructure and summer shipping program. Adjusted EBITDA improvement is a priority for us and I will provide more details shortly on some of the actions we are taking to achieve that. Taking a step back, last quarter, I spoke with you about the actions we were pursuing to better align our organization around our top company priorities. These priorities include; one, maximizing growth opportunities through customer centric product innovations; two, OTIF rates in our fulfillment centers; and three, a strong focus on adjusted EBITDA improvements. To help us achieve our top priorities, we announced the creation of our consumer products team and the further division of responsibility between key executives. This quarter, we continue to drive forward in this area and most recently, we announced a company-wide realignment of personnel, reducing some roles, opening others and streamlining decision-making across our company for greater accountability. The result was a net reduction of approximately 6% of our total workforce across our corporate offices and fulfillment centers, representing a savings of approximately $24 million annually. Brad will review the breakdown and implications of this realignment in more detail shortly. As an additional step in our realignment, we performed a review of our real estate and facility needs including our previous plans to build-out a new facility in Fairfield, California. Based on this review we are no longer pursuing the build-out of Fairfield. We believe our existing facility in Richmond, California is well positioned to support our West Coast fulfillment operations at this time. Brad will provide guidance on the financial considerations of this decision shortly. The changes we made to our organization were numerous, and should enable us to innovate faster and drive efficiencies. A few examples of these realignment actions included; centralizing certain teams including our creative and purchasing functions, reducing resources in areas that will benefit from new systems and processes, such as Human Resources and IT, and allocating additional resources to areas such as operational strategy, as well as opening up new positions on our consumer products team to invest in future growth opportunities. I'm also pleased to announce that Lainie Cooney has recently joined our team as Chief Human Resources Officer, reporting directly to me. Lainie has over 20 years of experience at companies across the food, retail, and financial services sectors including State Street and Home Depot. She most recently served as Chief Human Resources Officer at DPI Specialty Foods, a nationwide specialty food distributor with thousands of employees across eight distribution centers. Lainie's leadership will be invaluable as we continue to develop our people and strengthen our processes, culture, and organization. On our last call, we spoke about the unexpected costs associated with the ramp-up of our Linden fulfillment center, and its impact on the roll-out of our expanded plan and menu options. At the time, we reported that nearly half of our customers had access to our expanded product offering. I am pleased to report that, subsequent to the end of the third quarter, we did complete this roll-out, and now, 100% of our customers have access to our expanded product offering. Our initial indications, although early, show improvements in both order rate and retention when comparing customers who received the product expansion to those who had not yet received it. Product expansion is an ongoing journey for us, and we plan to continue to build on this success. The completion of the recent product expansion was tied to the transition of all remaining volume from our Jersey City fulfillment center to Linden, which I'm also pleased to report, is now complete. Specifically, in the second and third quarter, the total national volume serviced by the Linden facility increased from 3% to 29%, respectively. Now, Linden is servicing approximately 50% of our national volume. Even with our significantly increased product volume in Linden, we have stabilized OTIF, which is encouraging. We are also no longer running two East Coast fulfillment centers concurrently and starting in the fourth quarter, we will be taking steps to eliminate certain duplicative costs. Now that we have completed the transition of volume to Linden, we are focused on achieving the OTIF and margin improvements that we expect from a center with its level of investment and capability. To give you a sense of where we are now relative to our potential, in Q3 Linden performed at a margin, that was significantly lower than the average of our existing centers. The opportunity we have ahead of us is to improve Linden, and make it our most efficient center. We have already seen some progress on our action plan items, and while this is encouraging, it is too early to conclude that we have achieved sustained and meaningful results. Sustained progress is the key to unlocking the improvements in lifetime value that we seek to help fuel growth. Finally, while our immediate priorities are to focus on OTIF rates and margin improvements, I'd like to share some of the exciting product roadmap and brand building initiatives that we've been working on. First, we have been making improvements in how we merchandize recipes based on customer insights around taste preferences and cooking attitudes. For instance, we have continued to feature our new 30-minute meal options, and are seeing increased interest in these selections in our early results. Additionally, throughout September and October we featured our all-time customer favorites and merchandized them in conjunction with our company five-year anniversary celebration. We think the promotion was a great way to engage our customer base and plan to incorporate the learnings from these programs into our ongoing cycles and leverage known winners more often. In September, we completed a recipe integration with the television series MasterChef on FOX. Over 5 consecutive weeks, we featured 10 recipes that were inspired by MasterChef contestants across our 2-person and family plan menus, allowing our customers to cook and taste the winning dishes in real-time after seeing each episode. We saw a lift in engagement from our customers around the recipes, and the partnership enabled us to reach an expansive audience. We also recently launched a podcast and cookbook. Our podcast, called "Why We Eat What We Eat," explores the unseen forces that guide and influence the decisions people make about food, and can be found on iTunes and Spotify. Our cookbook, titled "The Blue Apron Cookbook 165 Essential Recipes and Lessons for a Lifetime of Home Cooking," was published by Harper Collins and can be purchased both online and in traditional bookstores around the country. We're particularly proud of how the cookbook came out and I shamelessly suggest everyone on this call pick up a copy. Initiatives like the cookbook and podcast are exciting from a brand building perspective in that they help us continue to build culinary credibility and relevancy, as well as reach customers in new channels. Such strategies can also be connected to our customer lifecycle and used to activate our powerful and engaged community in social media and elsewhere to ultimately drive purchases in our weekly recipe sales cycle. Looking forward, we have a number of additional meaningful projects on our roadmap, including further expansion and flexibility in our recipe offerings to better serve both existing and new customer segments. While our near-term results have been impacted by the OTIF and margin challenges in our fulfillment center network, we're focused on the right items to position our business for long-term success. While not diminishing the immediate work ahead, I'm encouraged by the recent progress we've made in mobilizing against our top company priorities. I'm incredibly proud of the brand we have built and how hard our team is working to execute in order to deliver for our passionate community of customers, as well as create value for our shareholders. Thank you for your time today, and with that, I will turn the call over to Brad.

[Brad Dickerson:]

Thank you, Matt, and good morning, everyone. As we articulated in our second quarter earnings call, we expected our third quarter performance to reflect a period of continued transition as we remained focused on implementing our product expansion roll-out, completing the transition of volume from our Jersey City fulfillment center to Linden, and managing expenses to fully align our investments with our current view of the business, balanced with our focus to capitalize on longer-term growth opportunities that Matt outlined. In the third quarter, net revenue increased 3% year-over-year to $211 million after more than doubling net revenue in the third quarter last year. Growth this quarter was largely impacted by the planned decrease in marketing spend of more than 30% year-over-year, that resulted in fewer new customers as we focused on the operational challenges that arose during the transition of volumes to our Linden facility. Marketing as a percentage of net revenue decreased to 16.3% in the third quarter, compared to a high period of marketing spend in the prior year of 24.2%. As previously guided, we planned a reduction in marketing as we worked through our transition to Linden, while fulfilling certain already committed offline marketing obligations. Cost-to-good sold excluding depreciation and amortization as a percentage of net revenue was 78.1% compared to 70.9% in the third quarter of last year. This 720 basis points increase is primarily due to a 410 basis points impact from increased labor costs due to the launch of new infrastructure to support our product expansion initiatives including the transition to Linden and wage increases implemented earlier in the year across our fulfillment centers. Additionally, a 260 basis points impact from food and product packaging costs largely from the expansion of our product offerings and increased use of premium ingredients in our recipes, to better align recipe rotations with customer preferences. Product, Technology and General and Administrative or PTG&A costs increased 31.2% of net revenue in the third quarter from 22.2% of net revenue in the prior year, attributable to increased personnel costs and higher facilities costs. As discussed in our last earnings call, there were also two separate expenses. First we reported a noncash impairment charge in the third quarter of $6 million primarily related to the transition of all Jersey City fulfillment center operations to Linden. As Matt just mentioned, the volume from Jersey City as now fully transitioned and we are exclusively focused on improving performance at Linden. And second, other expenses included a noncash loss of $18 million related to the automatic conversion and settlement of the convertible notes upon the closing of the IPO on July 5th. Net loss was $87 million compared to the prior year's period net loss of $37 million, adjusted EBITDA was a loss of $48 million in the third quarter compared to a loss of $35 million in the third quarter of last year. From a liquidity and capital resource perspective, our cash and cash equivalents was $266 million, as of the end of the third quarter. We closed our IPO of 30 million shares of Class A common stock on July 5th, generating net proceeds of $278 million. Capital expenditures including amounts in accounts payable were $11.5 million in the third quarter significantly down from earlier in the year as we have substantially completed the build out of Linden. As we look towards the remainder of the year, we continue our hard work to stabilize the operations in Linden and remained focused on improving our overall performance. As stated in our earnings release issued this morning, we reiterated our overall financial outlook for the second half of 2017, while updating our net loss estimates to reflect the recent company-wide realignment actions that I'll speak to momentarily. Specifically, net revenue for the second half of the year remains in the range of $380 million to $400 million. Coming off our third quarter net revenue of $211 million we are anticipating revenue to be lower in the fourth quarter compared to the third. This is primarily a result of our increased ability to pull back marketing commitments in the fourth quarter compared to the third quarter as well as the natural cadence of business. We continue to expect cost to goods sold as a percentage of revenue of 74% to 75% in the back half of the year. This reflects our expectations of a significant improvement in the cost to goods sold efficiency in the fourth quarter compared to the third quarter. Greater than half of this improvement is driven by favorable seasonal packaging and produce that naturally occurs in our business as we shift from the summer season into the fall. There is also a modest expectation that we will have operational improvements in Linden, particularly in labor costs due to the completion of the transfer of volume from our Jersey City facility. As previously guided, marketing as a percentage of revenue in the back half of the year is expected to be in the range of 15% to 16%. This represents a fourth quarter reduction in marketing from the third quarter, which reflects our increased ability to pull back on marketing as we work our way through the back half of the year. PTG&A spend is expected to be similar in the back half of the year compared to the front half of the year. The full financial benefit from our organizational realignment actions is anticipated to begin in 2018. We expect a non-cash charge of approximately $5 million to $8 million in the fourth quarter related to our decision in October not to pursue the build out of our leased property in Fairfield, California. We are exclusively focused on optimizing our current fulfillment centers, while also exerting financial rigor. This expected charge will be recorded in other operating expense and will be added back to adjusted EBITDA. As a result of the actions taken, net loss in the second half of this year is projected to be $131 million to $138 million with adjusted EBITDA loss still expected at $70 million to $75 million. Note this guidance includes consistent reconciling items between net loss and adjusted EBITDA that we discussed in our last earnings call except for the following. A fourth quarter non-cash charge of approximately $5 million to $8 million relating to our Fairfield property that I mentioned earlier; depreciation and amortization in the fourth quarter similar to amounts in the third quarter. We also anticipate weighted average shares in the fourth quarter towards the higher end of our previously provided range of 183 million to 188 million. As you know, we recently realigned our organizational structure to more appropriately reflect the current performance of the business while maintaining our ability to pursue our strongest growth opportunities. These decisions are never easy and resulted in the net reduction of approximately 6% of the company's total workforce, across our corporate offices and fulfillment centers. We expect to incur approximately $3.5 million in employee-related expenses, primarily consisting of severance payments, substantially all of which will result in cash expenditures to occur in the fourth quarter. These payments will be additionally added back to adjusted EBITDA. As a result of the realignment, we project total annual savings of approximately $24 million beginning in 2018, including $18 million of PTG&A savings and $6 million of cost of goods sold savings. In summary, I want to reinforce that we continue to be extremely focused on operational improvements and determined to minimize the financial impact these issues have on the business, while simultaneously executing on our strategic initiatives to drive long-term growth. I greatly respect our team's focus, determination and resilience to drive near-term results. Thank you and with that, we will now take your questions.

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Matthew DiFrisco of Guggenheim. Please go ahead.

[Matthew DiFrisco:]

Thank you. My question is sort of two-fold. I was curious about, if you could talk a little bit more about the roll-out of the new products and the expansion of that? I mean is that -- can you give us some metrics around that on how that looked in the quarter or is it too early to tell as far as percentage of sales or how much of that mix is that? I know in the past, you have given us the breakdown sort of as families of the meals of two and the meals of four. Can you give us somewhat of intel early on the velocity and the penetration or the mix that they represent, now the newer products coming out during the 30-minute meals in particular?

[Matt Salzberg:]

Yes. So it's a good question and I can't share ton of specific data with you on that. But what I can say in terms of the rollout as we mentioned on the call, we didn't complete the full rollout to 100% of our customers until after the end of the third quarter. And so throughout the year, we have been slowly rolling it out across the country. The completion of the rollout was tied to the completion of shifting the remaining volume from Jersey City to Linden. And so we are still in the early days of seeing the full implications of what that does to our customer economics. That being said, what I can say is that, as we rolled it out across the country and we've done controlled experiments observing the differences in behavior between customers who did and did not have the expanded product offerings. And what I will say, talking about that as a separate topic than just how we are constructing the menus, with things like 30-minute meals and customer favorites. I'm talking more about, more flexibility in choosing our recipes, ability to choose more or less recipes and having more recipes total on the menu. We saw some good results on that in terms of what it does to customer's order rates, customer's monetization, revenue per customer, profit performance customer and the like. And so we were encouraged by those early results, but we are still watching that. Product expansion is an ongoing journey for us and we continue to build on that and we'll continue to build on that, now that we have the infrastructure and capabilities in place to more flexibly do that in the future. As it relates to the 30-minute meals and customer favorites, it's hard to give specific numbers on that as we're still analyzing that as well. But what I can say is we did see increased interest in those, we've gotten some very good feedback on that and part of the contribution to our improvements in average revenue per customer in the quarter. And I would encourage focus to look at our average revenue per customer metric as a key metric to track quarter-to-quarter or driven by those optimizations that we have made in the mix of recipes on the menu in a given week. We've actually been very focused on how we construct those 12 recipes we create every week and we see ourselves as having made some improvements there quarter-over-quarter and we'll continue to do that.

[Matthew DiFrisco:]

Okay. I guess just to tie that back to the -- sort of the financials and you mentioned the direction. Obviously this will generate also better profit per customer. And then you have seen a mix towards more tenured customers and getting rid of the -- sort of the guys that were not really of the cooking lifestyle probably, were going to flip through quickly. When and how does this -- I mean this is all conclude to the 30-minute meal, the customer favorites and if these become greater percent and skew of your meals towards [it], if this is a better margin business and a better sale overall than what you've done say traditionally or prior?

[Matt Salzberg:]

I wouldn't comment on the margins of 30-minute meals or customer favorites versus our other historical recipes only because they all vary every week. And if you think about our business, 30-minute meals, is not one monolithic product line, every single week it's a different recipe. And even with the customer favorites, they are different recipes frequently. And so we construct our margin mix from a food cost and labor cost and product cost basis on a weekly sales cycle basis to hit aggregate targets, based on the mix that we think that we're going to use. In some recipes we make bigger margins on, some recipes we make lower margins on. And we use that aggregate portfolio to drive the sales and profit performance that we are looking to achieve in that given week.

[Matthew DiFrisco:]

Excellent. Just one last follow-up question and then I'll pass it off. Does the not going forward with California in Fairfield, does that change any bit of your plans to expand the product? Was this the West Coast Linden that was going to unleash another level of capability, or is this not sort of -- or they are not correlated?

[Brad Dickerson:]

I'll take that, this is Brad. So the truth of the matter is with Linden coming online and the capabilities of Linden, we are raising our capacity holistically across the country pretty substantially from where we were before Linden. So the decision on Fairfield is more around looking at our overall near term capacity needs with Linden now coming onboard and Linden gives us plenty of capacity for the foreseeable future for us. If you think about just the growth in capacity we had from putting Linden onboard it's roughly an 80% plus increase in capacity of square footage compared to where we were before, plus the fact of the matter is that it's much more highly automated too, so which would give us even additional throughput beyond that. So the reality is Linden gives us plenty, plenty of capacity that we can use and help us use holistically across the country to some degree.

[Matthew DiFrisco:]

Thank you.

[Operator:]

Our next question comes from Michael Graham of Canaccord. Please go ahead.

[Michael Graham:]

Hey, good morning. I just wanted to ask about any qualitative information you can give us on sort of the customer metric in the quarter. You've got gross adds, turns deactivate -- people who go dormant and then come back into the mix. And I know you don't want to disclose those, but I'm just trying to kind of map what's going on with the customer base to the Linden completion and your marketing spend. I know you pulled back on marketing and you're going to be sort of keeping it reserved in Q4 and then be coming back at the beginning of the year. But trying to get an understanding of how much of the customer sluggishness is related to your decisions to be -- temper your marketing spend versus other things like competition or churn?

[Matt Salzberg:]

Yeah, it's a good question. I would say to the extent I can point you to numbers and metrics there. Obviously we don't disclose or think about our business in that more detailed way that you mentioned. I would point you to the marketing spend. And in terms of thinking about what drives customers for us in a given period, marketing is a heavy driver of customers. And so as we mentioned, we reduced our marketing costs 31% year-over-year, with a much lower than that decline in customers. And so we think that the primary driver of our customer performance was our marketing performance and the strategies that we have around how we drive customer and order activities with marketing. Certainly, the Linden fulfillment center launch impacts how we chose to stage our marketing, because of the returns that we like to generate from our marketing, are impacted by the margins in the quarter. And so that was part of that, and as we mentioned on the last call, we did see some impact on customer -- revenue per customer from some of the challenges in Linden, but as you would see on net, we did increase revenue per customer year-over-year this quarter. So that's where I would point you to, and I think that in terms of looking at how our customer patterns evolve in the future quarter-over-quarter, the marketing budget is a key thing for you to track and watch.

[Brad Dickerson:]

And Michael, this is Brad, just I'll add on to that a little bit. Obviously the spend of marketing which drives a lot of new customers impacts kind of all our metrics pretty substantially and changes those metrics relative to average orders and revenue per customer and so forth. So, in quarters that we're growing a lot of new customers versus quarters that we -- like this past quarter we pulled back on marketing and added -- we left new customers that obviously has an impact on those numbers relative to the tenured customers that start the quarter and end the quarter and so forth. And then your comment around kind of going forward and I'm just trying to kind of add to what Matt said, I think just -- we're not giving guidance past 2017 obviously today, but it's important to know obviously that margins are a very, very important part of our business. So we're very focused on OTIF right now. We're very focused on getting margins in the right places, as we transition fully into Linden and now we have part of the expansion rolled out. And obviously healthier margins in the future at some point will give us the ability to have marketing investments that are a lot more attractive. So we're not giving guidance on 2018, but margins and the health of margins are a very, very important part of our financial outlook.

[Michael Graham:]

Okay. Thank you.

[Operator:]

Our next question comes from Kerry Rice of Needham. Please go ahead.

[Kerry Rice:]

Thanks a lot. Couple of questions. One, obviously the Linden facility is your most highly automated facility or at least was. Can you talk about -- are you doing anything related to the automation in the -- like Richmond and Arlington facilities, have you started that process? Are you going to embark on that process? And then the second question is have you started with a new product and the flexibility around the menus, started to segment a little bit more on targeting consumers? I know you've previously talked about whether it's with the BN Ranch acquisition maybe to meat lovers or barbecue this summer, vegetarian or so forth, if you can give any insights on that? And then one housekeeping, did you mention what OTIF was for Linden earlier in the call? If you did, I missed it. Thanks.

[Matt Salzberg:]

Great. So I'll try to get all three of those. So, the first question on what are our plans for automation in our other centers, other than Linden. What I'll say is this, over the course of the last year we actually did install a number of more automated technologies in our older centers in order to have them both support the product expansion and in order to generate ROI on investments from a cost structure perspective. And so we do have some of the technologies that we have in Linden in our other centers already today. There are some modest additional technologies that we are landing across those centers, on an ongoing basis. But as Brad mentioned, our capital expenditure expectations are fundamentally different looking forward, than they had been over the last year or so. And so Linden has the most capabilities and we are still quite frankly finishing the installation and turning on some of those incremental technologies in Linden like new food manufacturing equipment and working through some of the kinks on up time and efficiency for some of the technologies that we have installed there like [pick-the-way] technology and the like. And so there is more to come there, but it is not in aggregate nearly of the size and scale that we've done historically. Second question, I believe was around the product expansion and had we began to see -- one I mentioned we've seen some of the benefits on product expansion from offering more flexibility and more choice. And part of the reason that we see that benefit is because we recognize that we don't serve just one segment of monolithic customers. We have a diverse segment of people with different cooking attitudes and difference taste preferences that cook with us. And so part of what we are achieving with 30-minute meals and with customer favorites and with just generally optimizing the kind of proteins and ingredients and skews we work with on the menu is thinking about serving those different segments differently. So for instance you might imagine we have one segment of customer, which is a major cooking enthusiast who likes to try new things, who likes to discover new ingredients. And we have another segment of customer who things of cooking as a little more functional. Something they're just trying to get a healthy, affordable, high quality dinner on the table for their family. So that's part of what we're doing, by offering more choices and more flexibility allowing us to serve that diverse segments better. And as I mentioned, we are encouraged by the results that we are seeing there. With respect to OTIF that's not a metric that we specifically mentioned, but we were highlighting it as obviously a key one that we are tracking to measure the leading indicators of progress in Linden and elsewhere. And so I don't expect we will be disclosing OTIF as a specific number on future calls. But we'll try to continue to give you color around how it's impacting the business.

[Brad Dickerson:]

And I think Kerry, I'd just like to say that with both OTIF and margin, we are not specifically talking about a center-by-center metric there, but obviously Linden with the largest volume and being in transition a new center has the most impact and the most improvement that we look forward to with OTIF and margin. That being the case, even though, we have rolled automation out in Richmond and Arlington over the course for the last year, product expansion itself has been more complex in our centers too. So in the 2 person plan going from 6-meals to 8-meals and also given the option of two recipes versus just three recipes per week adds some complexity too. So by far again Linden is the greatest opportunity for us, but we also do see opportunity in Richmond and Arlington as we work our way through product expansion also.

[Kerry Rice:]

Thanks for the insight.

[Operator:]

Our next question comes from Heath Terry of Goldman Sachs. Please go ahead.

[Heath Terry:]

Matt, I'm wondering, if you could give us a bit of an update on your view on the competitive environment now? Just trying to get a sense particularly as it relates to some marketing, what kind of spend you're seeing in your performance channels and understanding you guys are obviously making your own sort of idiosyncratic decisions about your budgets, but sort of how that is impacting customer acquisition?

[Matt Salzberg:]

Yes. It's a good question. So I think it's obvious, we are in a highly dynamic category. There is a lot of interest in our category both from consumers and competitors and broadly speaking. It's not because it is such a big category as you know and we're going after a really, really big price. We've had a lot of competition in our business since the very first day we launched our business and so nothing has really fundamentally changed in terms of the competitive landscape in the recent quarters. I think our marketing budget as you know has been driven largely by internal factors impacting how we want to stage and spend marketing and how strategically we want to stage our growth and our product expansions. And so I think obviously things like market share are things that we look closely at. We're very proud of the fact that we are the market leader in the United States and have been for the history of our company. But market share isn't the only factor we look at when thinking about our marketing budget. And we're very focused as we mentioned on driving growth and profitable growth. And so we don't spend marketing at any cost in order to drive growth. We look at generating attractive returns. And we're focused also on having a strong balance sheet. And that gets back to why the margin equation and obviously we had a reduced margin this quarter. It's so important to us so that we can drive strong growth and strong profitable growth over a long term time horizon. And so that is how we're thinking about it. And we will continue to be the best we could be on a product innovation perspective to stay ahead of the competition just as we have done since the very first day we launched the business over five years ago, now.

[Heath Terry:]

Great. Thank you.

[Operator:]

Our next question comes from Mark Mahaney of RBC Capital Markets. Please go ahead.

[Mark Mahaney:]

Thanks, two questions please. On the customer base, can you provide any color on what percentage of your customer base now is tenured or give us some sense about what's your base level is in that customer base? How much further the customer base could decline or any sort of color that suggests the X number or X percentage of those customers have been with you for 6 or 12 months or something like that to help us think about what trough could be like or base levels could be like on the customers? And then in terms of marketing spend and picking that up, do you already have line of sight as to when you want to do that or is that still purely condition -- or it is that totally conditional on operational improvements and the metrics that you track over the next 3 or 6 months at Linden and the other facilities? Do you already know when you're going to reaccelerate marketing spend or is it still conditional on A, B and C?

[Brad Dickerson:]

Yeah, Mark. I think both of those questions kind of point to the same answer and you just kind of mentioned it at the end of your question there, is that margin is a key driver of this going forward. So the ability for us to continue to work our way through product expansion and specifically work our work way through the Linden transition is really, really important for us relative to the attractiveness of marketing spend and growth in the future. So focused on getting OTIF in the right place, focused on getting margin in the right place is really going to be a key driver of our ability to reinvest in marketing and grow our new customer base going forward. So I can't give you a timeline right now, but I can tell you that the leading indicator will be our margins getting back to where we would like them to be and obviously OTIF getting into healthy zone too. So we're excited about the fact that we've fully transitioned both in product expansion and to Linden. That's a great opportunity for us now to start to optimize as we work our way through the rest of this year. We just really have to kind of see how things go the rest of this year to determine what 2018 looks like and when we can start to press the pedal down on marketing investment again based on those metrics. As far as your question around customer base and tenured and so forth, it does kind of go back to marketing again. So, obviously, when we pull back on marketing, the biggest impact of that will be new customers, which will automatically skew you to more tenured customers when you pull back on marketing. So we saw that in Q3, we'll see that in Q4, obviously, also as we talked about in my prepared remarks that we are going to be pulling back on marketing even more so in Q4 than Q3, as we continue to focus on OTIF and operational improvements. So, again I would expect that when we do that your customer base will swing more towards tenured versus new, and the ability again for us to swing that the other way would be when margins and OTIF are in the right place and reinvest in marketing and start to grow new customers again at some point in the future.

[Mark Mahaney:]

Okay. Thanks, Brad.

[Brad Dickerson:]

Yes.

[Operator:]

Our next question comes from Ross Sandler of Barclays. Please go ahead.

[Ross Sandler:]

Great. Two questions for me. Can you guys talk about the last 90 days you have ramped up national volume at Linden I think to 29% to 50%. What learnings have you on path and -- or how much of the kind of kinks have been ironed out? And can you just like stepping back remind us, with this new automation, what is unlocked in terms of future innovation in products, in recipe, in selection for the business, once all the transition issues are done? And then the second question is going back to the order frequency question from earlier, the orders per customer increased in 3Q, I think Brad, you said it was mostly the new product changes, didn't get rolled in until the very end of 3Q. So was that just a function of less volume on the new customer side in the third quarter and that we should continue to see that to improve as we go forward, just any comment on order frequency looking forward? Thanks.

[Brad Dickerson:]

Let me take that last question first, and then I'll pass it over to Matt to talk about learnings from Linden and so forth. On the order frequency, you are right, so, obviously, a pull back in marketing, means less new customer growth, more tenured customers that are with you through the whole quarter. So that does impact those metrics to some degree. That's probably the biggest driver of some of those metrics, is this kind of year-over-year change. And obviously last year we're spending a lot of money on marketing and growing a lot of new customers versus this year. So that probably had some of the biggest impact on those metrics more than anything, it's just the fact that we're more tenured this year because we pulled back on marketing. As far as what that means going forward, same thing again like in the -- when we pulled back on marketing, our spending to marketing that will impact new customers and that will have a natural impact on some of those numbers. That being the case to Matt's point before, a lot of things that we can do on average revenue per customer are really important for us to continue to focus on. So, more recipes to choose from, the ability to have less or more recipes per week, 30 minute meals, all things that Matt talked about, we are seeing early signs, although very early and we anticipate and expect in the future that those things will have a benefit to some of our metrics around ordering more, more revenue per customer on a regular basis, and so forth. But really again, too early to tell exactly what -- how much that will come into play and so we kind of fully see that roll out into the future, and obviously another important part of that getting OTIF and margins in the right place too, so we can get back to kind of the normal cadence of marketing spend.

[Matt Salzberg:]

With respect to Linden, there are a lot of learnings from Linden obviously. I think one of the things to consider in understanding the performance and the ramp up of Linden is how much volume we transitioned from our Jersey City center to our Linden center and how quickly we did that. I think we did that ambitiously and perhaps a little too ambitiously in terms of how we ramped that center and the management bandwidth that was spread between those two centers. And so I think that was one learning, but something that we powered through and are happy now that all of our management attention is focused on one East Coast center looking forward. I think part of that includes learnings about employee onboarding and employee training to make sure that as we onboard hundreds and hundreds of new employees working through new more complex processes that we really focus and we are going through extensive trainings in our fulfillment centers to acquaint employees with the changed management and the new processes and new equipment that we have there, so I think they are some good learnings from that. As well as with new equipment installations and food manufacturing technology, the support and uptime considerations and the changed management associated with that. And we did have some challenges during the quarter, when we installed new equipment in terms of the time it takes to get them installed and up and running and performing to expectations. And so, I think none of these things in and of themselves are super complex crazy things that we shouldn't be able to figure out, it's just we did a lot in a short period of time and it was a pretty ambitious plan. And so I think we've learned from that and we are really focus on getting all of those things right and hope to see the benefit from the investments that we have made in Linden, in those capabilities over the coming period of time.

[Operator:]

Our next question comes from Rupesh Parikh of Oppenheimer. Please go ahead.

[Rupesh Parikh:]

Thanks for taking my question. So I will start a question on the competitive environment. So we saw Albertsons' recent acquisition equated. So I was just curious based on your surveys, is there a desire from your consumers in terms of potentially taking out meal-kits versus having them delivered? And also just wanted to get a sense, just given some of the competitive developments, how you guys potentially think about partnering with retailers? Thank you.

[Matt Salzberg:]

Yes. It's a good question. Thank you. What I will say and I've spoken about this a little bit in abstract is that, we are serving a wide group of consumers out there and there are different segments of consumers. There are some customers who just hate the grocery store. They don't want to go to the grocery store. It's an awful experience for them. They just want someone to stock their fridge for them every week and they don't want ever think about it. There are other customers who love the grocery store. They have been going to the grocery store for decades and they have great relationship with their grocer. They love touching, feeling the product. And I think, we think over the long time horizon certainly more and more dollars are going to shift online from offline grocery. But that's not a transition that's going to happen overnight. And in fact, I think one of the things we believe is that different customers are going to want to get their groceries, their food, meal experiences like the ones we offer included in different ways that serve them depending on what's convenient for them. And so we do see an opportunity for products like ours in other kind of channels other than direct-to-consumer delivered e-commerce. And I think that's certainly something that has a different cost structure, has a different inventory model, has potentially different kind of segments and product design that it serves, but is an interesting expansion and business opportunity for our business and the like. So I think we've done some partnerships in the past. We certainly always routinely look at opportunities to expand our brand reach and expand the way and improve the way that we serve our customers and reach new customers. And so partnerships are things that we look at on a case-by-case basis.

[Rupesh Parikh:]

Great. Thank you.

[Operator:]

Our next question comes from Brian Nowak of Morgan Stanley. Please go ahead.

[John Lane:]

Hi, guys. This is John Lane coming on for Brian. Just another question on sales and marketing, this expense line item has fluctuated a fair amount in the past year, how are you guys thinking about spend here? Specifically what are you guys finding effective? What works best, is it order discounts, referrals, search, TV, radio? And then maybe what isn't working? Where are you going back on spend? Thanks.

[Matt Salzberg:]

Well, I think as we've been looking at staging our marketing budget, there are a couple of considerations we take into account. Obviously we mentioned the direct returns on marketing spend as it relates to customer lifetime value and the impact of quarterly fluctuations in margin on driving that and there is seasonality components to how we stage that as well. As we've thought about scaling and staging our marketing budget, in periods where we decreased the total budget that we're working with we see opportunities to spend incrementally on more efficient channels as a mix of our total budget. And generally speaking that is the online channels versus the offline channels, where we're shifting some of our spend in recent quarters more towards that offline mix as a percentage in total. So we do see opportunity there. We do have been looking at things like product marketing and monetization marketing that are not just acquisition oriented. And thinking about how we unlock incremental profit opportunities and revenue opportunities through that kind of marketing as well. That's been an increasing focus of ours. And we continue to plan to continue with that.

[John Lane:]

Thanks.

[Operator:]

Our next question comes from Mark May of Citi. Please go ahead.

[Mark May:]

Thank you and I apologize if these have been asked already. But what role if any did change in plan mix have on average revenue per customer in the quarter? And another question is I know last year or I think last year in Q3, you -- is a fairly competitive period, and you guys decided to sort of lean into that and spend pretty meaningfully and aggressively. This year it appears that you're taking a different [tap]. I guess trying to understand a little bit if that's what you -- kind of what's going on here as you're basically rethinking your allocation of marketing spend seasonally and if that's the case how we should be thinking about your marketing spend going forward from a seasonal perspective?

[Brad Dickerson:]

Yes, Mark. So first question on the plan mix that's been relatively stable in consistent over the last few years since we put our family plan in place of the mix between the 2 person plan and the family plan. So there is any sort of really significant changes there that we've seen. It's been relatively consistent across quarters, so no change there. Obviously in our 2 person plan going forward now that we have two recipes versus three recipes for which we could choose from there is a mix factor there that again with rolling this out recently and completing the roll out product expansions pretty -- very, very early to tell of the impact that that would be if anything. So we'll kind of look those metrics as we go through Q4 and early next year seeing how much of the mix shift between the two of those choices for a 2 person plan. As far as the marketing spend, this really goes to a couple of things. One yes, we were very aggressive last year in our spend and then also if you remember, we talked earlier in previous earnings call about being more promotional also in Q3 last year too, so that's part of this also. The difference impact this year is not really -- it's not really more strategic or seasonal than it is about the conversations that we've been talking about relative to really focused on getting our customer service levels and OTIF back in the right place. Focused on operational improvements, product expansion has been -- is a pretty big change for us. So it's been challenging across our facilities let alone in Linden which is a brand new facility that's three times the size of the older facility. We had a lot of work to do on the operations side. Again we are fully rolled out in product expansion. We are fully transitioned to Linden Q4 and as we roll into next year, it's a great opportunity for us to continue to focus on improvements there, get our margin structure back in line and with that it gives us the ability to invest in marketing and have good returns on marketing. So the reflection of the year-over-year change in marketing is more about the internal focus of us getting our operations in line, getting margin structure in line than it is really any kind of strategic seasonal strategy at this point.

[Mark May:]

If I could ask a follow-up, can you comment on the percent of revenue that came from repeat orders and how repeat orders really compares to the average?

[Brad Dickerson:]

Yes. We don't really discuss those metrics on a quarterly basis. And again, I would say, it's a little challenging, when we go through this change and we are going through the back half of this year and pulling back on marketing, which tends to shift your customers more to tenured versus new customers, because of the pullback of marketing. With a lot of the operational things we are focused on right now, it's a little bit tough to really say what the impact of some of these things are on all of these metrics together, let alone the fact that that's when we probably don't really talk about on a quarterly basis as much as we do kind of, maybe on a go forward on an annual basis.

[Operator:]

Our next question comes from Youssef Squali of SunTrust. Please go ahead.

[Youssef Squali:]

Thank you. Not to beat a dead horse on this marketing spend, but I think it is a crucial question. So basically to reaccelerate the marketing spend that depends on margins and OTIF. I think Brad, I think you mentioned, three to four times now that you won't do that until those metrics are at the right place. So OTIF you are not disclosing, margins we do have. So is there [indiscernible] threshold of where margins or you'd want margins to be before you reaccelerate the marketing spend? Maybe, you can just help us understand of that 700 basis points decline in gross margins, how much of that is kind of the low hanging fruit, i.e., [condition] costs that will disappear and how much and basically how long they will take to hopefully get those margins back to a level or at that right place? And I have a quick follow-up.

[Brad Dickerson:]

Okay. So a couple of things there, one is what margin structure we point to -- there's not a specific margin number in line. Obviously we have seasonal components to margin also. So looking at margin more holistically on a annual basis, that is not an exact number that we would point towards, because there's so much connectivity between margin and marketing return and all the other metrics we're talking about. They have to be taken in a consideration kind of in a balance. So that's important to note that. Although, we obviously want to and need to see margin improvement to reinvest in marketing, it's not the only input to our decisions around how much we spend and lead into growth. There is a lot of components that we've talked about historically around seasonal parts of the year where customers are more engaged and less engaged and so forth. So there is a lot of input to that. But that being the case obviously as we are speaking here a lot today increase in margin and margin improvements are very, very important. Now as we look from Q3 to Q4, there are some important seasonal -- natural seasonal components of margins that we should just absolutely see improvement in going into Q4. Things like summer packaging, obviously in the summer months we have to put more packaging into our boxes to keep the product cool. That also increases not only packaging costs but shipping costs, because of weight. So there is some natural costs that start to go away as we head into the fall months. In addition to that, we tend to lean into more seasonal produce and specialty produce in the summer months and that also comes at a little bit of a higher cost. So as I said in my prepared remarks just naturally moving from Q3 to Q4 and looking at the increase that we are anticipating in margin, probably a little bit more than half of that is just really from kind of natural cadence of seasonal things that go in margin. And the rest of that in Q4, really improvements that we see across our facilities specifically in Linden as we continue to optimize now that we are fully transitioned. Again as we roll forward this year and go into to next year, [beyond] what we have is probably a modest improvement in Q4 that we anticipate in some of the operational things. We would anticipate that as we roll into this year, that we have again tremendous opportunities to continue improve margin going forward. Again, I can't give you a specific number we are shooting for. Obviously, we are going to talk about 2018 in a lot more detail on our next earnings call. I can probably give you a little more flavor around where we see margins and where we want to see margins going forward and how that would impact our marketing spend and growth in future quarters.

[Youssef Squali:]

Okay. And then lastly on cadence, I know you are not guiding to 2018. But where are you of course now where particularly in considering the decision you've made about in California that 2018 should already start to showing what maintenance CapEx should be or do we still have instances of heightened spend in 2018? Thanks.

[Brad Dickerson:]

Yes. So if you just go through the previous guidance I gave on CapEx, back in the earlier call in August, I basically guided to a $20 million CapEx number in the back half of 2017 and an additional range of $20 million to $60 million throughout all of 2018. We are sticking to our $20 million guidance for the back half of 2017. So again, we spent about $11.5 million here in Q3. So we'll have a little bit more in Q4. The $20 million to $60 million range in 2018, we really haven't spent enough time yet kind of going into detail and analyzing that, it's a pretty wide range. I would expect, when we talk to you in February around 2018, we'll probably narrow that range somewhat. But I would also expect that from a 2018 CapEx perspective with Linden built out, with automation equipment mostly in place and with plenty of capacity in the foreseeable future that I think to your point that you are going to have more of a normalized CapEx number here in the back half of 2017 and 2018 versus what you saw from us maybe in the front half of 2017 and back half 2016.

[Youssef Squali:]

Okay. That's helpful. Thank you.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Salzberg for any closing remarks.

[Matt Salzberg:]

Thank you everyone for your time today and we're looking forward to continuing the conversation the next time.

[Operator:]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.