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Edited Transcript of ZAL.DE earnings conference call or presentation 10-Aug-17 7:30am GMT

Thomson Reuters StreetEvents

Q2 2017 Zalando SE Earnings Call

Berlin Aug 12, 2017 (Thomson StreetEvents) -- Edited Transcript of Zalando SE earnings conference call or presentation Thursday, August 10, 2017 at 7:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Birgit Opp

Zalando SE - VP of Corporate Finance & IR

* Patrick Kofler

* Rubin Ritter

Zalando SE - General Manager and Member of the Management Board

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Conference Call Participants

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* Anne Critchlow

Societe Generale Cross Asset Research - Equity Analyst

* Dan F Homan

Citigroup Inc, Research Division - VP

* François Halconruy

* Georgina Sarah Johanan

JP Morgan Chase & Co, Research Division - Analyst

* Graham Ian Renwick

Exane BNP Paribas, Research Division - Analyst of General Retail

* Jurgen Kolb

Kepler Cheuvreux, Research Division - Analyst

* Michelle Wilson

Berenberg, Research Division - Analyst

* Volker Bosse

Baader-Helvea Equity Research - Co-Head of Equity Research

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Presentation

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Operator [1]

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Ladies and gentlemen, welcome to the Zalando conference for the publication of the second quarter 2017 results. At our customer's request, this conference will be recorded. I would like now to hand over to Patrick Kofler, Team Lead Investor Relations, who will lead you through this conference. Sir, please go ahead.

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Patrick Kofler, [2]

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Good morning ladies and gentlemen, and thank you for joining us on our conference call today to review our second quarter 2017 financial results. As usual, with me today are Rubin Ritter, one of our 3 co-CEOs responsible for finance and operation; and Birgit Haderer, SVP Finance. Each will be available for Q&A following today's call. This call is being recorded and webcast live on our Investor Relations website, and a replay of the call will be available later today.

Now I'll turn over the call to Rubin who will review our Q2 results. Go ahead.

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Rubin Ritter, Zalando SE - General Manager and Member of the Management Board [3]

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Yes, thank you Patrick, and good morning also from my side. Thank you for joining our call. As always the call will have 4 parts. We'll start with the results highlights and business update. We'll then take a closer look at our financials. We'll then comment on our guidance and then we have time for your questions.

So let's go ahead and start with the result highlights. So in the first half of 2017 we continued to see very strong growth at the solid level of profitability. We have been able to grow 21.5% in the first half bringing us to save about EUR 2.1 billion in the first 6 months of this year which is well within our target range of 20% to 25% growth. Actually GMV grew substantially faster at about 25% in the first half which indicates the partner program continues to grow over-proportionally and which I feel is very much in line with what we commented on the Capital Markets Day that we expect a picture where GMV growth is going to be more towards the higher end of our target corridor.

So I think this is very much in line with our strategy. We continued to significantly outperform the growth of the overall online fashion market and very aggressively gain market share and really make use of this continued window of opportunity that we see to grow our business.

On the profitability side, we achieved solid adjusted EBIT of EUR 102 million which is at the same absolute level as 2016 which translates into a profitability of 4.9% adjusted EBIT margin. As you know, we continued to invest to allow us to reach our long-term growth objectives which was also implied in our full year guidance that we gave at the beginning of this year.

In terms of cash flow dynamics, we see that the operating cash flow remains clearly positive. The free cash flow is impacted by the high level of investments we are making, most importantly in our logistics infrastructure, but also we see an effect from the acquisitions that we made in the first half of the year of Kickz, and also the increased investment in Anatwine where we now acquired a majority stake in the second quarter of this year. Now of course what are the main priorities in the second quarter and what were the areas that we invested in, I would like to run through some of the highlights, and I think you will see that really a lot of stuff is going on in parallel, a lot of things that we are driving in parallel around investing in our customer proposition, investing in our proposition towards brand partners and investing into our infrastructure.

So if I start on the customer side, we have launched a for-pay membership program which we branded Zalando Zet. I'll actually dive a bit deeper into this topic on one of the following pages. We have been able to extend our assortment quite substantially. We added 50,000 SKUs and now serve 250,000 SKUs which is I think an unprecedented level of selection for our customers. A lot of this increase is driven by the partner program where brands upload more and more styles, but also big part is driven by exclusive collections that we were able to bring online and offer to our customers to drive traffic. At the same time we continued to add new brands. We also serve the vast majority of fashion brands, but there are some that we are still hunting for, so we were able to get H&M weekday online which is the second H&M brand after Cheap Monday, and we also included a number of other interesting brands like Swatch, Thomas (inaudible) and [Drycon].

Then on the right-hand side of the page, we talk about the progress and the projects we are working on with respect to brand partners where we continued to push to make Zalando the online strategy for brands, so we were able to launch Nike on the partner program which I think is an interesting and big growth opportunity for the partner program in the next 12 months. We launched Fashion Trade which is a joint venture with Bestseller where we together aim to build Europe's leading B2B marketplace where brands and retailers connect to digitize the wholesale relationship. So I think this is yet another building-block of really digitizing the fashion industry.

And then we continue to integrate offline stores. We have integrated 4 Tommy Hilfiger stores in Berlin which brings us to a total of 14 connected stores and we continue to see positive feedback both from customers, but also from brands on the additional volume that we bring to their offline locations. Then at the center, the third area of investment continues to be the infrastructure to build really the basis for digital fashion industry in Europe. We have put significant effort into scaling of European operations network.

This is actually a big focus of our investment. So I will also comment here in more detail on one of the following pages. We continue to expand our same-day delivery and return on demand network. So on same day we are now serving 8 cities across Europe return on demand, we now also have 18 cities, 12 of them in Germany, 6 outside of Germany which is an initiative that makes returning even easier than before which we know will drive return rate, but more importantly will also drive customer satisfaction and therefore also retention and lifetime value which is why we think this is a very promising initiative. At the same time, we commented that we want to open up our fulfillment network to our brand partners, most importantly those brand partners that are using the partner program and there we have been making a lot of progress. We have 5 external brand partners live in Zalando Fulfillment services and we have quite a long pipeline of additional brands that are eager to join.

So all in all, we are convinced that these initiatives are the right initiatives to drive growth for the quarters and years to come. At the same time, we continuously evaluate growth opportunities that we can invest in. We try to test many ideas and then we try to scale those that work best. And this may also include the expansion into fashion-related -- other fashion-related categories or taking our model into new geographies.

Now I would like to dive deeper into two of the initiatives already touched on, one of them being Zet and one being our Fulfillment network. So Zet is our membership program which is tailored to fashion. We have started the rollout in Germany and the vision of this program is really to build a program that defines the best-in-class online fashion experience for our best customers and that we can long term also use as a platform to launch and showcase our newest developments and innovations along the entire customer journeys for convenience, but also assortment access and discovery and advice. So I think in the beginning this will be a program that takes out and is very focused around convenience, but I think over time it will become broader and broader and involves more and more parts of the customer journey.

At the start, we will offer this program for EUR 19 to selected customers in Germany where they get the benefit of even faster delivery. So for Berlin we even offer same-day and also of more convenient returns driven by the return on demand program that we have been scaling for a while now. We'll offer early access to sales. We'll offer person stylist advice and we'll offer premium customer service. This will be the starting proposition that we hope to build on in the years to come. In terms of target customer, this program is open for all customers that want to sign up, but of course it is designed and tailored at our most active customers that have a very high overall online fashion spend and a very high shopping frequency.

The economic objectives that we are following is to of course increase the service to our customers, make them even happier, and therefore also increase their frequency and share of wallet that they spend with us and it also gives us a tool to really differentiate our service and offer the very best experience to our very best customers and this is I think a theme that we have discussed in several earnings calls and also several individual investor discussions. The rollout of the program is currently at the test phase in Germany and we'll then gradually open it up to all German customers and then based on that also consider to roll it out to more markets over time.

Now the second deep dive I would like to make is on our fulfillment network which is actually one of the biggest areas of investment. So here we are really driving a huge number of projects in parallel and to give you an idea of the magnitude of these projects I would like to briefly run through them. So in Mönchengladbach, we have been launching the Bagsorter in the second quarter which is our biggest automation initiative. It's already running at 75% of the full capacity and some of you were able to take a look at it during the Capital Markets Day. I think it's a very promising project. Then we have launched at the beginning of the year the satellite warehouse in France close to Paris which is already shipping and delivering 50% of the orders made by French customers.

We continue to ramp up Lahr, the inbound automation is already live and outbound is also on track and the volumes are scaling. We are preparing the launch of our Nordic Spoke for the fourth quarter to significantly speed up delivery times for our Nordics customers and we are launching actually in this quarter our new hub in Szczecin where first parcels are being shipped over the coming weeks. So this network once fully (inaudible) already brings us to a capacity of EUR 7 billion to EUR 8 billion in revenue potential.

Now at the Capital Markets Day, we already communicated on our continued growth ambition and we said that we want to double GMV by 2020 and we also talked about Zalando Fulfillment services where we want to open up our network to our brand partners where we see great interest. And based on those two goals, we have now taken the decision to actually further scale our network and we are planning to kick off 2 new hubs in the coming 6 months. We expect one of them to be located in Poland which will also going forward give us not only additional capacity, but also give us additional cost advantages. And the second location is most likely going to be the north of Italy which brings us even closer to our customers.

We see continued growth in Italy and we see that the satellite warehouse in Italy is working well, so we want to upgrade to a full hub which then also could serve customers in Switzerland, Austria and the south of France. Both locations will be similar in terms of layout and automation technology to the hubs that we are already operating and once fully completed these additional facilities will bring us to a total capacity of about EUR 10 billion in revenue. So I think that underlines that we actually really mean it if we say that we want to significantly grow the company also in the coming years.

Now I would like to dive deeper into our financials starting as always with growth. So the IPOs now -- was now 3 years ago and I think it's important to underline that since that time we have been able to meet or exceed our growth corridor in every quarter except for one quarter. So we are very happy that we were able to meet this corridor again in the second quarter of 2017. When we look one level deeper into the two regions you see that that continues to show very strong growth at scale.

We see even a slight acceleration compared to last year even though absolute volumes of cost have increased significantly and when we look at GMV where that is also the strongest reason for the partner program, GMV growth is actually higher than 20%. When we look at rest of Europe, we continue to grow over-proportionately with growth of about 25% and also here GMV growth is higher than 25%. One other area I would like to point out, which is not on the page, is our other segment where especially our off-price offering, so the Zalando launch and our offline outlets have been able to grow substantially at the level of more than 40% which is also very strong result and allows and supports the overall growth of the group.

If we look again one level deeper at the customer economics, we see also very interesting trends, especially on the active customer side. So we were able to grow our customer-base by 12.6% and specifically we are able to grow quarter-over-quarter by 800,000 additional active customers which corresponds to a pretty large city and I think this is a great result because we have been able to actually deliver the fastest active customer growth since the fourth quarter of 2015. And this is I think especially impressive because we have actually reduced our marketing spending. I will comment on that on one of the following pages, but it really shows that more efficient marketing spending, but also investments into the customer proposition start to really also drive active customer growth, but of course also spending for active customer where we also have been growing more than 8%. This is primarily driven by additional (inaudible) customers where we have been driving to new all-time high of 3.7 orders per active customers where we also see that customer satisfaction is really driving loyalty and is driving frequency.

Now if we come to profitability, here on the next page we have the opportunity to also look one level deeper at the different drivers. So overall we continue to deliver profitable growth at very solid margins. I think we can say that also compared to competition, our margins are at a very healthy level. And nevertheless we are emphasizing also the continued investments that we need to make in order to reach our long-term growth ambition. And this has been -- primarily these investments have been focused on the DACH region, as you can see from the page. I had commented on this already last year where margin had increased even above our long-term target of 10%, and to ensure that we keep growth in our biggest and most mature region very high, and like in the first half even maybe able to slightly reaccelerate. We have decided to reinvest some of this margin that went beyond the 10%. And we are now trading at about 10% EBIT margin which is in line with our corridor, and I think in combination with this continued very fast growth is a very good combination also from a financial perspective.

When we look at rest of Europe, the EBIT remains relatively constant at around break-even, which continues to be our strategy for those regions.

Now when we look at the margin trajectory from a P&L perspective, there are also some interesting trends to comment on. So I think the first comment is that especially the second quarter was a quarter of increased investments in order to drive long-term growth. And secondly, we continued to shift marketing spending into convenience investments and also to some extent into cost of sales investments. And especially in terms of fulfillment, this is a quite significant shift. We have been talking about this also in the past. The main reason is that we think that investments in these areas are the more efficient driver and the more sustainable driver of growth for the long term.

So if we go to the cost lines on gross margin, we see that gross margin slightly decreased by 0.4 points, which is within our budget and is a result of a number of smaller effects. So as you know, we are addressing even more younger customers and here we're also focused on offering attractive price points, this is also something we discussed on our Capital Markets Day. We have been taking in a lot of merchandise in the second quarter, more than usual, in order to have a lot of merchandise ready already for the fall/winter season, which increased inbound cost, which also flows into the cost of sales. We had some seasonal effect due to later mid-season sale. And all of that can only partially be compensated through economies of scale, successful renegotiation with our brand partners and also the effects from the partner program.

If we look at the fulfillment cost, we really think that this is the primary area of investment that we are currently focused on. I already commented on the number of warehouse projects that we are ramping up in parallel, which of course also means that we are incurring lower -- temporarily lower efficiencies. So this is true for Lahr, for Paris, for the new facility in Poland and also for the new satellite in Sweden.

We are launching automation projects which we think have a lot of efficiency potential long term, but in the short term also mean additional investment and lower efficiencies, so especially the Bagsorter, Mönchengladbachk, but also the ramp-up of Lahr which would be our most automated facility. We are investing into our proposition. I already commented on return on demand, and same-day delivery. I commented on Zalando Zet, I commented on scaling Zalando Fulfillment services, and we continue to invest in technology because in order to scale our fulfillment footprint in such an aggressive way, we have to make sure that really the technology infrastructure is also advancing at the same speed, which also takes additional investments.

I would like to make the comment that this does not impact our target model. So we think that the cost, if we look at the first half of this year of 25.9%, that is a bit above our long-term target corridor of 24% to 25%. We think that this is to a large extent also driven by the ramp-ups that we are currently putting forward.

Now this as I mentioned is partly financed by the significant savings we have been able to make in terms of marketing cost, where we have been winning 3.2 percentage points in the second quarter compared to last year. This is a function of continued operating leverage that we talked about also in the past, but it's also the result in many cases of a conscious shift of spending and investment towards convenience. And I think it is important in this context to note that still our active customer acquisition has been very strong. Actually also our level of business has been very strong around 600 million visits, which is also new all-time high. So I think this indicates that we are able to manage this shift of investment in a very good -- in a very good way.

Now some brief comments on CapEx and working capital. So on working capital we continue to be negative minus EUR 37 million which corresponds to 0.8% as percent of revenues. This is negative, it's slightly less negative than last year. I already commented that we are taking on a bit more merchandise even earlier. So this has been the main root cause for this development.

And then in terms of capital expenditure, we are spending in line with budget EUR 130 million in the first half of this year, EUR 52 million of that in the second quarter, the majority of that going into fulfillment, infrastructure, and around 1/4 of it going into own developed software.

In terms of liquidity, the picture remains unchanged EUR 1.1 billion for liquidity, EUR 130 million of that is invested in short-term investments, which brings us to a cash balance of EUR 975 million.

So with that let's come to the outlook for the full year 2017. I think it's important to start with our strategy which I think remains unchanged. We continue to favor growth over profitability in order to reach our very ambitious long-term targets of doubling GMV by 2020. In order to achieve this, we'll have to continue to invest. We'll be able to leverage our scale and our capabilities, but we also need to strengthen them even further. And for this, we are willing to trade short-term profitability to have long-term gains and long-term value creation for our shareholders. In this context and based on the performance in the first half, we are specifying our 2017 guidance as follows; on the revenue side we expect revenue growth in the upper half of the guided range of 20% to 25%. Please note that we're talking here about revenue, so this actually implies a GMV growth above 25%.

In terms of profitability, we expect adjusted EBIT margin to be well in the lower half of our guided range of 5% to 6%. This is driven by incremental investments to achieve higher growth this year and also in the coming years. And in addition, we are actually accounting for some inorganic growth initiatives. So already mentioned that in the second quarter, we acquired the majority stake in Anatwine which is an early stage software as a service company to more directly drive our long-term inventory integration strategy. This means that we are now fully consolidating this business, and this was so far not reflected in our budget and also not in the guidance at the beginning of the year, and this investment will have an EBIT impact of about EUR 10 million in the second half of this year.

In terms of CapEx and net working capital our guidance remains unchanged. We expect slightly negative working capital at the year-end, and we expect CapEx excluding M&A of EUR 250 million as discussed also during the Capital Markets Day.

To conclude, I would like to make a quick note and a quick reminder on the dynamics of the third quarter. As you know, the third quarter is a seasonally challenging quarter, so first of all, it is an off-season quarter which means that there is pressure on margins through discounts on spring/summer merchandise. And secondly we are very bullish on the fall/winter season overall as reflected by our ambitious growth targets. But we are not able to exactly time the season starts. So assuming normal market conditions, the seasons should switch in September.

So with that I would like to conclude the presentation and now give you a chance to ask your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We have a question from François Halconruy, Morgan Stanley.

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François Halconruy, [2]

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I guess I have two questions. The first one is, if I look at your first half, you delivered around 21%-22% of top line growth, with a bit of a margin decline. And the question I guess is what gives you the confidence to guide today towards the upper end of the 20%-25% for the full year in terms of topline? Is it the initiative that you've spoken about in your prepared remarks that you have rolled out in H1 or is it also a bit of easier comps, so that's the question #1. And the question #2 is specifically on the DACH region, so we've been -- I think you've highlighted pretty clearly that maybe you were over-earning a little bit last year and now you're reinvesting the excess, running at around 10% margin, we saw this adjustment in H1 already, but then the growth remained at around 15%-16%, do you think that this 10% margin run-rate you are operating at now let's say a good level to sustain this type of top line growth so mid-teens, around 15% or so?

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Rubin Ritter, Zalando SE - General Manager and Member of the Management Board [3]

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Yes. So on your first question what makes us confident for the second half of the year, so I think there are number of pieces. I think the first one is in terms of mindset we have asked our team to be very forward-leaning in terms of growth for the second half of the year. I think the second piece is of course due to the initiatives we have been launching in the past years. And also in the first half, I have been commenting on many of the initiatives we are driving and actually we expect them to deliver continued growth also in the second half of the year. Also I think maybe the growth benchmark from last year is a bit easier for the second half than it was for the first half, so when you study the numbers of last year more closely I think that also plays a role, but I think most importantly it's really a result of investing and asking the team to really be aggressive in terms of our growth strategy. On your second question with respect to DACH, so yes, as you say I think we -- it's great that we saw last year that the margin potential in DACH actually goes beyond our original target model, so I think that has been a very important proof point and I think that can also give everyone a lot of confidence that they have quite a lot of margin upside in the DACH region once we optimize even more for margin, but I think that is yet too early and if we want to reach our growth targets, of course we also have to have solid growth and strong growth in our most mature region because in terms of absolute growth that is of course a very meaningful contribution. This is why we have decided to reinvest some of the margin upside we had last year because I think if we had continued to run at margins of last year it's clear that growth would have to come down at some point. Now we are I think at a really strong combination in terms of having growth -- having profitability around 10% and having top line growth around 15% and in terms of GMV even around 20%. So I think that is a very remarkable combination also financially. Of course what we have to keep in mind is the increasing level of absolute growth, right? So when we grew last year around 15% and now again roll on around 15%, the absolute level of growth actually has increased significantly. And I think it is difficult to say that a combination of 10% margin and 15% or 20% growth in terms of GMV can be sustained for perpetuity, but I think we want to try to sustain that growth really over the coming years to make sure we build a stronger and stronger position in our core market.

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Operator [4]

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Our next question is from Georgina Johanan, JP Morgan.

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Georgina Sarah Johanan, JP Morgan Chase & Co, Research Division - Analyst [5]

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Just two questions please. The first one just on working capital, I know you touched on the stock increase year-on-year, but if my numbers are right for the year-on-year your closing stock position is actually up close to 50%. So should we read this as a message again of your confidence into the second half or can you just run through the timing again, is there any reason why you've brought stock in earlier, perhaps early discounts or anything you can share there would be helpful, it just seems like an awfully high number? And then second question on the gross margin, again I know you kind of touched on this during the presentation, but could you just run through the moving policy please and perhaps actually put a magnitude on some of the moving parts for us please?

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Birgit Opp, Zalando SE - VP of Corporate Finance & IR [6]

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Hi Georgina, it's Birgit. I'll take the working capital question. So yes, we're up year on year, and there's predominantly 2 drivers behind that. The first one is that obviously the business continues to grow as well and as such the absolute stock position is growing as well. And the second driver is what Rubin already mentioned before that we are as a sort of convenience investment into our customer are increasing the availability of the fall/winter stock already earlier, so we're ready for the season switch and could already kick off fairly early into the season.

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Rubin Ritter, Zalando SE - General Manager and Member of the Management Board [7]

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And then maybe I can make an additional comment on the development of cost of sales. So the different factors that I mentioned were, first of all addressing a younger and younger audience. We also mentioned on the Capital Markets Day that we think this is a very interesting strategy for us because acquiring a young customer means that we can actually keep them for a very long time because we do not only cater to young customers, we also cater to people in their 30s and 40s. So we are actually able if we acquire a customer at a young age to keep them for hopefully 20 years and more. And we have seen that the spending level of young customers actually increases over time as they start to work and start up income, they start to also spend more on fashion. So this is why we are quite focused on the young audience which is supported by our fashion which we sell more and more which is supported by our focus on mobile and which is also supported by offering attractive price points for this audience which again does not mean that we are becoming a discount or anything, it's just about offering an attractive price-point specially for the younger audience I think to some extent that's also comparable to the strategy of a source to also win customers with attractively priced products. Then we commented on the intake of more merchandize which also Birgit just commented on, on the working capital side, on why we do it. We talked about the shift in the mid-season sale, which is more a timing shift. I think in terms of magnitude those factors have similar contribution. As you can see all of them add up to I think relatively modest investment in the cost of sales and I think that should give pretty clear picture for you.

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Operator [8]

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Our next question is from Volker Bosse from Baader Bank.

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Volker Bosse, Baader-Helvea Equity Research - Co-Head of Equity Research [9]

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Volker Bosse, Baader Bank. Three questions from my side. First of all you stated to consider to expand into new markets and categories. So could you share your view on that, what are your priorities until when we can decide what kind of markets, categories you have on mind speaking about that. And second question would be about your impression about the overall competitive situation, how is that developing price pressure, do you feel that the multi-channel retailer out there becoming better, e-commerce retailer and more pressure from that side or how do you see the dynamic from that front? And finally the third one among others, your Adidas flagship store in Berlin is now also part of your partner program and perhaps would -- interested to get your first takeaways. How is the option to pick up merchandize in store accepted by consumers and your first outcomes out of that integration of stationary stores into your model?

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Rubin Ritter, Zalando SE - General Manager and Member of the Management Board [10]

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Yes, sure. So on your -- with respect to considering new categories and new markets, I think the general message is that since 2013 we have decided not to add new geographies or any new categories and that has been a deliberate choice because we said there's a lot of focus on in our existing markets and our existing categories. And the message I want to send is that we think it could become again more interesting over the coming years to also focus on this as a additional growth driver. There are number of things that we are looking at and that we are evaluating. There's nothing yet to be announced, but we just wanted to comment that we think this could be an additional layer of growth for the coming years. Also in the context that many of the products we are offering, by the way also offering to our brand partners are more and more digital and therefore also have different dynamics in terms of internationalizing them. So I think this is a general direction that we are thinking into and we'll let you know if there's anything more specific to follow up on. On your second question, the competitive situation especially with respect to multi-channel, so we have discussed on several calls that of course we are competing with Asos, of course we're competing with Amazon and I think the continued strong growth number that we show indicate that we have our way of competing in this market and that we have our advantages that we can build on. I think when you specifically ask for multi-channel and for sort of offline and yes, offline retailers going online, then actually you have to say that we don't really see an increase in the competition level. Actually, I would say that there we if at all see a sort of decrease in the competition level which is interesting because you have more and more online players like ourselves and Amazon and Asos that are really gaining strength and that are all growing very healthily which at the same time goes I think clearly at the expense of offline retail and multi-channel. So I think this is really creating additional space for us to grow. So if I see them that context, I think actually the competitor situation is developing quite positively for us. On your third question with respect to the Adidas store, so right now when we integrate a store we focus on delivering customer orders from the store which has a number of advantages. It allows for faster delivery, it allows for the brand or the retailer to leverage their physical infrastructure and generate more frequency in terms of more business and more sales. I think to direct customers to the store is a very interesting opportunity long term, but that also require some changes in our front end in order to be more location-based. So right now the focus is really on delivering from the store and sort of making -- giving the stores the opportunity to turn into a sort of mini inner-city delivery hub in order to drive more business.

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Operator [11]

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Our next question is from Graham Renwick, Exane.

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Graham Ian Renwick, Exane BNP Paribas, Research Division - Analyst of General Retail [12]

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Just two questions for me please. Firstly, the profitability in the other segment was stronger in Q2 with 900 basis points of margin expansion. Can you give us a little bit more detail on the drivers here? You talked around more profitable sourcing deals, so can you give a bit more color on that and whether the performance in the other segment was in line with your budget end of Q2? And secondly, you are currently accelerating the ramp-up of your hub and spoke network. It certainly looks like you're working on a lot more projects in one go than you have done over history. I just wanted to know what you're doing to manage the execution risk around delivering those network upgrades without disruptions for the network or the customer experience?

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Birgit Opp, Zalando SE - VP of Corporate Finance & IR [13]

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I'll take your question on the other segment or the -- especially the lounge business which is the vast majority behind the other segment and the profitability. So yes, you're right, profitability has increased quite a bit year-on-year. When you look at it, the lounge sources its merchandise from internally, so our other premises, as well as from externally. So the internal source part is less than 1/3 and 2/3 or more is from outside-sourced merchandise. When you think about the market dynamics, you'll see that whenever the markets are not doing super well, then the lounge business is profiting from that because there's more merchandise available and so there's better sourcing deals available for the business. And this is what we've seen in Q2 that, yes, the business was able to manage to source merchandise more favorably which you then see in an improved margin profile.

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Rubin Ritter, Zalando SE - General Manager and Member of the Management Board [14]

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And then to comment on your second question, so you are definitely right, I think what we're doing on logistics and fulfillment infrastructure and that was also important to me to really highlight this on this call to allow you to really understand why we are making these also significant investments in terms of EBIT and also in terms of CapEx that we are really driving a huge amount of projects in parallel and the reason why we are doing this is that we are just convinced that speed is important and that we really want to conquer these markets and win new customers and become better in our proposition and this is why we choose to invest so aggressively. And of course, to grow at such speed especially at such scale also means operational risks that we are incurring. And these risks and these growth risks always happen in the history of Zalando, right? So if I think back when we launched Erfurt, it was our first own facility. It was the first time that we actually constructed a warehouse. It was the first time that we made a concept for warehouse and it was the first time that we did the IT ourselves. It was the first time that we did automation ourselves and I think that was also a situation where the team was quite under some pressure to really deliver. And I think we have shown in the past that we are able to manage this type of expansion operationally. So right now what we're doing to manage in the best way possible is that we continue to strengthen the team. There's already a very strong leadership in place, but we have been extending the team in terms of site search capabilities, in terms of automation capabilities, in terms of network planning capabilities. So there we have been doing a lot of hiring. Definitely, we can build on our experience, so we always try to innovate in terms of the design of our warehouses, but to some extent, we're also able to do copy paste. So for example very likely a facility in Italy would be a copy paste facility of Lahr and that allows us to leverage really the work that we have done in the past and not have to do everything from scratch. And then I really also can say the team is super-motivated and super-fired up because they see this really -- this is the -- by far the biggest B2C fulfillment infrastructure in Europe besides Amazon. And I think that is something everybody that is doing something around logistics dreams of and therefore we are really able to hire and motivate a great team and we are confident that they will also deliver.

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Operator [15]

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Our next question is from Anne Critchlow, Societe Generale.

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Anne Critchlow, Societe Generale Cross Asset Research - Equity Analyst [16]

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I've got two questions. The first one is on the fulfillment costs and the outlook for that. So with regard to timing fulfillment cost to sales, when do you think the pressure will build and when do you think fulfillment cost to sales will peak given that you've got a lot going on with additional warehouses in Zalando Zet. So just wondering if that's going to peak in FY '18 for example? And then linked to that, my second question, what do you mean by solid profit profitability in terms of solid? So at what level would the EBIT -- adjusted EBIT margin not be solid? So if you went below that, at what level would it not be solid?

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Rubin Ritter, Zalando SE - General Manager and Member of the Management Board [17]

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Yes. So on your first question, when will fulfillment cost peak, so typically of course they are -- when you look at the quarterly perspective they are relatively high in the off-season quarters in the first quarter and then the third quarter that at least the typical seasonal pattern that we have. In terms of 2018, I think they will have to wait for the time when we give our specific full year guidance. Of course what you see from all of these projects is that we will continue to invest into fulfillment and we'll continue to see an elevated cost level. I think that is evident from these projects, but if it will peak in 2017 or '18, I think that is something we'll comment on later when we address 2018. In terms of when is the margin solid and when is it not solid, I think there are different ways to look at it. So I think in terms of -- when you look at it in terms of our own history, I think we have been able to in parallel to our growth really ramp up margins very consistently and then we think we should also continue to invest at this level while we have held them -- so in absolute terms stable compared to last year where we think the investments we are making absolutely have the potential to pay off in a great way going forward. So I think in terms of being solid, being not solid, I think there's a way to look at it from an absolute level. I think there's a way to look at it from a relative level. So when you're going to -- very close to break-even, then of course the margin is only slight margin, not a solid margin. I think there are ways to compare to competition where I think also in relative terms we are tracking quite well to our (inaudible) fashion online competitors. So I think it is a matter of interpretation, this is how I would interpret it and I -- most of the people I talked to actually agree.

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Operator [18]

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Our next question is from Jürgen Kolb, Kepler Cheuvreux.

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Jurgen Kolb, Kepler Cheuvreux, Research Division - Analyst [19]

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Three questions from my side please. On the expansion with your warehouses, could you please share with us the project time that you're putting in here in terms of total CapEx volume which years will be affected, that'd be helpful? Secondly, on the increased share in Anatwine which you said was not in the budget in the beginning of the year, what caused you to share -- increase that share in Anatwine and what are the metrics behind it that you like so much? And lastly, on the merchandise intake again, please -- I mean I have fully understood why you decided to increase the merchandise intake for that season specifically; is that also referring to the -- your decision to be a little bit more active on the price entry level, the fashion area or maybe an additional word on why you've decided to be a little bit more aggressive this season?

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Birgit Opp, Zalando SE - VP of Corporate Finance & IR [20]

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I'll take the first two questions. So on warehouses and CapEx, so -- also when you look at our history and what we said before, it typically takes 3-3.5 years or so to ramp up a warehouse. And this is typically also where you see the vast majority of the CapEx being expensed or incurred. So then it depends a little bit on sort of the years when you start, do you start earlier in the year or later in the year, on how much it goes into a specific year, but in the end, it's fairly evenly distributed typically over that 3-3.5 years' time horizon. On your second question on Anatwine, as you know we've increased that stake in Anatwine piecemeal over the past roughly 2 years now. By working with the company, we realized more and more the importance of working on sort of -- or digitalizing the fashion inventory out there. Remember, we also acquired Tradebyte and did some other things around this whole digitalization effort. And for us, Anatwine is a key ingredient as part of this strategy. And so we decided earlier this year that it makes sense to increase the majority control to even have more, yes, push on the strategy and be able to influence the strategic path of the company. And when you think forward, you can think about scenarios where we really combine all our effort into or behind this digitalization effort. And just to repeat, so the impact in the second half is about minus EUR 10 million. As Rubin commented earlier today, it's an earlier stage (inaudible) company, so you virtually see very limited revenues at this point in time as the company builds its software and scales up. At the same time, though, you do see essentially the fixed cost behind the team.

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Rubin Ritter, Zalando SE - General Manager and Member of the Management Board [21]

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And then on the third question in terms of merchandize intake, so this does not change really our assortment strategy, it also doesn't change the assortment mix. It's after a decision also compared to last year where I think, the merchandise intake from our perspective was a bit too late on hindsight. And we thought we left some growth on the table. So there we are trying to just have the delivery curve slightly earlier. This is not a massive shift, but it's just a shift that has some effects, so I wanted to comment on it.

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Operator [22]

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We have a next question from Dan Homan from Citigroup.

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Dan F Homan, Citigroup Inc, Research Division - VP [23]

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First question for me, first on the fulfillment cost, the 230 basis point increase in fulfillment cost in the first half, are you able to quantify how much of that investment went into the warehouse ramp-up versus the investment in customer proposition and convenience? And then second question, just going back to the M&A, could you quantify the impact of Kickz on the financials in the second half both on top line and EBIT?

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Rubin Ritter, Zalando SE - General Manager and Member of the Management Board [24]

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Sure. I'll briefly cover on the first question, Birgit will take the second question. So in terms of fulfillment cost, we don't specifically break out the fractions of this investment. Of course to some extent those 2 areas are also linked. So for example when you open a satellite warehouse in Paris that brings you capacity, at the same time it enables you to do same-day delivery in Paris. So those 2 investments are of course also very tightly linked to each other.

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Birgit Opp, Zalando SE - VP of Corporate Finance & IR [25]

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And then on Kickz, just to quickly recap for everyone on the phone, that was an acquisition we did in Q2. It's a small specialty retailer, online and offline, focused on basketball and streetwear. When you think through the P&L impact from a top line perspective, it's a very small top line contribution given it is a small niche provider. We did not acquire Kickz because of its top line contribution to inorganically grow our top line, it was really more around the specialty knowledge that resides within that company around basketball and streetwear. From a bottom line EBIT perspective, the impact is also very marginal. The business is break-even, but at a very low level and as such is a, yes, very small impact only on our overall group level.

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Operator [26]

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Our next question from Michelle -- our next question is from Michelle Wilson from Berenberg.

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Michelle Wilson, Berenberg, Research Division - Analyst [27]

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Two questions for me please. First of all, just want to follow up on the question around the acceleration in revenue growth in H2, I know you mentioned you've asked teams to be more aggressive and forward-leaning, but could you give any more detail around the levers the teams have to pull to achieve that? Will it affect pricing at all or perhaps promotion activity? And then second of all just on reverse factoring, I notice that the balance there has been increasing to quite a material level now. And given you're paying interest on that loan, I just -- I guess looking for an explanation of why you choose to use a loan to fund that inventory rather than the EUR 900 million of cash that's on the balance sheet? Is there something that that cash is kind of being set aside for? And also are there any conditions attached to those loans along the lines of revenue growth or profitability?

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Rubin Ritter, Zalando SE - General Manager and Member of the Management Board [28]

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Yes, sure, I'll take the first question on the second half. So, yes, I said -- we asked the team to be more forward-leaning, but I also said that of course the growth relies on the initiatives that we have been driving over the last quarters and frankly also years that we have been talking about. So we expect these initiatives to have a positive impact. Of course it's also -- in terms of having lined up a great assortment, making sure it goes online really early and on time for the next season. I think promotional activity, we will not change our promotional strategy for the fall/winter season. Of course, you will see increased promotional activity in the third quarter and around Black Friday. But in the fall season we will I think play the season quite similar in terms of our promotion strategy.

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Birgit Opp, Zalando SE - VP of Corporate Finance & IR [29]

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And on reverse factoring, just a quick recap of what it is; so reverse factoring allows us in our tri-party agreement to extend our payment terms to the merchandize that we source from our brand partners. So what happens is we do receive an invoice from a brand to pay a certain amount. With the help of a financial institution we pay that invoice early and receive a early payment discount. So that's a positive for us. And then the bank extends that payment period for us and then we pay the bank at a specified point in time later and for that extension we do pay an interest expense. When you look at the sort of (inaudible) or discount environment relative to the interest expense environment today, you will see that the cost that we incur is essentially negligible or not existent. And so as such for us it's a very good tool to effectively manage our working capital. You also asked if there's any conditions attached. The answer is no. Also when you look at our financial profile today you will see that we are investment grade and as such the terms that we receive on our financing are very preferential. I think we also commented on that in our earlier earnings call when we end of last year refinanced our revolving credit facility that we received very favorable terms, also no conditions attached.

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Operator [30]

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We have no other questions. I will hand back to you for the conclusion. Thank you very much.

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Patrick Kofler, [31]

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Thank you for joining us today. And if you have any further questions during the day or afterwards, just do not hesitate to reach out. Thank you for joining again and have a great day. Bye-bye.

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Operator [32]

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Thank you. Ladies and gentlemen, this concludes today's conference. Thank you all for your participation. You may now disconnect.