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Edited Transcript of ZO1.DE earnings conference call or presentation 14-Aug-19 8:00am GMT

Half Year 2019 Zooplus AG Earnings Call

Aug 20, 2019 (Thomson StreetEvents) -- Edited Transcript of Zooplus AG earnings conference call or presentation Wednesday, August 14, 2019 at 8:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Cornelius Patt

zooplus AG - Chairman of the Management Board & CEO

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Conference Call Participants

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* Alvira Hamid Rao

Barclays Bank PLC, Research Division - Research Analyst

* Nikolas Mauder

Kepler Cheuvreux, Research Division - Junior Equity Research Analyst

* Sasha Karim

Inflection Point Investments LLP - Partner & Portfolio Manager

* Wayne Mervyn Brown

Liberum Capital Limited, Research Division - Research Analyst

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Presentation

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Cornelius Patt, zooplus AG - Chairman of the Management Board & CEO [1]

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Good morning and a very warm welcome to everybody that has dialed into our call on the first half year results of 2019.

It's peak holiday season. On top of things, in some countries in Europe, there is a holiday tomorrow. And so we very much appreciate your presence in this call. We will cover, as usual, the financials. In particular, we will look also into the already-published growth figures, our top line performance. And we will, let's say, give you background information and strategic assessment of the situation.

Let's start with Page 3, which gives you an overview what we have been achieved in the -- been achieving in the first half of the year. Most noticeably and already known is that sales growth has stabilized in the percentage sense so we made the sales turnaround in the second quarter of 2019, having achieved a growth rate of 14% in that quarter over the quarter 1 year before. In total for the full year -- for the first half year, we still look at a growth rate of 13%, taking total sales to EUR 727 million. Within that sales growth, we have 2 particular encouraging and important movements. We see that private label sales is up by 29%, so more than double the growth rate that we have in our overall business. And you also see that the registered new customers are up for the first half year over 1 year before by 23%.

So we're able in the 20th year of operational zooplus to scale our new business, and we scale it quite noticeably with that 23% up over the 1 year before. We also have achieved a gross margin, not only stabilization, but improvement over 1 year before by 0.7%. Anybody that is familiar with retail and with e-commerce, in particular, knows that this is a very important achievement. And it is a, let's say, important win for this company. We'll go into the details what kind of contributing factors we had in order to improve the gross margin.

At the same token, we have seen improvements for our total -- for our bottom line performance. And EBITDA is positive at EUR 4.5 million, and that is a significant improvement over 1 year before when it's been slightly negative. EBT, we'll get to this one, is still slightly negative. But that is due to the cyclic nature of our business with having, let's say, less gross margin in the first half of the year and more gross margin in the second half of the year. And, in fact, that we've been observing consistently over the past years. That it is also going to kick in this year.

If we look into free cash flow, again, we've been able to grow the business while freeing cash. So the working capital intensity has been reduced even further, and we were able to produce free cash flow of EUR 7 million. That puts us into the position, all of that combined, to confirm our guidance on sales and EBITDA.

So now let's look into the details. We will take you through the 3 main topics. The one is the growth. The other one is the competitiveness and the cost efficiency of this company. And then lastly, we will also have a couple of details and drill down on financials, as you'll probably also appreciate.

Now let's look into the growth, as you can see, we are on a good path and again added something to around EUR 200 million to our top line performance in the year of 2019. We still work with a range of plus EUR 190 million to EUR 240 million since we are a, let's say, quite a large company. And since we see major shifts in what happens in new customer acquisition, we also see a bit of impact of GDPR. We'll go into details on this one.

I would like to put the give and take EUR 200 million of added sales in this year into perspective. And this means that in the 20th year of operation, we are again taking 0.7% [-odd] of the total market additionally into the business model of zooplus. Or if you refer to the core of our business, which is specialty trade, we take another 1.5% of the total specialty trade market into the business model of zooplus. No small achievement and well done by the team, I would say.

Now let's look into what exactly has been driving the sales growth in the first half of the year. We have seen the additional sales -- gain of new customers, which is 23%. We see a bit of a dent when it comes to early-stage repeat customers' loyalty, and that is very important to see that. And if you look at the retention rate, we'll get to this one. You see a slight dent, and it is down by 2% from 94% to 92% but still at very high levels, typical of zooplus and typical of the business model that we operate.

The slight dent is mainly explained by 2 factors. The one is a smaller cohort than we were able to groom in the year of 2018, which simply reduces the base for these early-stage repeat customers in the year of 2019. And secondly, we have an impact of GDPR, which makes it more difficult to naturally onboard the people after first transaction to, say, something like 6 to 8 transactions, where you typically then have very stable repurchasing pattern by the people.

If you look into the structure of the sales, we also see that private label continues not only to be a driver for growth, but also for -- a driver for loyalty. And we see that we shift our business further towards food, which is the most sustainable part of the pet retail business.

The regional breakdown shows you that we continue to operate with some typically double-digit growth rates. We are minimally below that level in Italy and Spain, but that is really just minimally. And we have a special situation in the U.K., where all the uncertainty around Brexit, of course, is to realign our assortment for our U.K. customers and be more focused on what we can deliver using our Coventry fulfillment center, and that we operated successfully for about 2 years now in the U.K. So -- and we are down when it comes to growth rate, but we are prepared for being, let's say, much more self-sufficient winter in the U.K. market using our U.K. fulfillment center structure. And that, let's say, came at the price of slightly reducing the number of available SKUs in that market in some lines of business, most noticeably our bitiba line of business.

If you now look into another very important market, which is the region of Germany, Austria and Switzerland. And you will see a growth rate of 14%, which shows you that we are, let's say, after 2 decades of doing business exactly in that region, we still are able to shift people from off-line to online. But this shift had now, let's say, has gotten the second wind by the simple fact that our previously completely online-focused advertising strategy has been expanded. We explained that in the previous calls, to off-line measures of traffic acquisition for advertising and expanding. The 20-year campaign of zooplus clearly had one of, let's say, the focus country, I mean, for exactly this 20-year campaign was Germany. And I'm very happy to see a 14% growth rate exactly in that core market, which happens also to be the biggest market of Europe.

So let's move on to the retention rate. At the retention rate -- looking into the presentation, you might see -- you see 2 effects. It goes down from 94% to 92%, mainly because we now have stronger new customer intake. And people that have been looking into the details of our numbers, know that the retention rate year of acquisition and in the year, let's say, following the year of acquisition tends to be a little bit lower than normal. Now that we're taking more new customers, that also, let's say, shifts the cohort structure and explains partly why the compound or the overall sales retention rate is slightly down.

And the other key fact is that GDPR, which has changed the rules for direct marketing has given, let's say, restrictions but also opportunities. But the remaining opportunities are to sustain contact with our customer base and exactly the early-stage customers that we have been probably a bit slow to exploit. Put differently, we have implemented everything that GDPR imposes on us, but we haven't probably unlocked all the, let's say, remaining opportunities that stay after GDPR has been put into place. We're working with this one and jointly with the new customer intake with the effort of branding and making, let's say, the brand, zooplus and also bitiba a more -- most-reported to the customer. And we have a third pillar and that means that we're working on staying better in touch with our customers. And that we see as a compound set of measures that is going to stabilize the retention rate at the levels of above 90% that have been, let's say, the hallmark of the late years or the most recent years at zooplus. And we see the sales retention rate is so critical for the future of our business, and we're going to defend the high level of 90%-plus.

Now again, some information on the top line. And we see that the registered new customer business rely on 2, let's say, measures that jointly support each other. We've been a bit skeptical, if you recall, in the beginning of the year, how far we can take Google or how far we can scale Google-driven customer intake. And what we see now in the course of 2019 that Google remains to be not only the most important customer acquisition channel, but it's also a channel that continues to scale.

And that is partly explained because we have now additional marketing initiatives, which are not competing against a traffic acquisition by Google. But in fact, the one supports the other and being more visible, being more prominent as a brand also helps you, when it comes to Google marketing and conversion of Google Ads and Google Shopping offerings that are visible. So overall, we see a healthy new intake of new business with growth rates of 23% over the first half year of 2018.

So this was the growth chapter. And now let's look into the competitiveness. And here, the most important information and that must be also for those that have been observing the company for quite some time, very good news. We're not only able to stabilize the gross margin as we already did it for the last 3 years, we are even able to improve the gross margin at zooplus. And now with an improvement of 0.7% over 1 year before.

Mainly, this has been done by not that much touching the article prices but looking into the order structure itself and reusing what is referred to as terms and conditions for the customer that is partly shipping fees for extremely bulky shipments that are, let's say, more focused allocation of discounts and customer benefits like the savings plan. And in total, we also benefit from the fact that the private label business, which has extra margin and is growing double the speed of our normal business. So put together, we're improving gross margin without sacrificing our competitiveness and in the core of our business.

The second bit good -- bit of good news comes when we look into our cost efficiency and see here the contrast from what probably would have been expected. And we've been able to further reduce the logistics cost. And in the year of 2019, we had some headwind when it comes to factor cost. So the individual cost of, say, shipping a parcel or having a, let's say, 1 worker working for 1 month in 1 fulfillment center go up. But we've increased the overall efficiency in transferring orders into parcels and number of parcels to be shipped. We've been even better at allocating the parcels to the most cost-efficient route and into the market. And that allowed us to improve logistics cost by roughly 1%. You see a bigger figure when you look into the comparison charts, 20.2% to 18.4%. But part of that is explained by the implications of IFRS 16. So net of that IFRS 16 effect, we still are down by a full 1% in logistics cost over 1 year before.

So that is the second bit of very important achievement. And you would now say, well, where does the money go? You have extra margin and you have lower logistics cost. And the answer is, we put it into mainly advertising, hence, also the progress in new customer acquisition. We put it into branding. And we put it into, say, the good people at zooplus that continue to improve the product and the IT infrastructure and the Pan-European reach of the business model of zooplus.

So again, a deep drill now into what has happened in the advertising and your information before Google continues not only to be the most relevant acquisition channel, but it is also a channel that continues to expand in total, significant in output. This expansion comes at some cost. And Google does not get less expensive, but this is an overall situation that you have across, let's say, many industries and across almost all regions of Europe and also the world.

In fact, Google simply does a very good job of building the most important online advertising channel. And in this one, it is even, let's say, significantly stronger than anything that Facebook could build, which is probably the second most important online advertising and traffic acquisition channel.

We see this as good news. We see it, let's say, as a bit of a problem that now everybody rushes into Google. But since we have probably longest history of optimizing Google and since we have very good customer long-term value, we can live with a slightly higher cost per new customer as long as we are able to continue to scale the customer intake. What has helped is that in the second quarter of 2019, we've seen, let's say, additional effects from, let's say, our marketing activities beyond Google that are complementing our investments into Google. But they are not really competing for the same type of customers. There's just a boost in the conversion rates. And they increase partially the amount of brand traffic.

Brand traffic is the number of people that directly enter zooplus or bitiba into the search or across the window. Overall, it's still a bit too early to evaluate the success of that combined and more comprehensive and also more costly approach of new customer acquisition in detail, but we see the good confirmation that we have 23% of new customers growth than 1 year before. So we seemingly are onto something and that looks, overall, efficient and good.

Now when we look into why we have improved the logistics efficiency by another 1% in just 1 year, clearly what sticks out is that we are now in all relevant, let's say, larger markets of Europe, in a position to ship parts of anything that we sell directly from the country from -- of destination.

We moved into the U.K. in 2017. But we also moved into Spain in 2018. And we moved into Italy now in a meaningful way in the year of 2019. So all core markets of Europe are covered. France, we did as of 2015. And Netherlands, which is an important market for us, we already did quite earlier, in 2009. Poland, we did in 2013. So now everything is covered, let's say, North of Wales, South of Wales and also the Peninsula and the U.K., which, let's say, increases the price but also some efficiency.

The second big -- a very important addition is that we've been setting up yet another large-scale fulfillment center in Poland, which is located now a bit further up and -- north and a bit further up to the west of the original location that we've been picking in Wroclaw in the year of 2013. We continue to use the Wroclaw location simply because it is too good and too much needed because we're growing the business so fast in output. We now have further capacity, which sit very close to important markets and take Poland itself logically and -- for Germany, but also for the Nordics. And we're also a little bit closer for inbound merchandise that is shipped through the Baltic Sea into Poland.

And so these two effects combined, let's say, being close to all of the larger markets with local fulfillment centers and having expanded overall capacity and in superefficient Poland was, let's say, it was the biggest contributor to the cost improvements that we've seen over 1 year before in logistics.

Now some more information on the financials. And you would see that in the first half of the year of 2019, we have EBITDA, which is now positive and at a level of EUR 4.5 million. It has been negative in the year before. But what you see there is simply an increased impact of IFRS 16.

If you look into the earnings before tax situation, we are in the year of 2019, with added investment in advertising, still slightly better off than the year before. We are at a profitability of minus point -- 1.3%. And that is a slight improvement over the year before. And that is -- has to be seen in the perspective of a cyclical business in the first of the -- half of the year, not all supplier terms and conditions kick in fully. And also, we have -- we tend to have a better margin structure and a sales margin structure in the second half of the year. And lastly, the second half of the year also simply yields more absolute sales than the first half of the year. And that explains that we are expecting the second half of the year to be significantly better in earning than the first half of the year.

Just recall what we've seen in 2018, we've been negative NOA, as you can see here of minus EUR 9 million in the first half of the year. In the second half of the year, we closed that, and we almost ended with neutral results for the total year on EBT level. EBITDA is going to be significantly positive for the total year for 2019. We will continue to produce positive cash. We will reduce the working capital intensity and may reaccelerate growth. So all happy and good here.

And we would now skip one page of detailed information. On Page 15, you would now see the cash flow, which has been positive from -- on operational level of -- at a level of EUR 9 million in the first half year. We have some investment -- in investing activities, and we have a free cash flow of EUR 7 million, again, generated in the first half of the year, which tends to be, let's say, the less good half of the year when it comes to making money.

So overall, we'd say a very healthy financials, improvements in all core indicators around our competitiveness when it comes to cost structure, when it comes to margin management, when it comes to increasing the private label share.

And now let's finish off our initial presentation before we go into Q&A, with having a bit of a look at the Chewy IPO that materialized in the second quarter of 2019. We see 3 key takeaways. Not only zooplus, but also Chewy is living proof that there is for pet retail, online, let's say, plenty of space next to Amazon and plenty of opportunity to clearly position yourself not only against the off-liners, but also against the online, generally the Amazon.

What we also see is that both companies, that is Chewy and that is also zooplus build their business model on recurring revenues. The main difference in our perception is that Chewy also takes straight into their acquisition strategy, whereas zooplus acquires still roughly half of the new business using accessories or, let's say, one-off demands. And Chewy is, let's say, a lot stronger at acquiring straight from the beginning, food customers that also have a higher subscription rate from, say, day 1 or from the first transaction onward. And that explains why their early-stage retention rate is significantly better than zooplus. We are, let's say, we see the benefits of this one, but we also see the significantly higher cost for new customer acquisition that incur using the Chewy approach.

If you look at the marketing spend, I'll give you one indication, marketing spend that Chewy is roughly 10%. Zooplus is 3%. And if you break it down per -- cost per customer, Chewy sits at roughly 3 to 4x the cost of customer acquisition than zooplus does. Overall, we try to merge, let's say, the best of both. We would like to keep up our high efficiency new customer acquisitions, but combine it with, let's say, more efficient lock-in mechanisms in the early stage of customer acquisition and subscription clearly is helpful on this one.

Once you look beyond that, let's say, 2, 3 years into business, say, with the customer, it doesn't matter whether you have subscription, whether people simply use a very efficient well-designed shop for purchasing the regular demand. You have the same, let's say, lock-in mechanisms of sales and very low churn rates whether you use subscription or whether you do it, I'd say, with the soft lock-in mechanism as we do it in zooplus.

So probably a lot has been set on the chart that has only 3 lines on it. Now again, let's go into the details if we compare zooplus and Amazon, we see that now there is more than 10 years, varies a little bit market-by-market, of coexistence between zooplus and Amazon. And if you recall that, we have growth rate of 14% in Germany, Austria and Switzerland, clearly, a market, in which Amazon quite early on moved into our category. Clearly, market in which Amazon has a very strong position. It shows that there is, let's say, a perfect, let's say, combination of Amazon, probably more catering towards the people that traditionally would cater for their pet using grocery channel and probably they have in some pockets of our -- of accessories business, a slight lead against zooplus.

Zooplus clearly is the pet specialist that is best at providing anything that you would find in specialty trade offline business. We see that the presence of Amazon doesn't stop us from having high retention rates and the record new customer intake. And lastly, we see that our branded goods partners really appreciate the premium focus that zooplus has and the premium customers that the zooplus has. Thanks to Chewy, they take probably a lot more of an emotional approach. They are, let's say, more aggressive in locking the customers in the subscription at early stage. But we look into that one on the next chart, and then the following chart.

So the sales retention rates we can compare to Chewy, which in their current structure has even a retention rate of slightly above 100%, according to data that we could find. But if you look into the zooplus and compare it to subscription models like Netflix, we aren't competing Netflix. If you look into the best online fashion retailers ASOS, Zalando's and Boohoo, you probably look at levels that are, let's say, they look quite, say, with the standard levels of around 80%, whereas we are at retention rates above 90%. So the churn that we have at 10%, while they have a churn of 20%, and that shows you really the strength of the business model. If you look into say, Wayfair, of course, this compares more to the accessories business of zooplus. There you see the retention rate, which is significantly lower than the recurring demand business models that will build around pet food.

Now the auto shipment thing is something we're working on. The most difficult part in auto shipment is to also have auto payment and properly integrated into this one, credit card payments and other, let's say, country by country different payment formats do not make it, let's say, practically simple to charge the customer. So let's say, again and again, for each of the subscription, say, the shipment. This has delayed slightly the rollout of auto shipment in markets other than Germany, where we are on to this one, we see a further tool here to increase the early-stage retention rate by rolling out our auto shipment into zooplus.

If we now look into the Chewy specifics, we see a terrific market valuation, which is probably 5x the sales multiple that zooplus achieves currently. And we see, let's say, some areas where Chewy is clearly ahead of us, the growth rate is still at rate of 36% to 38% guidance for the year of 2019, whereas we have a lot more conservative guidance and a lower level of growth.

At the same time, we also see that zooplus already has, I would say, balanced the books and is doing a positive EBITDA margin. We have 0.6% of sales. And Chewy, we still see that their adjusted EBITDA margin is minus 7% of sales. And the key question is, how will they, let's say, migrate from minus 7% to something closer to a neutral and maintain the speed of growth? This is clearly a challenge for them. Whereas our company has currently, I would say, just the only task to keep the healthy financials, improve in the mid and long term by selling more private label and reaccelerate sales growth. This is what we see as our key, let's say, mission.

We went into a couple of relevant information during the presentation so far. We see that we are good at managing the margin without damaging the competitive position towards the customer. We see that auto shipment is something that we are, let's say, about to roll out in order to improve the early-stage repeat customer retention. We see that the new advertising formula of keep on pushing in Google and adding other traffic acquisition and advertising channels pay handsomely and brings in 23% of new business. Now the key job is to turn these 23% of new customers also into at least equivalent amount of extra sales exactly in the early cohorts that we are in the early stage retention. Now that we built new, stronger cohorts, we also need to turn them into strong new repeat buying customers. That is the one big thing to do.

You see that we have continued to be very good at managing the operational aspects of our business, and that is mainly our fulfillment efficiency. And that is also our financial efficiency and that consistently produces positive cash flow.

So on that note, I would suggest that we open for questions as they arise and looking into what we have been presenting so far. Please open up for Q&A.

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Questions and Answers

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Operator [1]

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And we will take our first question from Nikolas Mauder of Kepler Cheuvreux.

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Nikolas Mauder, Kepler Cheuvreux, Research Division - Junior Equity Research Analyst [2]

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As just said, I don't know whether everyone understood. Two questions: first one on marketing, second one on logistics. First one regarding marketing. Compared to your statement at the beginning of the year, you sound more positive on your Google acquisition channel and perhaps a bit more negative on your other marketing initiatives. Can you perhaps illustrate your thinking, how your perception of these different marketing channels changed from the beginning of the year?

Second one on marketing is, is your marketing cost in percent of sales already fully loaded? So does it reflect all additional marketing initiatives already? And on logistics finally, you say that your network is now fully built out. The only remaining white spot in my personal opinion would be Scandinavia. What are your plans regarding this region?

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Cornelius Patt, zooplus AG - Chairman of the Management Board & CEO [3]

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Okay. Thank you. Very good questions. Let me first answer the marketing question. And yes, that's right. Regarding Google, we see positive indications that if you're willing to spend, you can also scale the acquisition power of Google. And this is something that we have -- we've been a little bit more cautious on this opportunity at the beginning of the year. And what we see -- and that there is further space for using Google, say, slightly sacrificing, let's say, some efficiency. But then in return, getting scalability.

When it comes to the other advertising activities, I think the key learning for zooplus is that these measures have a less direct connection between spend and impact. Clearly, moving is not only, let's say, a tool that we know very, very well for about 20 years. But it's also, by design, very good for, let's say, directly tracking the relation between the money spend and the impact achieved.

If you do something like VR and if you do something like, let's say, TV advertising, if you do something like brand building, you can't expect the same direct connection between, let's say, activity and impact. And that is, let's say, new to us, and this is what we say. It's too early to tell. But what we see is that there are, let's say, already now a clear indications of a positive link between other marketing activities and the efficiency or the impact of Google. So overall, good news.

And answering your question. Yes, what we have now in the second half and the first half of the year in traffic acquisition and marketing costs includes the cost of the 20-year campaign as implemented so far. So the cost that you see there reflects the overall cost of traffic acquisition and the 23% gain in new business. If we see opportunities to scale at slight -- let's say, slightly at the cost of efficiency, we would allow ourselves to even increase minimally the ad spend as a percentage of sales.

But overall, we see that we work on higher level than 2 years ago, and this is something that simply is the best business decision to do. And we would love to have the same 2% of traffic acquisition cost as we had 2 years ago, but then we would not scale any acquisition.

So second bit of the question was what happens in logistics. Yes, that's right. And observed in the Nordics, we don't have fulfillment center installation. But in fact, the newly set up fulfillment center in north in Poland caters for that job.

Simply, when you look at the Nordics, the expanse of these countries is fairly large. The local distribution within the countries takes already a couple of days. So if you have 1 more extra day for shipping, we'll have the parcels packed in Poland and into the hubs in Denmark, in Sweden and Finland. You practically, let's say, extend delivery terms just, I would say, on acceptable level or just minimally, so to speak. But you increase your cost efficiency substantially. And in the Nordics, there is no such thing as a low-cost operation. And in the Nordics, you also fail to have a complete supplier base, let's say, at hand as we have it in Continental Europe and in Poland, in particular. So the best way to serve the Nordics is to have fulfillment center into Poland, which we have.

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Operator [4]

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We will take our next question from Wayne Brown of Liberum.

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Wayne Mervyn Brown, Liberum Capital Limited, Research Division - Research Analyst [5]

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Probably 3 questions for me. I don't know if you'd like it in one go or separately. But if I heard you correctly, when we're looking at your delivery pricing, it sounds like you've amended the costs on bulky items. And it sounds like you potentially lowered your number of discounts across the board or maybe in some particular categories or purchase occasions. And those were 2 effects on the gross margins. If you could walk us through practically what you've done on that front? And I will leave the other two.

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Cornelius Patt, zooplus AG - Chairman of the Management Board & CEO [6]

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Okay. Yes. So the one thing that we did, and we did that already, let's say, in the second half of 2018. We began with that. We're analyzing, let's say, overlap of different types of discounting: article discounts, promotional discounts and customer discounts. And we made sure that there isn't, let's say, a kind of unproductive and very costly overlap of all 3 types of discount. And previously, they were kind of only loosely coordinated and we made sure that customer discounts don't accumulate and build up because of that lack of coordination. And that's helped to clearly, let's say, reduce the cost exactly of article discounting, customer discounting and promotional transactional discounts.

When it comes to shipping, we still ship more than 90% of all our orders free of any shipment charge. What we now do is that we have, let's say, a final structure of motivating people to go into partially or completely free shipment. And we have, specific to our business model that sometimes, people can place orders to the tune of, say, EUR 80 in total -- in gross -- in total value, which would force us to pack something like 4 parcels just to the bulk -- due to the bulk nature of our products. They are simply extremely weighty. And these heavy -- let's say, these types of orders that have low value in euro or in sterling per kilo shipped, these are now, let's say, receiving a partial specific surcharge for the second, third and fourth parcel or whatever additional parcels we need. And again, we do that, that kind of surgical precision. More than 90% of our shipments are still free of any charge. But this 10% really matter for we need people to pay for the incurring special cost of extremely bulky purchases.

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Wayne Mervyn Brown, Liberum Capital Limited, Research Division - Research Analyst [7]

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And is there much more done on that front, or...

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Cornelius Patt, zooplus AG - Chairman of the Management Board & CEO [8]

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There's still, let's say, opportunity to improve further. But the key observation so far is that people are perfectly, let's say, capable of understanding the logic of it first moreover. But if it was something that they got for free all the time, will they accept that now? They have to pay for shipment of 80 kilos when they got it for EUR 80 and the clear answer is yes, they accept it. They were more or less probably silently awaiting that for a long time and they're wondering, but how can they do that? Ship so many boxes with all the bulky stuff without charging even a euro or a pence?

So this is something that is a clear win. And we simply were, let's say, too much afraid of doing the thing that is perfectly logical from a customer perspective also.

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Wayne Mervyn Brown, Liberum Capital Limited, Research Division - Research Analyst [9]

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Okay. Second question is what you're discussing on Chewy. And please, let me know if we're getting the right messages here from your strategic thoughts. But that higher retention rate due to -- as you said, they have a high propensity of acquiring customers that are buying food first off. So I suppose the question is, and actually throw more money at marketing spend and trying to drive a fast and a higher customer growth strategy. Is their strategy then different from yours in respect of the more customers I get, the bigger the rebates I'm going to get from our huge suppliers? And/or is it actually the type of food that they're selling might be structurally different from yours? And that's why they're able to necessarily drive a customer that is more prone to buying foods, and yours may be slightly more diverse? I'm just trying to get a better understanding as to if there's a, one, that's unusual in the operational or differences in the thought process on the strategy?

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Cornelius Patt, zooplus AG - Chairman of the Management Board & CEO [10]

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Okay. I would say if you look into customers that are something like 2 years even with Chewy or with zooplus, you would see almost completely identical metrics. And starting with gross margin and starting with basket -- or continuing with basket size and looking into, let's say, account loyalty and also revenue retention.

And the big difference is exactly with new customer acquisitions. In new customer acquisitions, Chewy is much broader in their acquisition mix. But they're also investing, let's say, massive amounts of dollars into customer acquisition compared to zooplus, in relative terms but also in absolute terms. And they allow themselves to be a lot more aggressive in investing into customer acquisition and partly also because they have a higher customer lifetime value. They pay -- they play the game a bit more aggressive than we do when it comes to acquire and invest into customers and then take the time, or years and years, in order to recover these spends.

The second bit of this difference is that Chewy has found better ways than we did to integrate new customer acquisition also with the acquisition of future recurring revenues. We have, in our business model, still sort of a distinction where we have acquisition of one-off business and acquisition of business that is of a recurring type. Whereas they have shifted more aggressively, more successfully towards bringing in new customers that also have, let's say, a better survival rate until, let's say, 6 or 8 transactions.

And on this one, we're learning but we don't see ourselves in the need to replicate completely what Chewy does because I think we all agree that we should not go from 3% marketing spend to something like 10%. Chewy is now closing the gap in a sense that their 10% of ad spend is also, let's say, long term, probably not fully sustainable because EBITDA negative at that level is something that at one point in time needs to be balanced. So probably you see a bit of convergence. They're getting more like zooplus, and us getting a little bit more like Chewy when it comes to efficiency of the early-stage customer retention.

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Wayne Mervyn Brown, Liberum Capital Limited, Research Division - Research Analyst [11]

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And how do you -- could you just -- could you discuss that maybe one layer deeper for us, just so that we can get a better understanding of how they are able to hold on to their first customer faster and get them to repeat faster? And how can -- that's more loyal for them? And maybe if it is the food element, then how are they being able to actually achieve that to greater extent than you all? Because you're all acquiring customers very quickly, but it seems like they're acquiring a different type of customer. Is that because of the channels that they're acquiring them through as opposed to yours being so much more heavily weight towards Google? Or is that far too simplistic to think about it like that?

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Cornelius Patt, zooplus AG - Chairman of the Management Board & CEO [12]

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Well there is -- let's say, you're on to something with this explanation. And this call is about zooplus, but let me finish with one more comment on what we see at Chewy. Chewy is using off-line address brokers in order to get access to pet owners and dog owners, in particular. And quite often, they successfully sell a subscription with the first transaction. And that is the thing which made their acquisition more expensive. But then also logically, if you sell a subscription, the churn from the first to the second and third transaction is a lot lower than what we have in our business model. That is probably the most distinct difference when it comes to acquisition tools. The size of the budget being the big difference.

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Wayne Mervyn Brown, Liberum Capital Limited, Research Division - Research Analyst [13]

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Okay. And then I'll ask just one last question. I was going to ask what your current cost of acquisition is looking like. And then particularly on Google, clearly get the message that it's scaling. But I'd like to just get a flavor for what the marginal cost of acquisition is looking like for zooplus as a whole and maybe in reference to Google itself?

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Cornelius Patt, zooplus AG - Chairman of the Management Board & CEO [14]

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Yes. When you do -- probably we'll be tempted to say, but now let's look into the first half of 2018. Let's take the total number of customers that we got and the total amount of money spent on Google. And now let's use the first half of 2019, let's say, a world-record cost that were increasing by something like, probably 50% to 60%. I don't have the number at hand. And the output was plus 23%. But don't use that for the marginal cost calculation because the cost also for the base acquisition went up. And that is a trend we see all across all industries.

As mentioned before, Google is getting, let's say, a fairly crowded space. And Google is able to monetize their traffic better than 1 year before. So you can't do the margin calculation just by using the first half 2018 and the first year of 2019. Give and take. But that's the last bit of information I can affirm this one is that the module cost for an extra customer are typically twice of what you have as average. And this is why you can't simply say, okay, we doubled the Google budget and we get double the impact. It doesn't work that way. Marginal cost typically are twice the actual cost.

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Operator [15]

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We will take our next question from Alvira Rao of Barclays.

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Alvira Hamid Rao, Barclays Bank PLC, Research Division - Research Analyst [16]

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I've got 3 questions. First one, another one on marketing. Could you give us some indication of how your marketing budget was allocated across different channels in Q2, Google versus brand building and so on?

Second question is on gross margins. Your gross margin was up 0.7 points in the first half. But if I understand correctly, you're still guiding for full year gross margins flat year-over-year. So this implies that gross margins will be down in the second half. Just wondering why you're guiding for this?

And lastly, you talked about slower growth in the U.K. and how it has been impacted by Brexit uncertainty. Just wondering if there is any competitive factors at play as well? And more broadly, if you have any updates on the competitive landscape in any of your major markets?

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Cornelius Patt, zooplus AG - Chairman of the Management Board & CEO [17]

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Okay. Well, the spread of the marketing budget in the second quarter, it is roughly, let's say, all full -- all of the money that we spent in Q2 2019. And we still spent 70% in Google. We spent 10% in other advertising channels such as price -- search engines, a bit of social media. That accounts for 10%. And 20% of the money spend in Q2 was spent on new ways of traffic acquisition and mainly via our brand-building activities, events and direct-response TV. We also venture into, say, leaflets distributed in, let's say, core regions in which we have a higher market penetration. So we've been trying out quite a couple of things, but that, in total, accounts for only 20% of the money spent in Q2 2019. So Google is important. It works and works better than expected at the beginning of the year.

So the margin guidance question, I'm not 100% sure that I got what you're aiming at. Can you please restate what you would like to know there?

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Alvira Hamid Rao, Barclays Bank PLC, Research Division - Research Analyst [18]

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Yes. So in the first half, your gross margin was up 0.7 points, but it looks like you're still guiding for the full year gross margin being flat year-over-year. So this implies that the guidance for second half gross margins is down year-over-year. And I'm wondering why you would expect that?

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Cornelius Patt, zooplus AG - Chairman of the Management Board & CEO [19]

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No, no. And that's -- you shouldn't assume that we are going to spend the extra margin that we made in the first half of the year in the second half of the year. So what we probably cannot expect is that we increase further, let's say, starting from the gains that we have, but we keep consistently the margin also for the full year above the level of 2018. Does that help?

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Alvira Hamid Rao, Barclays Bank PLC, Research Division - Research Analyst [20]

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Yes, it does.

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Cornelius Patt, zooplus AG - Chairman of the Management Board & CEO [21]

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Okay. When it comes to the competitive landscape in -- across Europe, there is probably 2 bits of information. One cannot be new to you. We have a situation in the U.K., but that is mainly because we all live with the risk of the U.K. of being a semiautonomous market that is not integrated into the EU anymore. And legally awaiting, let's say, a turn for the better. Current outlook is not too rosy at this point.

The second bit is that we see that some specific markets are used by off-liners in order to find out what -- is there a way to take away business from zooplus. And we see a bit of extra-competitive action in Denmark where one of the offliners tries to build the case on how far do you have to go in order to break the loyalty of the core repeat customers at zooplus. And the shocking truth is it takes an insane amount of incentives in order to take the business out of the hands of zooplus once the customers are properly, let's say, locked in. And that happens usually happens after 6 to 8 transactions. So not that much of news.

If overall -- and there is one thing that needs to be watched is are the parcel delivery services in each of the markets able to cope with the, let's say, increased relevance of e-commerce as a retail channel, and that has implications for can they scale the physical operations. And can they also maintain the service level quality and that the customers would expect when it comes to the delivery at the doorstep. Overall, more parcels mean more efficient networks. So while tactically, they might get into a squeeze, or operationally, strategically, a thriving e-commerce sector is very, very good news for the parcel operators. And more efficient partner networks, again, is very good news for the e-commerce sector. So just -- if you look into this one, make the clear distinction. Whatever you hear as, let's say, news and noise from logistics and parcel distribution, separate tactical situations and operational issues from the strategic outlook, which is overall very positive for their business and our joint business.

So we would have one more question?

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Operator [22]

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We will take our last question from Sasha Karim of Inflection Point Investments.

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Sasha Karim, Inflection Point Investments LLP - Partner & Portfolio Manager [23]

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Actually, just a question on Chewy versus zooplus. Apart from the retention, the most striking difference between your businesses seems to be that Chewy has a much higher contribution margin. I think this is what you were touching on earlier when you said they have a higher lifetime value of customers. So it does seem to make more sense for them to pay more in year 1 for customer acquisition because they make significantly more profit in the repeat years. But it also seems to me like the higher contribution margin is something that's out of your control because the 2 most important elements are your supply terms and your logistic costs, which are the sort of external factors. Would you agree with this? And I mean is there anything you can do to raise contribution margin to get it more in line with Chewy's?

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Cornelius Patt, zooplus AG - Chairman of the Management Board & CEO [24]

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Yes. Sasha, I'm not 100% sure whether I'm with you on your analysis to start with because what we see is that Chewy spends 7% more for traffic acquisition. But then, also Chewy is 7% less profitable on an EBITDA level than zooplus. So in fact, their margin and their cost structure is almost exactly identical. It's difficult to compare because there are different interpretations of IFRS this side and the other side of the Atlantic. But overall, they don't have a higher contribution margin in percent.

What they have, and this is what I was referring to, is that they have better account survival rates. And that drives the average value of a new customer. So whereas we lose something like 75% of new -- of our new customer cohort until the transaction #10, they score much better in retaining the customers through the early transactions. And that gives the each acquired account, a higher sales value because they have better survival rates and slightly more sales per annum, which is also characteristics of the U.S. market where the spend per pet is higher than it is in Europe.

So put differently, we would say we need to learn how to onboard our customers better so that the survival rates are better and -- but that is the key issue. We don't have an issue when it comes to gross margin compared to Chewy. Quite the opposite. We would say, if you spend 10% of your revenue for customer acquisition, you need to make more margin. And that is the challenge Chewy is facing.

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Sasha Karim, Inflection Point Investments LLP - Partner & Portfolio Manager [25]

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Just a follow-up on that, maybe. In the U.S., they have this thing called map pricing, which means that there is less competition between Amazon and Chewy versus in Europe. Do you recognize that as a difference?

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Cornelius Patt, zooplus AG - Chairman of the Management Board & CEO [26]

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Surely, because the regulator is really strict on this one in the EU. There is no such thing as aligning the pricing, even between competitors in the retail space or between the brand owner and the retailer.

In the U.S., you have a different situation on this one. And in the U.S., on top of the regulatory framework, you also have, let's say, one common economic area with one currency only with one language only and also with one VAT regime only. Whereas we have, in Europe, quite differing, let's say, tax -- taxation exactly for food, which sometimes carries a lower VAT rate or preferential VAT rate. In some countries, it doesn't. You have different levels of VAT. And lastly, you have the impact of currencies, like the Polish zloty and like the Danish krona, which is kind of back to the euro or the penny or the pound sterling through which is clearly not back to the euro. So that's right. And it's also more complicated to pricing in Europe that comes on top.

Chewy has -- I'd say, we have one -- let's say, a bit of a tailwind against Chewy, whereas the specialty retail sector in Europe has brands that you wouldn't find in grocery. And the grocery segment and the specialty trade segment is a bit more overlapping in the U.S. to finish that off.

But maybe we should do a separate session at one point in time really explaining the fundamentals of the U.S. market and the fundamentals of the European market if that is of great interest. Right now, I think we've covered a lot of the key learnings that we see at Chewy case for zooplus.

On that note, we, again, apologize for the disruption between the presentation and the Q&A. That was due to technical difficulties. We appreciate very much your attention, your attendance in the call, the competent questions and a fruitful discussion. I would say goodbye and hear you soon, see you soon in the next couple of months. Thank you very much.