Zalando SE

XETRA:ZAL

Earnings Call Transcript 2022-Q1

[Operator]

Good day and welcome to the Zalando SE First Quarter 2022 Results Analyst Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Patrick Kofler. Please go ahead, sir.

[Patrick Kofler, executive]

Good morning, ladies and gentlemen, and welcome to our Q1 2022 earnings call. I'm joined by our Co-CEO and founder, Robert Gentz; our new CFO, Sandra Dembeck; and David Schröder, who served as CFO until March and has just transitioned into his new role as COO.

Robert will kick us off with a holistic update on the current performance and an update on the progress we have made against our strategic objectives. Sandra will then walk you through the financial developments of the quarter, and Robert will discuss our outlook. Robert, Sandra and David are available for questions afterwards.

As usual, the call is being recorded and webcast live on our Investor Relations website, and a replay of the call will be available later today.

Robert, I will now hand it over to you. Please go ahead.

[Robert Gentz, executive]

Thank you, Patrick. Good morning, everyone.

Yes, since we last met at the beginning of March, the world has changed dramatically. So there's a prolonged war in Ukraine. There's even more cautious consumer sentiment, the inflationary pressures, as well as ongoing supply chain challenges. And although these circumstances have affected the business, they have not derailed our three goals or ambitions.

So jumping into the numbers, let's talk about the key drivers and challenges for our performance in the first quarter and how we are addressing them.

So when we shared our full year results in March, we communicated we expected a rather flat Q1. And we expected that because the challenging macro environment combined with the more technical lapping effect of a comparison of an extraordinary Q1 last year with 56% GMV growth. So Q1 came in as we expected in early March, unfortunately, not better. And I'm not proud to present the results of a quarter where, for the first time ever, we have not grown. I guess the result of this -- the drivers of this result are much more complicated, technical and external than we'd like them to be.

So here's what has happened. So first, we are comparing this quarter with an extraordinary Q1 '21, with extraordinary new customer growth last year and extraordinary GMV per customer. And we already knew that we would likely see normalization in '22 both for new customers and on customer spending when the economy is reopened. So this is the technical part of the transition.

Second, we faced a more -- a very volatile market environment in Q1. So on the consumer side, the EU consumer confidence index dropped significantly, driven by inflation and war, and even lower than at the beginning of the pandemic. So it wasn't, partly it still is, not so much on everyone's mind to buy fashion lifestyle articles. And for those work on their mind in '22, they have more choices than just the digital starting points from the pandemic -- from height of the pandemic last year. And on the industry side, we saw a continued disruption in supply chains, making it harder to access the merchandise. There was more demand, particular in the footwear area.

So this is what has driven the result of a rather flat year-on-year comparison.

What the flat top line yet does not tell you, and looking into the machine room of our business, we actually made good progress on our fundamentals in Q1. So let's look at the key customer and partner metrics.

Since we communicated our strategy in 2019, they have developed all positively. And these same positive trends now continue in Q1 '22. So our customer base continue to grow. The visits and engagement metrics continue to grow, and we saw more proposition adoption. In fact, our unpaid traffic actually grew with a CAGR of 20% since the pandemic, and so it grew in Q1 '22.

We are making great progress on deepening our customer relationships. So the customers that spend more than EUR 500 per year with us we're at a CAGR of 29% since 2019. Our Plus membership program grew and grew in fact more than 150% year-on-year in Q1. So we're continuing to build deep relationships.

And we as well made great progress on the platform proposition to enable D2C for the brand. The 32% of our Fashion Store GMV in Q1 was driven by partners. Zalando Fulfillment Solutions, Zalando Marketing Services have as well grown very well in Q1. So there has been great progress in Q1 on our strategic metrics, and this is what is the most important thing for us and that drives long-term success of Zalando and ultimately moves us forward on our path to EUR 30 billion in GMV by '25.

Yes, there were as well some important learnings for us in Q1, and we will leverage them to improve our performance going forward. So first, the spending per customer in Q1 was lower than last year, yet it was higher than prepandemic. And we also saw a shift in demand in Q1. One shift was low and high price points continued to grow fast and were in much higher demand, while the mid-segment in fact actually saw contractions on our platform. So there's an observable trading up and trading down.

And another shift. So occasion- and trend-based categories are growing ahead of need-based categories as the pandemic impact on our [ face ]. And these shifts were negative and they were positive for us.

And why were they negative? Because last summer, the biggest concern, as you might recall in the fashion industry, was access to stock, and we deliberately increased our wholesale commitment to mitigate the supply chain risk. And as some of these shifts we see now were not anticipated in our buying decisions, this caused an additional headwind on our growth path in Q1 and as well our gross margin in Q1.

And why were they positive? Because we saw, once again, that our platform business model works and offers a high degree of flexibility and resilience. The partners could and did jump into the demand shifts and grew their business on our platform.

And the second insight was the challenge we saw in our order economics. So our fulfillment cost per order increased by 10% year-on-year driven by 3 drivers. So first, the return rate normalization trend continues as the temporary return rate benefits observed during the pandemic are unwinding. And second, the lower-than-planned volumes, which are causing lower utilization and operational deleveraging of our logistics network. And third, the rising energy prices and fuel surcharges from our carriers, increasing our logistics costs in the short term.

So these are the insights. So what are we doing now to mitigate these challenges?

First, we will be smarter in fall/winter with regard to our offer and risk position in our inventory. We're doubling down on the platform model and additionally adjusting our fall/winter wholesale offer to match the demand patterns that we now better understand.

And second, we are improving our order economics. Ands this enables us to further deleverage our convenience proposition and invest in deep customer relationships. We will introduce a minimum order value in more of our markets where we see it helps us to deleverage. We had positive experience with minimum order value when we introduced it in 9 of our 23 markets in 2019. And based on this experience, we will further drive the rollout now. On top, we will pass through the fuel price surcharge that were seeing in logistics to our ZFS partners.

And third, we are laser focused on driving cost efficiencies across our business. So not only marketing and logistics but also pacing our overhead investments.

And finally, we invest through cycle. So we believe in our strategy and we see very solid metrics that confirm it. And we know from experience that crisis is always a good catalyst to become a better company. So getting more efficient and lean at the core but also laying the foundation for future growth and going as well after the opportunities where they present themselves. And our strong balance sheet allow us exactly for that.

So our goal remains to reach more than EUR 30 billion of GMV by '25, and we continue to make progress towards this. We're acting decisively on the short-term challenges, focused on our long-term vision.

Now I'd like to hand over to Sandra, who will provide you some more details around the Q1 performance.

[Sandra Dembeck, executive]

Thanks, Robert, and good morning to everyone on the call. Let's start with a more detailed look at our top line performance.

As Robert already alluded, after many quarters of strong growth, we experienced a challenging first quarter of flat growth. Our group GMV grew by 1% to EUR 3.2 billion, and our revenues declined by 1.5% to EUR 2.2 billion. The extraordinary strong growth in the first quarter of 2021 somewhat distort picture. So when looking at the 2-year CAGR for GMV, we delivered 25.3% growth.

Taking a look at the performance of each segment in the first quarter. The Fashion Store, our core sales channel, so GMV grew by 1.7%. The DACH region lost 3.4% of GMV. It was lapping very strong year-on-year comparables due to the strict lockdowns in the first quarter of last year. Rest of Europe delivered 6.7% GMV growth. All new Eastern European countries, the ones we launched in 2021, performed very well, and this gives us confidence for our upcoming launches in Hungary and Romania in the second quarter of 2022.

Moving on to our Offprice segment. It recorded a broadly flat GMV development and a decrease in revenue of 1.6%. We faced a challenging supply situation, impacting the quantity and quality of the offer, as well as weaker demand. Zalando Marketing Services had another strong quarter and delivered year-on-year growth of around 40%. Our partners continued to use ZMS to increase their visibility on the platform and drive sales.

Let's turn to our customer metrics. Robert already mentioned that we made great progress in line with our strategic agenda. Looking at our last 12-month key customer metrics, we continue to build deeper customer relationships, and our active customer base grew to 48.8 million. That's 17% or 7 million more customers compared to the first quarter last year.

Let me explain the two black bubbles you see on the chart. They show the trailing 3-month customer metrics to help explain why our GMV grew by 1%.

We grew our active customer base by 5.2%. Both new customer acquisition and retention were well above prepandemic levels. GMV per active customer saw a 4% decline year-on-year, and this reflects the changes in customer spending patterns compared to the pandemic peaks. But it's important to note, despite the decline, GMV per active customer in the first quarter remains well above the prepandemic levels.

So there are two key takeaways from our customer metrics. First, in the first quarter, our key metrics continued to perform above prepandemic levels. And our deep relationships with new as well as existing customers remains really strong. Second, the cohorts we acquired in 2020 and 2021, so the pandemic cohorts, are outperforming. They're outperforming with regards to their engagement activities but also in regards to their spend.

Let's turn to profitability. For the first quarter, we recorded an adjusted EBIT loss of EUR 51.8 million, representing a negative margin of minus 2.4%. This was the result of the slow growth we experienced and temporarily changing customer spending patterns.

When looking at the regional profit distribution in our core segment, Fashion Store, DACH and Rest of Europe saw a similar drop in margins. In DACH, the slowdown in demand led to overstock, challenging order economics and cost deleveraging. Additional price and marketing investments helped to clear the inventory, albeit at the cost of margin. In Rest of Europe, investments in convenience and a change in customer behavior towards smaller baskets impacted profitability. Offprice delivered a profit of EUR 6.5 million, while Other businesses delivered a small loss.

Let's move on to the P&L, and let's go a bit more into detail on some of the line items.

Our gross profit margin declined year-on-year by 2.1 percentage points. In order to activate demand and increased inventory sell-through, we increased promotional activities at the beginning of the quarter. Our platform business model made a positive contribution to gross margin given the strong performance of the partner program. This was slightly offset by the strong growth we experienced in ZFS, which is a lower-gross margin business.

The fulfillment cost ratio increased by 4 percentage points year-on-year, and this was mostly due to an unfavorable development of order economics. We saw increasing return rates, lower items per order and lower fixed cost by Russia. We benefited from a temporary COVID-related reduction in return rate, which we are seeing normalized now but in line with our expectations. In addition, investments into customer convenience, particularly to enable Plus, increased logistics costs.

Marketing costs improved by 0.1 percentage points. During the first quarter, we increased our focus on marketing return on investment and reduced both brand and performance marketing accordingly.

And finally, our administrative costs increased by 0.6 percentage points as we continued to invest in people and systems as enablers of future growth.

Let's turn to cash-related items. We recorded an increased net working capital year-on-year. The main driver behind this development is a relatively higher increase in inventories and in receivables compared to the payables. Robert already mentioned it, back in fall 2021 when supply chain issues first emerged, we committed to buy additional stockpile wholesale business. We wanted to mitigate supply chain disruption for the spring/summer season 2022. Back then, we had not anticipated the change in spending patterns that we experienced. We have now put in place measures to address any risk of overstock.

CapEx spend is at EUR 66 million, is in line with our plan and reflects investment into our logistics infrastructure and in-house software development.

Because of the strong increase in net working capital and negative net earnings, we recorded in the first quarter a negative free cash flow of minus EUR 532 million. This compares to minus EUR 143 million in the prior year period. Our cash balance remained strong, and at the end of the first quarter, it was EUR 1.6 billion.

Let me now hand back over to Robert to conclude the presentation by looking at the full year 2022 outlook.

[Robert Gentz, executive]

Thank you, Sandra. Let's now come to our outlook.

When we presented our full year '22 outlook to you in March, we shared our expectations that our key business metrics would continue to normalize as pandemic-related effects subside. And we shared that we would also experience a significantly more volatile market environment.

So back then, our outlook explicitly excluded a potential negative effect or impact from the war in Ukraine, which has started only days earlier. So since then, we have seen the market environment become even more volatile. The uncertainty remains high with regards to magnitude and the duration of key macroeconomic developments. And as expected, the first quarter proved to be challenging.

Further, we have seen more positive traction after the Easter break across several areas of our business portfolio. We won't be able to fully isolate ourselves from current market development and uncertainty remains high. But we are confident that our platform business model, our agile business gearing approach and an increased focus on cost efficiencies will allow us to successfully navigate through the challenges ahead.

So we expect a significant acceleration in the second half of the year, when we will no longer be comparing ourselves against pandemic peaks. So we are thus confirming our full year '22 guidance and now expect to reach the lower end of our outlook in terms of GMV growth, revenue growth and adjusted EBIT.

So let me close by reiterating that we have a clear strategy and a clear direction. Our foundations are strong. And thanks to our team, we're making continuous progress in deepening customer relationships and driving our platform transition.

While the current market environment has a negative short-term impact on our business, we are taking decisive actions to address these short-term challenges. And we do not expect them to change our longer-term trajectory or our '25 targets.

Our vision remains consistent and relevant going forward: to be the sign point for fashion in Europe. And wherever possible, we're prepared to invest through cycle and drive long-term value for our customers, partners and shareholders.

And then I would like to end on a personal note.

So this macro environment of war in Europe, inflation, the supply chain disruptions that we're seeing now, that we mark the third crisis that I've experienced as a founder of Zalando since we started this company in 2008. And although all these crises were different, our job here is to make the best out of each crisis and use it as an opportunity to come out stronger and better. And we have always done so in the past, and we will, as well, do so this time.

Thank you very much. That concludes our presentation, and so let's jump into Q&A.

[Operator]

[Operator Instructions] Our first question comes from -- [Operator Instructions] And our first question comes from Adam Cochrane from Deutsche Bank.

[Adam Cochrane, analyst]

Two questions. On the first one, can you give a bit more description around the negative unit economics, please, in terms of what has moved from basket size through the cost lines, if there's any flavor you can give on that and which bits you would expect to improve from your cost actions?

And then secondly, a bigger question. In terms of how are you -- what discussions have you had internally about balancing the profitability versus the long-term investments? Is it a case of you're just prioritizing investments that make the highest return or some of them you're pushing into the following year? Can you just talk about how you've balanced or made the decisions to balance profit versus investment?

[Sandra Dembeck, executive]

Thank you, Adam. I'll take the first question. Robert will take the second question.

In regards to the negative unit economics, I think it is three different dynamics in here. First of all, because of the slow demand, we, of course, had a much lower fixed cost degression. So the overhead base that we have in our logistics, we now needed to cover it with little lower sales.

The second one is really, as you alluded to, the customer metrics. So what we saw is that they ordered less items per order. And that, of course, then also doesn't help our order economics.

And the third area is really the inflationary pressure. So when you think about the warehouse operations, there you have inflation around the wages. We saw, of course, in transportation, which is another big block for us, the massive inflation on fuel and, in addition, the electricity. So all of those inflationary pressures, we had to digest and we had to absorb. So I would call it -- there is a lot of operational deleverage from the fixed -- lower fixed cost degression. And at the same time, there is the impact on the order economics largely by the way the customer shops at the moment with less items per basket, as well as the inflationary pressures that we had to weather.

[Robert Gentz, executive]

Thank you. And -- yes. And on your question of how to balance growth and profitability. So we're saying first like we are a growth company. So we are at -- like the big prize for us is in the future. It's that -- we want to have more than 10% of the European fashion market that will be on our platform. And we believe that everything will -- no doubt, is still like very early in this journey, yes? So there's just so much potential down the road that we are -- that we believe, as a platform and as a business, we can drive value for our customers, for our partners and just make the fashion history more long. And we believe by doing so, it is very much aligned with the interest of our shareholders, because in the long term, there's actually scale effects and the big prize is in the future. So that's -- like that's the mentality.

However, we as a company, we also are very mindful when it comes to investment, as you as well know. So we don't chase growth when it's not -- when there's no positive ROI on the investments that we do and when there is -- and when it's too costly.

So as well, when we -- how we approach now the situation, as we allude to, is -- I think it's a good -- it's about being real in terms of driving efficiencies in our business, yes? And this is what we as well allude to. But it's as well not only about that, it's as well about investing through cycles, yes? And our balance sheet is what allows for that. So investing through cycle where we actually see opportunities that present themselves that help us in the long and midterm for our margin and as well for our path to EUR 30 billion and even beyond that under 10% of the European fashion market that might be passing through our platform. So that's the mentality. We're a growth company at heart but very mindful as well.

[Operator]

Our next question comes from Rocco Strauss from Arete -- oh, pardon, from Georgina Johanan from JPMorgan.

[Georgina Johanan, analyst]

I've got two, please. And the first one was just on current trading and Q2 performance. I think you referenced that you've seen an improved performance post the Easter weekend. Is it still sensible to assume growth in sort of the region of 10% for Q2, which I think is where consensus is sitting at the moment? Or given everything else that's going on, is that still looking a bit ambitious, please? That's my first one.

And then the second one was I think you referenced that you've put measures in place to alleviate the overstock in the quarter. Can you just explain what you mean by measures, please? Do you mean sort of extra planned promo or giving stock back to partners? If you could just explain that, that would be great, please.

[Sandra Dembeck, executive]

Thanks for your question. Talking about the current trading in Q2. So as we exited Q1, we saw the market was very pretty much mute. There wasn't really much elasticity in it. And that basically continued into April. And the last 2 weeks now, we have seen some green shoots. And I think that's also reflected in when we look at the fashion query volumes, they basically represent a little bit the picture that we can see in our numbers at the moment. So the single digit in March and as we start April, and now really gripping into the 18%, 20% week-on-week over the last 2 weeks -- year-over-year over the last 2 weeks. So I think that this is what we currently see as a positive momentum.

However, yes, it shows you what swings are currently possible on a week-by-week base. And so I think -- personally, I think we feel that we will end better than Q1. But at the moment, it's too early for us to really comment on where we will end the quarter.

In regards to your second question around the inventory, you will have seen from the release that we ended the quarter with EUR 400 million more stock than last year, and we have already started to proactively address the overstock that we kind of incurred.

There were good reasons for the overstock, yes, because we really wanted to ensure the customer experience gives them the full choice and mitigate those supply chain disruptions. But now, given the change in the customer behavior as well as the slower demand, the sell-through rates are just not where we would have wanted them to be. And we have created some overstocking categories that we would now call the pandemic staples that we just need to get off from.

And the measures that we have taken here is we already started the exercise towards the end of Q1, and we have leveraged tremendously now the mid-season sale to really address those risky stock areas. And we still have another end-of-season sale ahead of us to get rid of the remainder of the stock.

At the moment, we feel quite comfortable with where we are. And so I would say, just as a heads-up, we feel that we have our stock position under control. We are not worried at this moment in time.

You may not see that reflected when you look into the Q2 number because what we are doing at the same time is, given all the news analyses about supply chain -- potential supply chain disruptions again, we are sticking to our strategy of preponing stock so by the time we will report on Q2, we will have taken in already quite a large amount of our fall/winter stock.

[Operator]

Our next question comes from Rocco Strauss from Arete.

[Rocco Strauss, analyst]

I will have two as well. First one on ZMS. Could you talk a bit more about the 40% growth year-on-year that you mentioned? Is that more driven by innovation around -- on platform ad formats? Or is that more by brands warming up to the retail media opportunity? And then further, to what extent is ZMS driven by partner program or third-party sales versus wholesale?

And then the second question I would have, I mean, we have seen commission increases on various players like Etsy and so on to reflect the challenging marketing environment mainly driven by like the deprecation of like various IDs on Apple and soon also Android and Chrome. With S&M or marketing likely remaining at elevated levels moving forward, have you internally thought about commission increases around partner program to offset some of these cost pressures?

[Robert Gentz, executive]

Yes. Thank you, Rocco. So yes. So first of all, ZMS continues to perform well and like has seen a very good growth in Q1. So there is no magic like in Q1 on them. And so it's a continuous progress that we see like with the formats and as well as with the demand that was as well strong both across -- both the partners but as well our partner programs for driving more visibility in Q1, yes? So there's no magic.

So in terms of commission increases that you were asking for, so no, we have not thought about -- we have no plans to and want to increase commissions to our partners. What we have said is just like in terms of ZMS, which is a cost-plus model, that we're just passing through the additional costs that we're seeing now, short-term costs through the fuel price surcharges, to our partners, which is in line with the strategy of a cost-plus model and adjust there.

[Operator]

Thank you. We'll now move to our next question from Liv Townsend from UBS.

[Olivia Townsend, analyst]

Also, I have two. Just the first one would be around fulfillment costs into the rest of the year. Obviously, as an online retailer, a large proportion of those are going to be variable. But I'm just wondering, of the costs that can be contracted out, how much of the fulfillment costs can be contracted out? And have they been contracted? So do you have visibility for the rest of the year?

Secondly, just on expectations for marketing costs and how you're thinking about that for H2. Would you be looking to pull back on marketing costs if demand is suddenly lower than you expect? Sort of following up from Adam's question on how you're thinking about investment would be helpful.

[Sandra Dembeck, executive]

Thank you very much. I'll take the first question, then I'll pass on -- I'll take the second question, and I'll pass on the fulfillment cost question to David.

On the marketing cost, our focus really is on the return on investment, and therefore, it depends really a lot on our top line, and this is how we invest in marketing, as well as the elasticity we see in the market. So we do expect that the marketing for the remainder of the year is kind of in line with what we have reported previously. So neither big cuts nor big increases in -- when it comes to the cost of sales ratio.

[David Schröder, executive]

Yes, Liv, on the fulfillment cost, I mean, we told you on March 1 that we actually expect fulfillment costs in percent of revenue to increase this year mainly driven by two effects. First of all, unwinding of the temporary return rate benefit we saw last year. And second, continued investments in our proposition, particularly connected to the further rollout and expansion of Zalando Plus and also our investments into making our operations more sustainable. So this is the -- what you should expect for the full year.

What we are obviously focused on as part of the action plan that Robert talked about is to make sure that any additional pressures from increasing logistics costs due to fuel price and the likes actually are managed well. For example, from measures like MOV from measures like passing on the costs to our ZFS partners. And that's obviously where we have still a lot of flexibility to mitigate these effects for the rest of the year.

[Operator]

Our next question comes from Jurgen Kolb from Kepler Cheuvreux.

[Jurgen Kolb, analyst]

Two questions also from me. First of all, again, on the inventory side. I was wondering if you -- or part of your strategy also includes that you may have canceled orders for the fall/winter collection or maybe discuss with the brands that you may not take in all the orders that you've written for the second half.

And secondly, if we could maybe talk about pricing and what have you seen in the first quarter in terms of price increases and what is on the agenda for the remainder of the year. And do you feel that there is a certain elasticity from clients or from customers to act on that?

[Sandra Dembeck, executive]

Thanks, Jurgen. On the inventory side, so I think what we did is we took the learnings from the first quarter. And what we saw there is a shift in the demand pattern towards certain categories. So within our portfolio of categories, we saw double-digit growth in some and then less growth in others. And so our buying budget for the fall/winter reflects primarily that.

The second thing we saw was a shift in price points. And so we have rebalanced our buying budget in that respect as well. And so I think it is not a question of now discussing it in the detail of like cuts, et cetera, it's really a question of rebalancing the buying budget for the second half.

[Robert Gentz, executive]

Yes. And on your second question on the price and the customer sentiment around it, so as I alluded to in my presentation, so first of all, we see like there's a certain level of shifts that we see with customers, yes? So that -- actually, the mid segment is the one that has seen the most contraction and like there are some customers that just like go more towards lower-priced items and as well some customers that more go to -- as well towards the higher price. So this is the effect that we observed. So there is something around like inflation and customer sentiment that we're observing as well on the platform.

Yet, the customer -- the sensitivity towards discounts is actually like quite high as we've seen in mid-season sale. That was where customers react to it. So there is a continued, yes, sensitivity towards prices on the platform as we see that.

[Operator]

Our next question comes from Miriam Jasia (sic) [ Miriam Adisa ] from Morgan Stanley.

[Miriam Adisa, analyst]

First question, just a follow-up on the last one about the sort of shift in price points. Is that sort of concentrated or -- in particular markets? Are you seeing that as a more broad-based trend? And would you expect the trend of the average basket sizes declining to continue for the rest of the year? Because I guess in your comments around current trading, you said you started to see more positive momentum. So is that more on the volume side rather than in terms of price points?

And then secondly, if you could just give a bit more color on the performance across your markets specifically in Rest of Europe. And if you could talk a bit about what you're seeing in the CEE region, if there's been a recovery since the situation in March.

[Sandra Dembeck, executive]

Thanks, Miriam. In regards to the price points, so it is a complicated picture because on the one hand, we see people trading up and our Designer segment is really growing and with good double digits. And at the same time, we see a higher share of red prices towards the lower middle end, the low -- and into the price -- at the lower price segment.

So I would say, coming back to the question around what will be the average basket size going forward, in Q1 it was heavily dependent -- it was heavily impacted by the share of red prices. We believe that, that will fade away to a degree in the second half of the year. And we believe that as we are rebalancing the brands within our portfolio, that actually this will give us good momentum to further improve the average basket size. I just want to point out our average basket size is still well above the prepandemic levels, yes?

In regards to the market, CEE was an interesting one because right when the war was unfolding, of course there was a shock momentum, but demand picked up quite quickly afterwards. And so I would say that now, actually, our markets are performing according to expectations. So we haven't seen a massive deviation from the ingoing trend in Q1 to where we exited now in Q1. So I hope that answers your question.

[Operator]

Our next question comes -- pardon.

[Robert Gentz, executive]

So maybe as a follow-up, I think -- especially on Eastern Europe, I think, yes, like the shock was there, I think, in the beginning of Q1, but it actually quite recovered well. And this is one of the reasons why we actually continue to open in Romania and Hungary, where we as well push ahead, as we've seen as well, this positive momentum there.

[Operator]

Our next question comes from Guido Lucarelli from Citi.

[Guido Lucarelli, analyst]

Just one on the price segment. If you can please define your definition of low, mid and high price segment in terms -- in euro terms.

And the second one, on your take on M&A. I mean I guess the consolidation in the sector would make sense considering the improved economics that you get from that. And maybe it makes even more sense now from a valuation standpoint, at least compared to 1 year ago. So are you looking at all, if any, M&A opportunity? What's your approach there? And if not, what is, in any case, your take on consolidation in the sector?

[Robert Gentz, executive]

Yes. Maybe on the price segment. So I think the way of how we look at it is more like the positioning -- so in the way -- the positioning of the brands, yes? So we're not -- it's not about like the price points, it's more the positioning on the brands. So there are brands that are in the lower -- in the entry price segments and there are brands that are more in the mid-segment and there are brands that are more in the higher segment.

So what we see there is the brands in the higher segment and the brands in lower segment, they are the ones, in general, that are higher demand of our customers. And those that are in the mid segment are the ones that are in the less demand. So this is not a very clear-cut definition, it's more like our understanding of the market, our understanding that it's more a management from Zalando kind of classification of these segments. And it -- and we want to provide that to you just to provide some flavor of what we are seeing and how we are acting on that and how we are as well dealing with that. Yes. And I think as a platform, we have 7,000 of them, and I think it's -- on our platform. So it's very much, I think, a reflection of what happens in the market, yes?

In terms of M&A. So as we said many times in the past, like our main focus and priority is -- first of all, is organic. And when it comes to M&A, it's about capabilities that could add something to Zalando in terms of our, yes, our ability to build better experience for our customers or for our partners and -- right? So this is our main focus when thinking about M&A as an additional way next to organic efforts, which is in our -- mostly in our DNA.

[Operator]

We'll now take our next question from Charlie Muir-Sands from BNP Paribas.

[Charlie Muir-Sands, analyst]

One on guidance to start with, please. I just wondered if the revision to your expectations now I'm anticipating to be towards the lower end of the range is reflective of just the kind of experience that you've experienced, sorry, in Q1 and the clearance impact you're expecting for Q2 or whether you've actually revised your expectations for the consumer and for profitability in the second half. And indeed, if not, is that an incremental downside risk from here?

And then the second question is -- very much appreciated the color you've given around performance of these different categories. You also, though, alluded to some availability shortages in footwear. So I just wondered if you can update us on the demand picture in leisure, both apparel and sneakers.

[Robert Gentz, executive]

Good. Yes, in terms of the first question on guidance, well, when we shared our guidance in March, yes, beginning of March, we -- as I said, we explicitly -- as we've said, it's -- it does not yet reflect the full impact of any -- impact of the Ukraine war because it just had started just a few days before we actually about -- spoke to you. And so -- and I think what we've seen since then, first of all, was a slower consumer sentiment that continued into -- as well into -- continue but as well some strides of - -good, positive signs in our business that we especially see over the last couple of weeks now, over the last 2 weeks. So I think that's -- so that's a part of the picture.

Second part of the picture is actually that -- like in the second half of the year, it's -- there's just this technical -- so we are not comparing ourselves anymore to pandemic height, that just it's a technical effect that we will see double-digit growth again.

Plus, the third thing is we don't stand still here. So it's not like we're not in an observer seat. So we see the opportunities, we see the demand patterns, and our job is to act on them. It's our job to make the best of the situation.

Again, the second question was on performance of...

[Sandra Dembeck, executive]

Regarding categories.

[Robert Gentz, executive]

And the second question was the performance of categories, yes? So yes, the supply chain topics, they are -- like they are relevant, but they are not the big piece of the picture at the moment, yes? So it's not going to be about our Q1 performance, it is a minor effect, I think, of our performance. And we're in continuous discussions with our brands. And as a platform and as one of the key partners, obviously we're in a good position to solve these supply chain issues and get the access, I think, better -- comparatively better, and -- yes. And we are, throughout it, I think, in a good shape to be better equipped exactly on these categories where we see the demand shift our customers are moving towards.

[Operator]

We'll now move to our next question from Michael Benedict from Berenberg.

[Michael Benedict, analyst]

I have a couple as well. Firstly, you mentioned you are introducing minimum order values in certain markets. Could you give us an idea of which major markets they will be implemented in? And when you previously implemented minimum order values, have you seen any material impact on the top line?

And the second question is on the gross margin. It looks like it may well continue to fall in H1 despite the successful platform transition. I wondered if you could give us an idea of when you expect that to stabilize and begin to move in a positive direction.

[Robert Gentz, executive]

Yes. And maybe first on minimum order value. Just to -- just like -- mentality behind the minimum order value is to deaverage the proposition, yes? So -- and it's -- for us, it's a way to -- as we'll continue to be able to offer items that are in demand at a lower item value. For example, Beauty, secondhand and, as well, other articles. So -- and it's a mechanism that we -- that were tested out in nine markets, and what we've seen in these markets is actually positive. So we didn't really see a material impact on the top line, but we saw actually a good shift of the customer behavior and direction upwards, yes?

And as said, we are entering into more markets, so -- and it might be all markets, but we're entering in more markets. That's what we can say for now. And Germany is, well, included as one of our biggest markets where we as well see the share of orders that are below threshold that we want to move upwards. But the experience is very positive, and that's why we are doing this. And it's very normal. It's in line with our strategy.

On gross margin?

[Sandra Dembeck, executive]

And then, in regards to your second question about the gross margin, I think you've got it right. The -- for the second quarter, of course we still need to churn through our inventory in what is still a very low-demand environment. However, in the second half, as we see growth return and we have adjusted our buy, as I said earlier we rebalanced it, we will be able to avoid exactly that situation to an unnecessary markdown. So therefore, we do expect our gross margin to perform better in the second half.

[Operator]

Thank you. And we will now take our final question today from Simon Irwin from Crédit Suisse.

[Simon Irwin, analyst]

I think most of my questions have been answered. Can you just quickly talk about the impact of product mix on gross margins? I mean presumably, higher return rates and a lower participation of COVID categories should be quite positive for gross margin mix preclearance.

[Sandra Dembeck, executive]

I think you pointed out in the right way. It's positive for gross margin but not to forget that it has a negative impact on our fulfillment costs.

[Robert Gentz, executive]

Yes, those had a negative -- it has negative impact because especially those categories that were in high demand before COVID were the ones that actually saw lower return rates, yes? And like occasion wear dresses and these categories are the ones that have higher return rates. So this is, I think, the shift of the -- we're alluding to in -- of quarters around what is actual return benefits, the temporary return benefit through the pandemic that is now past unwinding, yes? So good for gross margins, not too good for the fulfillment cost.

[Operator]

That was our last question today. With this, I'd like to hand the call back over to Mr. Patrick Kofler for any additional or closing remarks.

[Patrick Kofler, executive]

Thanks, everyone, for joining this Q1 2022 call today. If there are any with any questions, do not hesitate to contact us. And for the first time in 2 years, we'll also be on the road from next week onwards physically, and hope to see a lot of you there.

Thanks a lot and thanks for joining. Have a great day.

[Operator]

Thank you. This concludes today's conference call. Thank you for your participation. Ladies and gentlemen, you may now disconnect.