Zalando SE

XETRA:ZAL

Earnings Call Transcript 2018-Q2

[Operator]

Dear, ladies and gentlemen, welcome to the conference call of Zalando SE regarding the publication of the Q2 results 2018. At our customers' request, this conference will be recorded. [Operator Instructions]May I now hand you over to Patrick Kofler, Team Lead, Investor Relations, who will lead you through this conference. Please go ahead.

[Patrick Kofler]

Good morning, ladies and gentlemen, and thank you for joining us on our conference call today to review the second quarter 2018. As always, with me are Rubin Ritter, one of our 3 Co-CEOs responsible for the Zalando Fashion Store; as well as Birgit Haderer, our SVP, Finance.This call is being recorded and webcast live on our Investor Relations website, and a replay of the call will be available later today.With that, let me now turn the call over to Rubin.

[Rubin Ritter, Co]

Yes. Thank you, and good morning also from my side. Thank you for joining our earnings call. As always, the call has 4 parts. We will start with the business highlights. We'll then talk about our financials and then about our guidance before we turn over to your questions. So let me start with the result highlights of the second quarter. I think in the second quarter, we once again achieved a really strong revenue growth, in line with our target corridor. Revenues increased by about 21% to EUR 1.3 billion. I think we were able to execute well in a fairly challenging market environment. We saw the fashion market actually declining in the second quarter. So I think in that context, we really continued to significantly outperform the market overall and continue to gain market share, as it is in line with our long-term growth strategy.This development was really supported by another quarter of strong customer KPIs. Order volumes grew massively by about 30% to 29 million orders, which is very clearly a new all-time high. Also, visits we saw growing really strongly by about 23% to more than 730 million visits just in 1 quarter. We will have a chance later to dive deeper into active customer numbers and frequency numbers, but I think we can really say that the growth engine is still intact and running well. When you look at these numbers, you -- that also already suggests that we had a negative development in the basket. Also, that is something we'll have in the presentation a little bit later.If we turn to profitability, we saw very solid growth year-over-year. Adjusted EBIT grew to EUR 94 million, above last year's levels of EUR 82 million. And we also saw that the Partner Program continues to be one of the key drivers of our growth, which reached now, for the first time, 10% of GMV. And this is actually something I would like to go into a bit more detail on because I think it's really important and has been one of the main themes also of our last calls that we want to really focus on bringing the platform and bringing the Partner Program to life. So now it's at 10%. We see that really, the top partners have been growing quite strongly because we gave them more and more opportunities to trade on our platform, so to onboard more merchandise even faster and, therefore, also take better trading decisions and, therefore, driving growth. We put a special emphasis on taking the Partner Program to a more international setting. In the second quarter alone, we created 65 new combinations of brands and countries. And we were able to launch Poland, so now the Partner Program is live in 14 markets. Also, the services that we drive around the Partner Program were able to add a lot of value, supporting our partners and driving their growth. So for example, Zalando fulfillment services is now live in 13 -- in all 13 countries of the European Union that we operate in. And we were able to add about 10 brands to the program and also have a strong pipeline to continue to grow it in the second half of this year.In general, we also, of course, invested a lot in driving our customer proposition. We increased the reach of our platform by adding Ireland and Czech Republic, so the first 2 new markets for a number of years, adding 15 million potential new customers to our reach.We further enhanced the shopping experience. For example, we realized that we have many customers that come, for example, to the German web shop with English-language browser settings. And we noticed that these customers tend to have a lower conversion rate, so we decided to offer multi-language options to our customers in Germany and Switzerland. And depending on how the reception is, that is also something where we have the option to roll it out to even more markets. We started to offer more convenient payment methods. So for example, we launched Pay Later in Denmark and Italy, which is essentially a sort of try-before-you-buy mechanism where customers' credit cards are charged only after these customers have really made their buying decision in terms of what they wish to keep. And we see that this drives conversion and also net baskets.And then we have continued to work, of course, on our on-time delivery. Through AI-enabled delivery prediction, we were able to reduce the size of the delivery time window by 15%, which has a very positive impact on customer satisfaction and also on conversion.As another business highlight, I would like to talk about our Offprice segment for the first time in a bit more detail. The Offprice business started as an emerging business in 2010 and since then has shown outstanding growth performance. And now it has actually reached a size and a level of success that we will report it as an independent segment going forward. You will also see this in the following financials. Now Offprice, for us, is an additional way to connect customers and brands. It consists of 2 parts: Zalando Lounge and Zalando Outlet stores. And clearly, Lounge is the much bigger part of this. If you look at the proposition of the Lounge towards the customers, it is a shopping club that is offering attractive deals and specifically targeting very discount-affine customers. So you will get daily sales campaigns with very high discounts of 50% to 70% while we are selling leftover and old season merchandise. Lounge actually has 15 million members and is operating in 14 markets.For the brands, that allows us to offer additional services. It allows them to manage their excess inventory in a way that is respecting and maintaining their brand image, but with an international distribution, so also able to drive quite high volumes. And this model is highly synergetic to our platform overall because it allows us to target additional discount-affine customer segments, and it helps us to solve the overstock problem both for our brands but also for our own wholesale merchandise. Overall, this proposition has led to very strong financials. So we saw about 45% growth since 2016. Lounge -- Offprice is trending towards EUR 500 million in 2018. And during that time, it always has been operating profitably. Now let's move on to our financial update for the second quarter, as always, starting with growth. So year-to-date, our growth is a bit above 21%. Also, in the second quarter, it has been around 21%. Actually, if we look at the second quarter and if we were to account Partner Program at full revenues and if we also were to adjust for FX developments, actually, the growth would have been around 25% for the group overall.The page also outlines the growth of the different segments. So you see the growth in the Fashion Store, so our core business, you see the Offprice segment and you see the Other business units. If we dive deeper into the Fashion Store, I think you see a very similar pattern compared to previous quarters. You see the DACH region growing faster than 15%, and you see the Rest of Europe region going close to 30%.Now if we dive deeper into the customer KPIs behind this growth, we see that active customers have been growing by about 16% to close to 25 million active customers, who actually placed in the second quarter around 29 million orders. And this already hints at the very strong trends that we see in frequency. So frequency is up about 14%. We are now at 4.2 orders per 12 months, which is clearly a new all-time high. And this is also the strongest driver behind the growth of GMV per active customer.At the same time, as mentioned before, we see that the average basket is declining by about 6% year-over-year. And behind that, I think we have 2 -- sort of 2 major reasons. The first reason is the continuation of the longer-term trends that we have also described on previous earnings calls. So they include the shift towards mobile, which now makes up about 80% of our traffic and more than 60% of our revenues. It refers to the higher mix of low price points, especially driven by fast fashion. And it also refers to the shift that we see from DACH to Rest of Europe, where Rest of Europe tends to have lower net baskets. So those are more the longer-term trends that drive down the basket but also help us to really drive frequency. On top of that, in the second quarter, we have seen a more seasonal effect. So given the temperatures that we observed in the second quarter, this led to significantly lower share of sales in transitional items so, for example, summer jackets, which again led to a negative effect on the baskets. And we expect that effect to be seasonal and, therefore, temporary. In terms of order of magnitude, we would estimate that those 2 effects have a fairly similar magnitude in the second quarter.Now moving to profitability. You see here that profitability is slightly down for the first half. And you see that profitability is up by about 15% for the second quarter. Specifically in the core business, profitability has increased by about 23% compared to the second quarter of last year.When we look one level deeper, we see that profitability in the DACH region is at a similar level compared to last year, and we see that profitability in Rest of Europe has increased quite meaningfully. In absolute terms, it has actually almost doubled compared to last year.If we look at the profitability trend by cost line. As an introduction, there's one brief reminder I would like to make because, as we said already on the Q1 call, in the context of our updated management and reporting structure, we also have reallocated some cost. With that, we wanted to increase cost accountability and speed of decision-making in the business by shifting some costs from the admin cost line into the respective operating cost lines where we think that they ultimately belong.So in terms of the shift, you see the same dynamics as we pointed out in the first quarter, which means admin expenses is about 1 percentage point lower because that has been shifted from admin cost to fulfillment cost and, to a smaller extent, also to cost of sales. So the increase in those 2 operational cost lines would have been less pronounced without the shift. And of course, the decrease in the admin cost line would also have been significantly less pronounced.Now if we go to the different cost lines, we see that cost of sales is down by 1.2 percentage points in the second quarter, which is due to increased price investments and, to some extent, also a consequence of the seasonal dynamic that we have seen in this season overall.The fulfillment costs are down by 1.4 percentage points, which continues to be driven by our investments in our convenience proposition. It continues to be driven by the fact that we are ramping up significant warehouse capacity. Right now, we have 5 warehouse locations that are in ramp-up, which obviously also incurs extra cost. It is also impacted by the basket size development that I have described. And it's also impacted by the shift in cost lines that I have alluded to in the beginning. When we look at marketing costs, we continue to see operating leverage. Even though our absolute spending has increased compared to last year, it has increased less than our sales growth, so we see marketing cost 0.9 percentage points lower compared to last year. And admin expenses, we see a decrease, which is primarily driven by the reallocation of cost into other cost lines. As a result of that, adjusted EBIT margin is fairly similar, fairly close to the prior year period.Now let's take a quick look at working capital and CapEx. You see that working capital for the second quarter is at EUR 16 million or 0.3% of sales, so fairly neutral. Actually, inventory development is at the level of prior year, if you account for the growth, which I think is a good result. And we expect -- we continue to expect slightly negative net working capital at the end of the year. If we look at CapEx, in the first half of this year, we spent EUR 109 million on CapEx; and in the second quarter, we spent EUR 67 million. CapEx this year will be very meaningfully back-end loaded, which is related to the timing of our projects, which are all progressing in line with plan but will be very concentrated in the second half of the year. And we continue to expect EUR 350 million CapEx for the full year.Now with that, I would like to come to the outlook. Given that we are 7 months into the year, we want now to specify our guidance and make the ranges a bit more narrow. So on revenues, as you know, top line growth continues to be our main priority. In the first half of the year, we were able to realize strong revenue growth of 21.4% in an overall challenging season with a very late season start and then a very fast change into extremely hot weather, which significantly reduced our sales of transitional merchandise. We see that the extreme summer conditions continue into July and August. Today, I heard it's going to be 37 degrees in Berlin. And I think that is one of the drivers why we expect for the full year revenues to be in the lower half of the annual growth corridor of 20% to 25%.I would also like to point out that this is in line with the midterm communication that we gave at our last Capital Markets Days, where we said that for the next years, we expect revenue growth to be potentially in the lower half of our growth corridor; while GMV growth, we expect to be in the upper half of our 20% to 25% range. If we come to profitability, so as you know, while we are very focused on growth, we want to maintain a solid level of profitability despite our high levels of long-term investments. And so far in 2018, we have achieved an adjusted EBIT of EUR 94 million, which is a bit behind last year's level if we look at the full first half.On this basis, we expect to come in at the low end of the EUR 220 million to EUR 270 million that we communicated at the beginning of the year. This will translate into a still very solid adjusted EBIT margin of around 4%, at the midpoint of the revenue range. For the cash flow metrics, we expect net working capital guidance and CapEx guidance remains unchanged. If we look at the current trading of the third quarter, I would like to point out that, as you know, the third quarter is a seasonally very mixed quarter. July and August are offseason months, which means low margins due to discounts on spring/summer merchandise, which is even more pronounced due to the ongoing heat wave that we observed in July and August. And then September is typically the time of the season start. But of course, as always, the exact timing depends on when fall/winter actually starts.And I think overall, I also would like to say that we are very excited to head into a new season. I think we have a number of exciting activities lined up. We will have Bread & Butter coming up at the end of the month. We will then have the season start, where we will really celebrate the 10th anniversary of Zalando in a way that I think will be also very impactful.From a customer perspective, we then are heading into the cyber days, we're then heading into the Christmas business, so the coming months really will be very important for our business. And I think it's also months where the entire team is looking forward to deliver the best possible outcome for the fall/winter season.And with this, I would like to conclude the presentation and continue with your questions.

[Operator]

[Operator Instructions] We've received the first question, it comes from Volker Bosse of Baader Bank.

[Volker Bosse, Co]

Volker Bosse. First question would be on the Partner Program, 10% of GMV. So what was the driver of the above-average growth increased assortment? Any specific brands worth to mention? Any new brands? You mentioned 10 new brands, so perhaps some names here and some background would be helpful. And yes, a final one, on the tax rate. Just for clarification, what would be the tax rate for the full year you would expect? And perhaps, finally, on the beauty segment, an update on the expansion plan here out of Germany, any new brands would also be helpful.

[Rubin Ritter, Co]

Sure. So on the Partner Program, I think the predominant driver of growth is really that we continue to internationalize the program, so we roll out more and more brands across more markets, which obviously gives them more customer reach. And the second big driver is, of course, the assortment. So in there, I think predominantly, we have been able to grow with the large accounts that we already have, by giving them more opportunity to onboard merchandise even faster, to onboard more merchandise. So we see that many of our large accounts, like Mango, like adidas, like Esprit, like Next, they have really been able to drive very efficient growth on this basis, and I think that's also going to be the main driver going forward. And a quick comment on beauty. So there, really, the expansion is running, and we have a number of ideas for the coming quarters on how to further grow beauty. So very recently, we have started our first offline beauty locations in Berlin. We were able to onboard MAC, which is a very important brand. And we also have a really good pipeline of brands to come online in the second half of this year. But as you know, we typically comment on brands once we've really signed and launched them. But clearly, extending our assortment even further will be one of the core drivers of our growth, and we also see a lot of interest from brands to work with us.

[Birgit Opp]

And briefly on the tax rate. So we do expect similar to what you see in Q2, on an unadjusted earnings before tax basis, a 40% tax rate; on an adjusted basis, obviously below. And the drivers that drive it above the 30% statutory rate is differences in tax accounting treatment, for example, for SBC.

[Operator]

Then we come to the next question, it comes from Simon Irwin.

[Simon William George Irwin, Director]

A couple of questions. With beauty, I know -- obviously, you mentioned that you've opened a store. Are you going to have to open a store in each country in order to get physical access to product? Is that the principal reason for opening a store?

[Rubin Ritter, Co]

So no, we don't expect that we would have to open stores in every country. And we expect to open potentially some more stores in Germany or maybe some will also be outside of Germany, but we don't expect to do that in every market.

[Operator]

The next question comes from Jurgen Kolb.

[Jurgen Kolb, Analyst]

Two questions. The Partner Program, you said it's 10% of GMV in the second quarter. Maybe you could share with us where it was last year at the same time and what the growth rate was obviously here. And then secondly, you referred to the CapEx line saying that you continue to expect EUR 350 million. That's about -- if we go to the low end of your sales guidance, about 6.5% of group sales. Is that the level you -- we should also punch in for the coming years? Will it stay on the 6.5% level for '19 and '20?

[Rubin Ritter, Co]

So I will take the first question on the Partner Program. As you know, we don't disclose the Partner Program share on an ongoing basis, and we also don't intend to do that going forward. But before that, this 10% sort of milestone is one that is important to share to give you some transparency on what part of our business it is currently driving. Partner Program growth has been significantly above average growth, as you would expect, because we continue to onboard new partners, we continue to internationalize, we continue to bring on much more assortment. So clearly, it is a very fast-growing portion of our business mix.

[Birgit Opp]

And then briefly on CapEx, so as you might recall during Capital Markets Day this year, we gave CapEx guidance for '19 and '20, saying it should be around 6.2% of revenue. So how we've arrived at that at that point in time was to look at bottom-up lead projects that we see coming up, so EUR 1 million amount. And so for the time being, please assume that we stay with that EUR 1 million amount. Depending on what growth we will see in the next 2 years, that then translates into the respective percentage of sales.

[Operator]

The next question comes from David Gardner of Morgan Stanley.

[David J. Gardner, Equity Analyst]

Two questions from me. Orders per active seem to keep increasing. How do -- I mean, where does this max out? And how does this vary between DACH and Rest of Europe? And then secondly, with the expansion into Ireland, does this indicate that perhaps the U.K. could be more of a focus going forward?

[Rubin Ritter, Co]

So on the first part of the question, where do sort of orders per active max out, to be honest, I think that is fairly difficult to foresee because already, driving activity rates to above 4 orders per year is maybe something that a couple of years ago, we would not necessarily have expected. But I think it is a really great time because typically, a high frequency also means lower churn and higher loyalty. So that is a development that we definitely want to continue to drive. I think more high level, if you don't look at the orders per active, but if you look at the GMV per active customer, we are at 200 -- a bit more than EUR 250 per year. And as we communicated before, if you look at the average spending per European consumer on fashion, you are talking about something like EUR 1,000 per year, even a bit more. And I think for the more fashion-savvy customers that we are addressing, it is probably going to be somewhere around EUR 1,500. So if you compare to those overall budgets per customer, I think that suggests that with EUR 250, we are not yet close to the end. I think there's still opportunity to drive our share of wallet. I just think it's very difficult to forecast if that will be driven by orders per active or if it will be driven at some point also by higher baskets. But I think overall, there's more leeway to drive sales back to customers. And then on your question regarding the U.K., I think the launch in Czech Republic and Ireland, it doesn't mean any shift of priorities in the other markets. I think in the case of U.K., it is still important for us to see how this whole Brexit topic plays out. And the fact that we launched 2 markets, I think it's a great time. And also, the team enjoys it, and it's great to be again entering new markets, but it has not really altered the way that we set priorities in the existing markets.

[Operator]

The next question is from Anne Critchlow of SocGen.

[Anne Critchlow, Equity Analyst]

Two questions from me, please. The German market did seem a bit stronger in the second quarter compared to the first. So I'm just wondering whether it was pushed more offline into physical stores in the quarter and whether you felt that, or whether there are any particular weak KPIs to mention in that DACH region. And then my second question is on marketing. It did rise a bit in the second quarter. I'm just wondering how it might pan out for the full year and whether you're seeing good opportunities now to invest in marketing.

[Rubin Ritter, Co]

So according to the numbers that we see, the second quarter in Germany was actually down year-over-year, which I think includes the fashion market overall, so it includes offline and online. Of course, there's always the question, how precisely that can be measured in the short term, but those are the steps that we have available. And it's also, I think, in line with what we hear in general from our brand partners on how the second quarter has been going overall. Specifically on marketing, I think in general, it's our strategy to bring marketing down relative to sales but to continue to increase it in absolute terms. And I think specifically, in the second half of the year, we would like to actually drive a bit more of marketing spending. So specifically, for the season start, we have a, I think, really great campaign in the pipeline that sort of celebrates sort of the 10th anniversary of Zalando and really communicates quite well what we stand for and what we bring to the customer. So that, we will play very prominently. And I think for us also, like in the competitive environment overall, it will be important in the next seasons to be again a bit more present in terms of marketing. So definitely, we hope to see some investment opportunities at good ROIs.

[Operator]

The next question comes from Dan Homan of Citi.

[Dan F Homan, Vice President]

A couple of questions from me. First of all, just on the decreasing average basket size that's been going on for a couple of years now. Can you comment on any trends in items per basket versus average selling price per item or essentially, are items per basket still going up? And then is there any future solutions that you could just help us with around whether there's a possibility of increasing that average basket size, anything you've looked at? And then the second question was just I noticed you've got a new long-term incentive plan, which is going to push the share-based payment costs up to EUR 55 million this year. Is that the level of cost that we should be expecting for the next few years?

[Rubin Ritter, Co]

Sure. So on the baskets, I'm afraid we don't break down sort of basket trends in even more detail. However, on your question on what can be done about them, I think there are 2 parts to the answer. I think one part is that as we have seen this being a continuous trend that is driven by very important consumer shifts, like the shift towards mobile and shift towards lower price points, and since we want to leverage these shifts in order to drive more frequency and to drive more growth and more customer loyalty, I think, to some extent, the pressure on the net basket is something that we will have to accept and that we have to learn to work with and really fine-tune our proposition in terms of the cost structure, in terms of our customer acquisition strategy to reflect that shift over time. But of course, the second part of the answer is that yes, there are ways to also work on the basket and to work on it on a way that can be also positive from a customer perspective. So for example, in the way that we drive cross-selling or in the way that we use also upselling opportunities, I think that is something where we definitely are not doing everything possible yet and where there's options to actually also improve our customer proposition. For example, we have started recently to offer full outfits to our customers also on our main Zalando destination, which I think is great from a customer perspective because that's exactly the advice and the inspiration they're looking for. And on the other hand, it also tends to lead to higher baskets because customers then decide to buy actually full outfits. On the LTI and the stock-based compensation, I think there, it's important to keep in mind that accounting for stock-based compensation is always front-loaded. So in the first years of the program, you incur significantly higher costs than in the last years of the program.

[Operator]

We have another question, it comes from Michelle Wilson of Berenberg.

[Michelle Wilson, Analyst]

Two questions from me, please. First of all, just on the fulfillment costs that are up 220 bps in H1. Could you give a breakdown of how much of that drag is caused by the rollout of new distribution centers? Or any sort of details you can give on the labor cost per unit of the new distribution centers versus the old and when that should kind of start to drop out? And then second question, you mentioned on the gross margin some price investments that you've been making over the last, I think, 12 months or so. How long should we expect that to continue for? And how will you kind of gauge that you're happy with your price positioning versus competitors?

[Rubin Ritter, Co]

So I think on the fulfillment cost, we have commented also in the past about the effects driving up our fulfillment cost relative to sales, which continue to be related to increased convenience offering to our customers by even faster delivery, return pickup proposition and all these elements, which have been a significant driver in our Net Promoter Score and also a significant driver in getting retention up and to make sure that, as we explained on our last Capital Markets Day, cohorts really are growing their spending over time and are increasing their loyalty over time. So we think that has been a very good investment for the company to make. In terms of warehouse ramp-ups, we can comment on the magnitude of the ramp-up, which affects 5 warehouses. So almost half of our warehouses are currently in ramp-up. And of course, that incurs additional cost. And given that we have really been preponing some of the warehouses to be ready for future growth, so we don't expect that pressure from warehouse ramp-ups to increase going forward. Actually, it should help us slightly as we grow into that footprint. And then as I mentioned, basket size also has been the driver in that development. In terms of cost of sales, you're right that for a number of seasons, we have been putting a bit more emphasis on price investments because we saw it as a actually more effective driver in some cases to get additional growth and also to target younger customers and to make sure that we also win younger customers that we then expect to be serving for a very long period of time. So I think also there, we have really tried to look at the ROI and see what the effects are and how we can drive it. I think also in the context of the discussion around the basket size, we are currently reviewing, so to what extent we want it to continue with that shift or if there comes a point in time where we say actually now, we are at the right spot and we don't need to continue into that direction. But I think that is really something that we will play season by season. And as you have seen also over the past, the investments we have been making into pricing, I think also have been quite measured. And this is how we also intend to drive it going forward; to continue to take little steps, but then also to revisit if these steps have been value creating for the company overall and value creating from a sort of growth efficiency or growth perspective.

[Operator]

the next question comes from Andreas Inderst of Macquarie.

[Andreas Inderst, Senior Equity Analyst]

I have 2 questions. The first one, on your online delivery, you mentioned you improved it by 15%. How -- can I ask you how much of your orders are actually arriving on time or earlier? And maybe you comment how you think you perform versus the overall market when it comes to order fulfillment. And the second question is maybe a clarification on your inventory position. Rubin, how do you see your inventory position right now? Is it clean, current? Maybe you can elaborate a bit more.

[Rubin Ritter, Co]

Sure. So on the first topic in terms of on-time delivery, maybe there's a slight misunderstanding. So in the presentation, I talked about the size of the delivery window, right? So if we tell a customer, look, your parcel will arrive -- if you order today, it will arrive Wednesday or Thursday, so we give a 2-day window. And the size of that window, we have been able to reduce by 15%. So we make our prediction more narrow, which customers like because then they know more clearly what to expect. Right? So the size of the window has gone down by 15% -- or improved by 15%. If we look at our on-time delivery, that's, of course, a different question. That's then a question, in how many percent of the cases do we manage to fulfill within that window? And that number, of course, is very high. So our internal benchmark is always 97% on-time delivery. Actually, we frequently outperform that internal benchmark and trend more towards 98%. So 98 out of 100 parcels will be delivered as promised. In terms of the inventory position, the inventory position grew in line with sales. So from that perspective, I think it is fairly clean. Of course, there are still some spring/summer stuff that we are now selling off. But it grew in line with sales, so it is developing according to plan. And we don't see any major underlying issues in our inventory position.

[Operator]

The next question is from Rocco Strauss of Arete Research.

[Rocco Strauss, Analyst]

Two questions from me. One of your British competitors have called out GDPR as a negative impact on growth, given that some customers could not be properly targeted as done before. I was wondering if you saw any disruption from the GDPR coming into effect in May of this year. And secondly, more in general, I mean, given the 25 million active customers on the platform by now, and I know you generally do not talk about churn, but could you share any insights on how many European customers you had seen overall in recent years? And how much room is left to grow customers that have not tried Zalando before?

[Rubin Ritter, Co]

Sure. So on the GDPR question, I mean, of course, GDPR has been complex and cumbersome to implement, so it has taken also some internal resources to get to the place where we need to be. But really, on the customer side, we have not seen any meaningful impact. And it hasn't changed the way that we do our business, that we are able to target customers, that we are able to address customers, that we really have not seen any impact. In terms of churn, we have shared some steps with you on the last Capital Markets Day, and I think that is sort of the level of detail that we are comfortable to share. Of course, we have sort of seen more European customers than the currently 25 active -- 25 million active customers. But Europe is very large, and I think, clearly, there is more opportunity to grow. And quite frankly, every customer that has shopped with us but then churned away or did not buy again, of course, we are eager to win these customers back, and we have seen many cases in the past where that was possible. So actually, I would look at this population that has become inactive for whatever reason actually as a growth opportunity that we quite actively try to retarget and win again and convince that Zalando is the right place for them to shop fashion.

[Operator]

The next question is from Chris Chaviaras.

[Christodoulos Chaviaras]

Two questions from me as well, please. The first question, just a clarification, Rubin, from what you said towards the end of your presentation about the third quarter. Did you say that because of the weather, there's going to be more discount -- more discounting on the transitional merchandising? And if that's the case -- if I haven't understood wrongly, if that's the case, has that already been baked into the guidance that you have given? Or is there a risk for a bit more gross margin deterioration in the third quarter? And the second question, on the average basket size, I'm afraid. Given the reasoning that you've given on what causes the average basket size to go down, it seems like unlikely that this will reverse anytime soon. Is there a level -- if we assume that there isn't any upselling that can be materialized, although that's a possibility, as you say, but is there a level where you could be potentially alerted and you'll have to bake a smaller average basket size into your longer-term EBIT guidance?

[Rubin Ritter, Co]

Sure. So on your first question, I think you correctly understood my comments on July and August where I just wanted to emphasize that in those quarters, we see a very high share of spring/summer merchandise, driven by sort of the current temperatures and the current environment. And as a result, that also leads to a higher share of spring/summer discounted merchandise in the overall mix of the quarter. Of course, we try to reflect in our guidance what we currently see. Of course, for us, it's difficult to fully reflect, for example, when exactly the new season will start. We don't know yet really how September and October are going to play out because that is, to some extent, also really driven by events that we cannot fully foresee. But to the extent that we can, we have tried to give a fair and reasonable forecast. In terms of the average basket, as I said in the presentation, I think there is one element, which is sort of a structural more long-term trend. And then the other element is a more seasonal effect that we have seen specifically in the second quarter and then also, of course, in July and August. And I think the second one, like the temporary trend, is something where we don't expect that to continue in every season naturally. So I think based on that, the trend will be less pronounced in the coming quarters compared to what we saw in the second quarter. Ideally, our idea would be to really try to influence this change in a way -- or shape this change in a way that this transition to lower baskets is sort of in line with our proposition and that it is in line and can be sort of reflected and absorbed by the way that we manage our overall financials and our overall strategy to acquire customers and to grow their spending. And I think that can be achieved by a number of the measures that we discussed and that we pointed out. And maybe also additional ones to make sure that this development, even if we cannot fully revert it because then we would stop our growth, that this sort of continued trend is really well-absorbed by our financial profile overall.

[Operator]

The next question is from Andrew Hughes.

[Andrew Hughes, Managing Director and Head of the Pan]

It's Andrew Hughes from UBS. Could I just try and get a bit more color on the profit swings in Fashion Store just by region? So obviously, you mentioned that Rest of Europe almost doubled in the second quarter, but it was pretty flattish in Q1. So what sort of special factors happened in Q2? And the same for DACH region, I mean, that pretty much halved in Q1 and it was up in Q2. So have you got any -- just any broad comments on those areas? Second question is really going back to the average order value. I think you said at the Capital Markets Day the cost per parcel delivery was rising by about 3%. Is that still the case? And is that the sort of key metric we should be looking at: your average order value down 6% or so; and your average delivery cost up 3? Is that really where the squeeze affects you most?

[Rubin Ritter, Co]

So on the Rest of Europe segment, I think there are a number of factors contributing to it. One was the way that we drove, for example, marketing specifically in the second quarter. But I think besides that, there are no really bigger structural shifts. On the average order value and the pressure on fulfillment cost, I think you're sort of -- I mean, the observation is correct that we see basket sort of coming down. And at the same time, we see that we invest more into our fulfillment proposition and that we invest more into this really big ramp-up of our capacity. So I think directionally, you are right that we see both factors coming together in this fairly large impact on fulfillment cost in the first half of this year.

[Operator]

The next question is from Andreas Riemann.

[Andreas Riemann, Analyst]

Andreas Riemann, Commerzbank. Two questions. First topic, personalization. How many Zalando customers do already have an individual landing page today? Or is there a target for 2018 or 2019? Or in other words, when can we assess the benefits from personalization? And the second topic, private label. Given the higher relevance of the Partner Program, which is obviously bad for private label business, is it fair to assume that the revenue contribution from private label should decrease steadily over time? Or are there any plans to give private label an additional push in the future?

[Rubin Ritter, Co]

Sure. So on the personalization question, I think it is difficult to see how many customers have a personalized landing page because it really depends on what entry points customers choose into the assortment and depending on what that is, it might be personalized or it might not be. I think, in general, what we try to do -- I mean, to assess the impact on personalization is very difficult to do. The way that we try to assess it is through A/B testing, and that we already do quite continuously. And there, we look at the different measures and we look at the different touch points and try to assess from the test setup what impact a more personalized experience for customers have. And we see that, actually, the impact can be quite meaningful. I think in the global KPIs, it is not easy to fully assess it. I think one data point I can give you is the conversion rate year-over-year was actually up 5% to a level of a 3.9% conversion rate, which is quite high and which is quite strong. And I think that gives an indication that we are trending into the right direction in terms of making the digital experience and the front-end more and more successful and more and more interesting to our customers. On the Partner Program question, you're right that this affects our private label business because essentially, by on-boarding more and more partners and giving them more and more space, we are creating more and more competition for our own private label. And obviously, that is not in line with the strategy where you would expect a private label share to increase. So that has been a strategic decision to say, actually, we see the bigger value to create the platform for all the European fashion brands. And then our private labels can be one brand on this platform and hopefully very successful. But of course, in that environment, it's difficult to see the private label share to grow over time. So we would rather expect it to be constant or even decreasing, which means the private label business can still grow in absolute terms. But in share of the platform, it might well be that it decreases or continues to decrease over time.

[Operator]

The last question is from Tushar Jain of Goldman Sachs.

[Tushar Jain, Research Analyst]

Two questions. Can you just give us an update on the loyalty program and share some KPIs, how many people are there, and is that also a big drag -- a slight drag to your basket size? And the second question, I just was wondering if you can remind me what is your open-to-buy in current season at this stage? And are you planning to increase that, given the volatility in the weather and the impact on the gross margin?

[Rubin Ritter, Co]

Sure. So on the loyalty program, we continue to drive and grow that program and that effort. And what we see is that specifically, with customers that already were very active and that especially live in urban areas, where, with our local delivery network, we can offer a far superior service, that once we get them to sign up to the program, their revenues increases actually quite substantially and also their profit contribution goes up. So this is really the type of customer group that we are currently targeting the program towards. In terms of open-to-buy, we have about 20% to 25% of merchandise that we always buy within the season. And on top of that, as you know, we have now an increasing share of Partner Program sales. And I think both elements really help us more and more over time to manage our inventory risk more and more efficiently. And I think also, when you look at this season and the trends that we saw and the market environment overall, I think we're able to really manage our inventory position quite well due to these levers that we have.

[Operator]

As there are no further questions, I would hand back to you, Mr. Kofler.

[Patrick Kofler]

Thank you very much for joining us today. We are looking forward to speaking to you soon. If you have any follow-up questions, do not hesitate to reach out. Enjoy -- now enjoy the day and a hot day, and have a great summer. Bye-bye.

[Operator]

Ladies and gentlemen, thank you for your attendance. This call has been concluded. You may disconnect.