Zalando SE

XETRA:ZAL

Earnings Call Transcript 2022-Q2

[Operator]

Good day, and welcome to the Zalando SE Publication of the Q2 2022 Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the call over to Patrick Kofler. Please go ahead.

[Patrick Kofler, executive]

Good morning, ladies and gentlemen, and welcome to our Q2 2022 earnings call. I'm joined by our Co-CEO and founder, Robert Gentz; our CFO, Sandra Dembeck. Robert will kick as off with a holistic update on the current performance and an update on the progress we've made against our strategic objectives. Sandra will then walk you through the financials of the quarter, and Robert will discuss our outlook. Robert and Sandra 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, and yes, and good morning, everyone. Thanks for joining. Since we last met in May, the market environment has further deteriorated. So consumer confidence continues to decline, and we continue to face supply shortages. And we also lapped another quarter of extraordinary strong growth in 2021.

So as a result, Q2 came in weaker than expected and we recorded another quarter of flat growth. While this result stems from the circumstances affecting our business, I want to clearly emphasize that our strategic goals and ambitions are on track. We're already seeing initial results of the efficiency measures we are taking.

So despite the volatile market environment, we're able to grow our active customer base on a trailing 3-month basis by almost 4%. Our loyalty program, Zalando Plus grew 164% year-on-year, which now more -- with now more than 1.5 million members. So this showcase our progress in deepening customer relationships.

But we see as well as customers spend contracted as consumer wallets remains under pressure. The drivers and challenges for our performance in the second quarter are very similar to Q1. So we face the volatile market environment in the second quarter.

On the consumer side, the EU consumer confidence index dropped further due to the cost of living increases triggered by supply shortages and the ongoing war in Ukraine. And on the sourcing side, supply chain disruptions continued and driven by prolonged COVID-related disruptors in China.

So as expected, we saw a further normalization of customer growth and spending. Then last year, these 2 key drivers of growth experienced an extraordinary strong momentum given the pandemic situation, which resulted in our strong GMV growth back then.

So now let's have a look at our guidance, which we revised on June 23 in light of the deteriorating macroeconomic conditions and the weak Q2 performance. In early May, we pointed to the lower end of full year guidance based on challenges but also early signs of a potential recovery. We now expect macroeconomic challenges to be longer lasting and more intense than we previously anticipated.

So looking at our multi-year growth performance since the beginning of the pandemic, we now expect a return to growth and an improvement in profitability in the second half of 2022. So these expectations are based on actions we are taking to adjust our business to the shift in demand and reduce our cost to mitigate the challenges. So we're fully focused now on executing our action plan for 2022, which brings me to the next slide.

So as I presented to you last time, we are successfully adapting our business to the new environment and took several actions to improve profitability in the second half of the year. We adjusted our offer to better meet consumer demand in light of the shifting demand spending patterns. We implemented measures to improve our order economics to overcome the challenge of the increasing fulfillment costs. And we're driving cost efficiencies across the business by reducing our marketing expenditure and pacing our overhead cost growth.

So let me now present some of the key measures that we implemented in the second quarter. First, we adjusted our wholesale order volume for the upcoming fall/winter season to reflect revised growth expectations for the second half of the year and reduce inventory risk. While the majority of our preorder volume has been already locked in by the end of Q1, we leveraged the remaining flexibility to adapt our assortment to consumer preferences.

We'll continue to leverage in-season management levels and our platform business model to further optimize our offer going forward. So these measures will help us to stabilize our gross margins in the second half of the year and with further improvements expected in the spring/summer season of 2023.

The second, we introduced minimum order value now in 15 additional markets in June. So this means that we now charge for delivery below a certain minimum basket size across all Zalando markets. Just like when we introduced minimum order value in 9 markets back in 2019, we are seeing positive results as customers migrate to higher baskets and remaining small basket profitability increases.

The positive impact from the minimum order value and some other efficiency measures that we're taking across our European logistics network are expected to offset the cost inflation that we're seeing in carrier costs and packaging costs that continue to impact our fulfillment cost line.

And third, we focus on driving cost efficiencies across our business in performance and brand marketing to ensure the return on invest in the current environment. So we reduced the maximum payback period for performance marketing investments from 720 to 360 days to achieve an earlier breakeven. And in addition, we continue to pace our overhead investments across the group and target now a flat head count development until the year of the -- until the end of the year.

So to sum it up. Over the last 6 months, we have seen multiple challenging developments in the broader macroeconomic environment. While some of these developments may last not longer than to be more intense than previously expected, they do not change our view on the long-term opportunities ahead of us. And that is why we continue to believe in our strategy. We keep our clear focus and selectively invest in 3 core dimensions of our strategy.

First, we focus and invest in deep customer relationships at scale to play an important role in our customers' lives. And examples of these investments are Plus, Beauty, Designer, also Highsnobiety that I will touch upon a little bit later. Second, we are focused on our transition to a true platform business, bringing together customers and partners in a way that creates unique experiences and benefits. And examples of this are the partner program, Connected Retail, enabling the Zalando Fulfillment Services or Zalando Marketing Services and as well the doubling down that we do on the multi-channel fulfillment.

And last but not least, we are building a more sustainable platform and driving positive impact for people and planet, which believe is in line with the long-term interest of our customers and partners. The examples of this are more sustainable assortment and packaging. Our online learning platform, we recently launched the support brand partners in setting their own climate targets aligned with science and the secularity criteria and our investments in e-commerce.

But we can talk about Highsnobiety. So in June, we acquired the majority stake in Highsnobiety, which is one of the most influential fashion and lifestyle media companies in the world. So they have an audience of 7 million Instagram followers who serve as culture pioneers for a new generation of consumers. So this acquisition gives us access to creative and marketing partners and in building upon our already very strong brand relationships and offers us now industry-leading trend analysis and insights.

So the combined network will allow now Zalando to deliver curated content, exclusive assortment and fashion-driven [ notarials ]. We also acquired by a way, a business with healthy financial margins and some of the best , greatest minds of shape in fashion today.

So being the starting point for fashion means building an engaging and inspiring experience for our customers and brands. And this acquisition will certainly help us to accelerate on our evolution. We are looking forward to driving our strategy now together with Highsnobiety and we're very excited to share more with you soon.

I will now hand over to Sandra, who will provide you with some more details around our Q2 performance.

[Sandra Dembeck, executive]

Thanks, Robert. Let's start with a more detailed look at our top line performance. The second quarter came in weaker than we expected, in light of the further deteriorating consumer sentiment and the macroeconomic outlook. We had a second quarter of flat GMV growth. Revenue declined by 4% to EUR 2.6 million.

Let's look at the performance of each of our segments. First of all, the Fashion Store, our core sales channel. Here, we saw GMV decline by 0.2%. The GMV in the DACH region decreased by 2.1% on the back of strong growth last year. As a reminder, last year's lockdown started to get lifted in mid-April, but the strict safety measures remained in place, impacting off-line retail sales.

Rest of Europe delivered 1.6% GMV growth. Here, during Q2, we launched 2 new markets, Hungary and Romania. Coming to our Offprice segment. Here we saw a slight increase in GMV and revenue of 4.9% and 4.3%, respectively. This development represents an improvement against last quarter, the demand and supply situation for the Zalando Lounge business remains challenging.

And lastly, Zalando Marketing Services. Here, we had another strong quarter and delivered year-on-year growth of around 40%. We're very pleased with the strong growth of Zalando Marketing Services.

Now turning to our customer metrics. In Q2, we grew our active customer base to 49.3 million. However, we recently started to observe changes in our customers' behavior, which are reflected in our trailing 3-month customer metrics. There are 3 key takeaways here. First, our active customer growth is slowing down. Second, customer retention rates show signs of normalization post the pandemic peaks. And this is more pronounced for the lockdown cohort. It is important to note that they are still above prepandemic levels, which indicates that our deep relationships with new and existing customers remain strong. And third, our cohorts are very engaged, but we need to focus even more on profitable order economics given the overall decline in spend per customer.

Let's now turn to profitability. For the second quarter, we recorded an adjusted EBIT of EUR 77.4 million, representing a margin of plus 3%. Our profitability was impacted by lower growth and the continued pressure on unit economics.

Coming to our segments. Our core segment Fashion Store delivered adjusted EBIT of EUR 61 million. Margins declined more strongly in DACH than in the rest of Europe region, as we saw a more pronounced slowdown in growth there. The decrease in profit in both regions was mainly driven by higher promotional activities to help reduce the high stock levels as well as increased fulfillment costs, and this was partly offset by lower marketing spend.

Our Offprice business and other businesses delivered a profit of EUR 9.5 million and EUR 7.6 million, respectively.

Let's now move on to the P&L. And let's dive into more detail on this slide. Our gross profit margin declined year-on-year by 3.2 percentage points. This was because we prolonged the sales period and increased our price investments to reduce the stock level. Our partner business and value-adding B2B services showed strong performance and making a slight positive contribution to our gross profit margin.

The fulfillment cost ratio increased by 1.8 percentage points due to the unfavorable order economics, cost deleverage and investment in convenience. During Q2, we introduced minimum order values in 15 additional countries as Robert already alluded to. And we also introduced a temporary fuel surcharge for our ZFS partners, both of those measures will support the fulfillment cost ratio in the quarters to come. Our marketing costs improved by 1.8 percentage points as we adjusted our marketing expenditure in both performance and brand related spend to respond to the lower demand that we saw in the market.

And lastly, our administrative costs increased by 1.3 percentage points, given the flat top line development. While we reduced the third-party spend and slowed down our hiring pace, we continue to selectively invest to attract and develop and retain great talent.

Lastly, let's turn to cash-related items. We recorded an increased net working capital year-on-year, primarily as a result of higher inventory levels. The 2 main drivers here are first of all, an increased inventory commitment back in autumn 2021 to mitigate potential supply chain risks. And secondly, the significant slowdown in demand we saw in Q1 and Q2 against more aggressive growth assumptions we had originally.

CapEx spend was EUR 74.5 million in Q2, primarily driven by investments in our logistics infrastructure relating to the fulfillment centers in Poland as well as in the Netherlands. And in addition, we had some capital expenditures on internally developed software.

On the next page, we see our cash balance. Our cash balance remains strong at EUR 1.6 billion. And in the second quarter, we also recorded a positive free cash flow of plus EUR 56 million.

That concludes the financial part. Let me now hand this back over to Robert to conclude the presentation by looking at our full year 2022 outlook.

[Robert Gentz, executive]

Thank you, Sandra. Now let's come to outlook. So at the beginning of May, we pointed to the lower end of full year guidance based on anticipated challenges, but also early signs of potential recovery. And since then, consumer confidence has dropped further and inflation has increased. So as a result, we recorded weaker performance in the second quarter and incorporated the high intensity and the longer duration of these external developments into our assumptions for the second half of the year.

So this consequently led us to announce a revised outlook for the full year. We now expect the GMV to grow 3% to 7% for the financial year 2022. Revenue is expected to grow 0% to 3% with an adjusted EBIT of EUR 180 million to EUR 260 million in the same period. The CapEx is expected to be in the range of EUR 350 million to EUR 400 million. At the midpoint, this represents a reduction of EUR 75 million, which was driven by an adjustment of our logistics infrastructure investments to drive utilization. And we now expect neutral net working capital driven by increased inventory levels.

So let me close by reiterating that we expect to return to growth and improved profitability for the second half of the year. Here, we're not -- we're no longer lapping pandemic peaks and our efficiency measures will show the full impact. So this outcome is a direct result of our action plan which we keep executing on to adapt our business to the new reality to improve performance going forward.

So our vision remains consistent and relevant to be the starting point for fashion. We have a clear strategy and a clear direction and we continue to invest through cycle to drive long-term value for our customers, partners and shareholders in the long term.

Thank you very much. That concludes our presentation. And now we're looking forward to your questions.

[Operator]

[Operator Instructions] We will take our first question, Miriam Adisa from Morgan Stanley.

[Miriam Adisa, analyst]

First one is just on margins. So just picking up on the comment that you said that you expect the efficiency measures to offset fulfillment cost inflation. So it sounds like you have a better visibility on costs. So how are you thinking about fulfillment cost for the rest of the year? And perhaps if you could give us a sense of where within your guidance range you'd now expect to come? And do you feel like you have more flexibility to adapt if we do see further deterioration in the macro? Or do you think you've done as much as you can?

And then second question, just on the RCF, I just see that you've doubled the size of the RCF. So just if you could give some color on the thinking behind that and what the M&A environment looks like at the moment? Do you have more appetite to do that in the current environment?

[Sandra Dembeck, executive]

Thank you, Miriam. In regards to your first question around the margin and the fulfillment cost for the rest of the year. So indeed, I think throughout Q2, we have been very much focused on identifying cost savings and efficiency measures, particularly in the area of logistics or the fulfillment cost line. So as a reminder, where we are today is the fulfillment costs are impacted by unfavorable order economics, a certain degree of cost leverage as well as our investment in convenience.

What we are saying here is that with the measures we have taken, we can offset any inflationary pressures, which means that basically the first impact, which is around the unfavorable order economics we can almost eliminate. However, there will still be a remainder left around our lower utilization, and therefore, cost deleverage from the lower growth that we have seen as well as our investment in convenience, yes. So we will not fully close the gap towards the year-end on fulfillment costs.

In regards to your question around flexibility. I think the actions that we have identified and to a large extent, already implemented have injected flexibility and resilience. So we are, at the moment, protecting the downside. So I think there is a question, of course, who knows what the winter will be like. But a certain degree, we have, of course, factored into our guidance.

And on the RCF, this happened in the due course of the business. Actually, those conversations already started ahead off of 2022. And as we are growing our business, we are also growing our RCF. As a reminder, the RCF is there to on one hand be a risk buffer. On the other hand, be therefore, for any future investments we may want to undertake.

[Miriam Adisa, analyst]

That's helpful. And just a follow-up in terms of where within your guidance range you're sort of currently tracking towards?

[Sandra Dembeck, executive]

A volatile environment. And therefore, for that reason, we gave a very broad range. We're only a few weeks into this half year. And so therefore, we don't want to narrow the guidance at this moment in time.

[Operator]

We will take our next question. Charlie Muir-Sands from BNP Paribas.

[Charlie Muir-Sands, analyst]

Yes. I've got a couple please. Firstly, what is it that gives you confidence that you will see an acceleration in sales in the second half. I also acknowledge that the comparative base perhaps, but of course, the macro seems to be getting tougher and tougher. Is it based upon anything you've seen in the last 6 weeks since the trading update for example?

And then secondly, you've obviously reduced your CapEx guidance a bit for this year. And I understand that's about postponing the start of new projects rather than pausing and I think it's ongoing. But I just wondered, are you sort of committed to building the capacity out to handle your 2025 targets still? Or maybe is it possible that some of those 7 DCs that you'd identified you would be to build -- get built a little bit later in the future?

[Sandra Dembeck, executive]

Maybe I'll take the first one. So where does the confidence in the growth comes from? Yes, we do believe that we are at the inflection point at this moment in time. And as you rightly pointed out, there is, of course, a baseline effect here. We have a much softer baseline material comps. And so if you do the math, basically, thus the second half is an extrapolation of what we have seen in the second quarter.

There is another reason of why we believe despite the current tougher macroeconomic environment, we can deliver that. And that is due to the initiatives we have taken around the assortment. We alluded to in the Q1 call where we said we see specific trends within the customer segments trending towards also categories like Designer. We have increased our Plus membership, so these are valuable customers. Beauty is performing very well and adding to the growth and so recently entered markets, yes. So I think these are the 2 comments here.

On CapEx, I hand to Robert.

[Robert Gentz, executive]

Yes. Happy to do so. Yes, thank you for the question. So on the CapEx, all our recently announced projects of the logistics expansion like the 2 in Poland, the 1 in France and Germany, they're all progressing as we planned. And we -- not only for our own capacity but as well for enabling us for the B2B that we talked about in the previous earnings call. So the CapEx reduction is actually more coming from the -- coming from postponing future and new projects that have not yet been started that, yes, that we will start at a later point in time.

[Sandra Dembeck, executive]

Then on current trading, which was another question of yours, so far in July, we have seen an improvement of our performance and that supports our full year guidance. And we are now basically focused on building up momentum for a successful start of the fall/winter season.

[Charlie Muir-Sands, analyst]

And if I could just squeeze one follow-up question. In order to clear the surplus inventory of your own stock that you have, are you prioritizing a tool on your platform, the sales of your own goods above that of partners? Or is there a risk that partners who are in a similar situation might be pushing a lot through your platform and perhaps crowding you out?

[Sandra Dembeck, executive]

So I think the -- there are, in general, elevated stock levels in the market, yes. So that is on our side, that is on the partner side. So you're absolutely right there. I think we have found the right balance throughout Q2, yes, where we have seen also partners discounting heavily. And so I think we are on a good glide path now to clear out the majority of our overstock for the spring/summer season and some of the partners.

And I think for the full winter season, the situation is slightly different because we were able to adjust our buying budget to the revised growth assumptions. I mean we couldn't do that through the preorder volumes because those, of course, had been locked in since Q1 that we were able to use the flexibility we have created to adjust those volumes.

And then now we will continue with those effective in season, inventory management tools that we have leveraging also heavily our Offprice business. So I think the situation was already there in Q2 with elevated stock levels in the market and, of course, I think we find the right balance between our wholesale business and the partner business.

[Operator]

We will take our next question from Guido Lucarelli from Citi.

[Guido Lucarelli, analyst]

Yes. I ask you, if I may. The first one on the improved performance that you're seeing in July. I was wondering to what extent as we increase the level of discount helped this performance or put it another way, was this an underlying improvement that you're seeing or was there a strong contribution from the higher level of discounts.

And second question, in light of the more muted economic projections for FY '23, which you fully pointed out in your report. How do you see current consensus, which is seeing, I think, 13% sales growth for FY '23. How comfortable are you with that?

[Sandra Dembeck, executive]

In regards to July, I mean July and August are always the clearance months. So these are the months where we have end of season sales across all of Europe, so June, July and into August. And therefore, of course, the level of discounting is high. I hope that addresses a little bit the first question.

In regards to the second question around a bit of color on 2023, I think it is definitely a bit too early to comment on 2023 because we are still in this quite volatile environment, we still see a high degree of uncertainty in the market. And to be honest, the full winter season for us, which is critical every year hasn't yet started, the season start really is only in September. So I think I wouldn't want to now comment necessarily on top line growth in 2023. I think we will get to that a bit later in the year.

[Operator]

We will take our next question Volker Bosse from Baader Bank.

[Volker Bosse, analyst]

Volker Bosse from Baader Bank. I would like to start with your ordering. You said, you'd order less of course, but you'll also order differently, given the changed consumer sentiment, the more lower price points, for example, or in other words, which product segments are still at relatively healthy demand levels is the first question.

And second question would be on Zalando Plus. I think building customer loyalty is the cornerstone of your strategy going forward. So what potential add-ons you could think about in order to make the Zalando Plus offer more appealing for customers? And what are your first observation, what makes people signing up for Zalando Plus and how you plan to accelerate that?

[Sandra Dembeck, executive]

Maybe I take the first question and then for the second question, I hand over to Robert. In regards to our fall/winter side, yes, we reduced it, but we also improved it. So we took into consideration the learnings from the changes in the consumer behavior. Thereby, we saw different tendencies. One was move, as you mentioned, downwards to lower price lines. This segment primarily is being served by our partners. We also saw a move towards actually the higher price segments and this is what we have reflected in our buy, so the Designer category, for example.

We also saw a move towards more occasion wear. And so we have also moved away from the comfy lounge wear to what's more the occasion wear for our fall/winter assortment. So yes, we do have to the degree that was possible, reflected, of course, the changes in the customer behavior in our buy but also in togetherness with our partners. And Robert, maybe over to you for the Plus program.

[Robert Gentz, executive]

Yes. Yes, as you rightly pointed out, I think Zalando Plus is at the core of what we see as the ultimate [ crounders ] of deep relationships. This is like when customers actually pay your membership program to get the best out of Zalando, and I think that's really the journey that we're on. So we're very happy that we now have crossed like 1.5 million members and seen like 160% year-on-year growth. So it's a good journey we're on.

I think that being said, we are still like always experimenting what are actually the right benefits that we incorporate there. So what we're seeing is generally that the service benefits, they already are a good argument. So even fast delivery give more convenient returns now as well, like advice services that we will bundle into the Plus program. But what has as well been a great success so far is actually the access now to like a very exclusive assortment where we have just very limited -- limited merchandise and that our Plus members actually get the access exclusively to these drops. So these are good arguments for customers to sign up.

And last but not least, I think even like the minimum order value introduction, I think, makes Plus -- yes, makes the Plus for even more exciting as well because where customers that don't commit like so much to Zalando, like they just -- they get like the normal experience, but like the Plus members, they don't have to worry about minimum order values. They don't have to worry about any of these services. So -- and I think that's one of the drivers that keeps on committing even more customers to deep relations with Zalando.

[Operator]

Next question. Anne Critchlow from Societe Generale.

[Anne Critchlow, analyst]

I've got just one question relating to the reduced CapEx guidance and postponing some warehouse projects. Do you believe you're still on track for the EUR 30 billion of GMV by 2025. Or does the postponed projects reflect maybe a slower build of GMV.

[Robert Gentz, executive]

Yes. Thank you for the questions. I think that we are -- we just come from like 2 years that were -- like our growth was much more than we actually expected. So far in 2022 is now a year where, yes, I think, we all have not expected like, I think, like this environment. And we have now 2 quarters where we're growing less than we actually expected.

But we are not a company that just like that talks about long-term goals or changed long-term goals just on the back of like 2 good or bad quarters. So we are sticking to our goals, we're sticking to EUR 30 billion GMV. We're sticking to 10% of the fashion market that will be on Zalando. We're sticking to our 3% to 6% midterm guidance. So all these goals we're sticking to, obviously, like the trajectory, given like the volatile market environment, we need to see like how it goes up, but the goals remain the same as our strategy does.

[Operator]

We'll take our next question Clement Genelot from Garnier.

[Clement Genelot, analyst]

We have 2 questions from my side. So maybe first one is on the U.S. expansion. Is this still on board right now? And what would be [indiscernible] behind it? And the second point is on the ZMS, you and other players in the consumer space are currently marketing marketing spending. So does it mean that ZMS will be lagging behind Asia?

[Robert Gentz, executive]

Yes, thank you for your questions. So first of all, I've seen this report as well. So -- so what can I say about I think, first of all, like we are an [ entrepreneurial ] company. So we always look for good opportunities, like, be it like expansion of what we can do more for our customers within Europe as well as geographic expansion. So like we constantly look out for like new opportunities.

I think that being said, I think there's certainly an opportunity as well from Zalando at one point in time, maybe as well outside of Europe. But I think the time is not -- yes, it's not now, it's not in the next -- and for the time being. So we are very much focused on the 25 markets that we're in, in Europe. There's no organic launch in the U.S. any time soon.

So we are very focused on our opportunities in terms of Europe in the 25 markets and the propositions that we're in. On the ZMS question, yes. So as Sandra said, like we've seen actually a very good growth of ZMS with 40% plus. What we've seen interestingly in ZMS is that brands as well behave differently. So we have actually some brands that actually contract a little bit like they're spending to ZMS, but then there's other brands that actually take it more as an opportunity to double down investment.

So it's -- it's a different behavior by brands, which overall actually leads to an increase of ZMS by 40% as we'll see generally in the fashion market that there are some brands that are more gaining and some brands that are more -- see more contraction. And we see the similar pattern as well in ZMS, but at a 40% growth so far.

[Operator]

We'll take our next question. Simon Irwin from Credit Suisse.

[Simon Irwin, analyst]

Two questions from me. The first is, can you just talk a little bit about invoice payments, do they attract higher return rates? And is there anything you can do to reduce invoice payments and the return rates on that part of your business?

The second is just thinking longer term about inventory management, to your overall kind of commitments are high you keep a lot of inventory kind of spread across the network. What can you do to be more reactive and not be in a position like this year where you read the trends wrong and are overcommitted, which takes a long time to kind of clear through. Is there anything that's strategically within the business, which -- where you can either kind of commit later or just hold less stock within the business?

[Sandra Dembeck, executive]

Thanks. I'll take the invoice payments question, and then Robert will take the inventory management question. On invoice payments, to be honest, it doesn't really attract higher return rates. I think it is learned behavior. Invest payments has always been strong in Germany ever since the catalog businesses. And therefore, it's learned behavior of that in the German environment, you do get an invoice get the product and then the invoice only afterwards we pay. And so we don't really see material difference in return rates whether it's invoice payment or whether it's PayPal or credit card.

[Robert Gentz, executive]

Yes. And maybe just to add a little bit to that, I think, to the invoice. So we're not seeing any elevated levels actually of defaults on that. So I think it's is actually part of the service suite of Zolando actually have, which is something we're very proud that we have an own high-performing BNPL service buildup that is so much catered for fashion and actually is, yes, one of the most favored payment method, and it really is part of the value proposition to -- yes, that we're actually able to offer that.

And our investments to reduce returns are actually more, I think, on the technology side, on the to help customers to have the right choices, yes, and this is more catered to -- through technology, through better selection, through better description and maybe in the future as well through augmented reality and many of these investments. So that's what we are very, very focused and excited about.

So on your second question on how we see actually wholesale and partner program going forward. And I think you're right, like I think generally, I think our view has, I think, well evolved over the last couple of years, what is actually the right approach for wholesale and taking on own inventory risk and as well the partner program, where we also see a lot of like these benefits where we just more service our infrastructure to the brands.

So I think generally, what we use the wholesale business model going forward more for is that we buy those brands that anchor and authenticate our fashion assortment. So that we can actually make sure through our wholesale that we make sure that our customers find their most loved fashion brands in an inspiring multi-brand environment. So it will be the favorite business model for brands. We see like the risk is very low and the high -- the confidence for the consumer relevance is actually very high.

And brands where we see they have a higher risk or the customer relevance is a bit lower. We will continue their transition towards the partner program. And I think that's the right mix that we will use going forward that actually, yes, brings the best to our customers, but as well caters for the right mix of, like, risk return in our assortment going forward.

[Operator]

We'll take our next question, Anubhav Malhotra from Liberum.

[Anubhav Malhotra, analyst]

I've got a couple of questions myself. Firstly, on the returns rate, if you can give me an idea on where it's trending at the moment? And how does it compare to prepanamic levels? And if the requirement for minimum order values, have you ever seen any impact on return rate once you introduce those requirements?

And then secondly, on the partner program and just in terms of what the reaction of the partners has been when you have increased your ZFS fuel surcharges to them and you pass them on?

And then also on the partner program, you talked about the higher risk, lower prominence brands being moved a lot more to the partner program than the main dominant brand in the market. Can you give me an idea on whether those lesser prominent brands are making money on the platform at the moment given that I think a lot of them would be shipping individual shipments, especially those who do not take on the ZFS program with you and they would be selling single product shipments as part of a bigger order and it may be quite costly for them. So can you give me an idea of whether they are making money with you guys?

[Sandra Dembeck, executive]

So thanks for the question. Your question about the return rate and where we are trending versus the prepandemic level. So we have seen a gradual increase in the return rate, but we are still trending below the pre-COVID levels. We do expect that this trend will continue, but that we may not -- that it will normalize at a slightly lower level than prepandemic because we are taking a lot of measures to actually help the customer to -- on the size and fit side to hopefully then choose the right outfit firsthand and not having to send back the parcel.

The MOV from everything we have seen so far in the new countries, but also from the experience in where we introduced the MOV previously didn't have an impact on return rates. So no change there.

In regards to your question about the ZFS fuel surcharges, whether they were accepted, we generally operate on a cost plus contract with those partners for ZFS. And so therefore, the fuel surcharges were somewhat expected. It's pretty much industry standard. Other companies like you may remember, Amazon has done it slightly earlier than us. So it's pretty much common market practice. So it was broadly accepted by our partners.

And then I hand over to Robert for the third question.

[Robert Gentz, executive]

Yes. And I think your third question, I can understand correctly, is like was a question, how does the probability of the partner program actually looks for an individual partner. And obviously, like -- like I don't know in detail like how the P&L for every single brand, how it looks like. But obviously, like it's only sustainable long term is like the partner makes good money, and we make good money. And that's, I think, fundamentally, our job that we like that we're on to enable them to make good money.

And I think fundamentally, as you see that the partner program is like still like so massively growing and increasing I think it can only grow as much if the partners actually make good money with us. So just, I think, I'm overall very confident. But I think ZFS is actually a good example of how we then use our services to then enable partners to make even more money out of that and then to invest even more into the same, because with ZFS they are then able to combine packages with other partners, so split the cost of shipments, split the cost of returns and make even more money.

But as well on a stand-alone basis, I think that is what I stated so shipping directly from the store shipping directly from their own e-comm as well. This is a piece that is as well continues to grow in our business. So I assume there's good money being made.

[Operator]

We'll take our next question. Georgina Johanan from JPMorgan.

[Georgina Johanan, analyst]

Three quick questions from me, please. The first one, apologies if I missed it in all of the materials. But can you sort of share a rough number as to where partner program penetration is sitting now with in Fashion Store, please?

Second one was just with regards to expansion outside of Europe. I know that you said is not the right time for organic expansion. If an inorganic opportunity did come up, would you still consider it not to be the right time, given the backdrop? Or would that be something you're open to, please?

And then finally, I know you referenced that there's been no increase in defaults on buy now, pay later, but we have seen some stats in the U.K. that certainly, there are longer delays in payments and people sort of missing first payments and things. Are you seeing anything like that, please?

[Sandra Dembeck, executive]

Thanks a lot. I take the first and the third one and then hand over to Robert for the second question. So the partner share remained stable. So it's no material change to the partner share versus what we said in -- what we published in Q1.

In regards to the default rate. So far, we haven't seen anything, yes. But rightly, as you point out, we are very much -- very, very closely now watching, of course, how the consumer behavior is changing or not in that area. So that's one that we have very clearly on our radar.

[Robert Gentz, executive]

Yes. And on your question on -- so like as I said, like our focus is on Europe. So our focus is on our business in Europe. There's some channels that we talked about but as well as a lot of opportunities that will as well come out of the situation. So that's our focus, and that really where is our mind. It's really where -- what we're thinking about. And yes, and I think like will ever be no business. And yes, I don't -- like at this stage, I can't really say even like Highsnobiety has a big business in the U.S. And therefore, we indirectly now have some business in U.S. But I think our focus to make it very clear, is on Europe, is on the opportunities and as well as challenges that we've seen now in Europe, and that's where our mind is.

[Operator]

We'll take our next question. Geoffroy De Mendez from Bank of America.

[Geoffroy Thibault Antoine De Mendez, analyst]

I have 3 questions, please. The first one, I wanted to come back on your comments on the acceleration of growth that you are seeing so far in Q3. I think you also said that July and August were driven by clearance in general. So I was just wondering how you feel about the month of September when still go back from holidays with presumably a lower budget when at the same time, you've got marketing expenses and you've introduced a minimum order value. So yes, just your thoughts on the month of September, I think it's also in terms of weight in Q3, the largest months? That's question number one.

And then question number 2 is in a scenario where growth is not falling where you hope it will fall for the second half of the year? What would be your priority? Would you reinvest in pricing? Or would you protect the margins? So that's second question.

And then the last one is on the gross margin that we saw in H1 and Q2, it was down quite a lot. I was wondering if you could give us a sense of what your expectations are for the for the second half if you're expecting to discount as much as you did in H1?

[Sandra Dembeck, executive]

Thanks a lot. I hope I got it all, but please remind me if I'm not -- if I missed something. So in regards to Q3, so as I said, we have seen an improvement in our performance in July. That does support so far our full year guidance. As you rightly say, September is the critical month for Q3, which way the consumer will behave? Who knows?

Yes, I think that's up to the consumer. What we have done is, we have factored in the behaviors and that consumer sentiment that we saw in -- over the recent months into our guidance and that will hopefully then address that.

What will then be the priority in the second half growth or margin? We are trying to strike a good balance between both of them because it relates also then to your third question. Of course, we have elevated levels of inventory, and we need to churn through those inventories. So on the one hand, we need to make sure that there is sufficient growth to get off these inventory positions, while at the same time, of course, we want to protect the downside.

And I think in order to protect the downside, we have really been busy over Q2 to identify all of these cost saving measures and efficiency measures, whether that is on the fulfillment cost line, but also within the areas of marketing and overhead to just ensure that we can protect that downside.

And in regards to your third question around gross margin expectations for the second half, so I think Robert said it in his presentation, the ambition is to stabilize the gross margin, yes. So we have been able to amend our buy in a way that gives us the confidence that we have a better buy in terms of categories and price points that we cover, while, of course, at the same time, the cut off the buy came at a later stage. So it doesn't -- it does just put a risk on inventory, and we will transfer that.

[Robert Gentz, executive]

And I would actually like to add a little bit of color to the second question here because of this growth and profitability. And just to make clear like what kind of company we're. So fundamentally, we are a growth company, and this is in our DNA. And this is really where our -- all our beliefs actually come from that. I think at a larger scale, there's actually much benefits for the consumers, for the brands. And as for our agenda that we have on sustainability that we have more impact and have higher -- high return on capital as well at larger scale.

So fundamentally, we're a growth company. And that's, I think, important as well for -- to always remind ourselves, I think this current situation that we're now in. So how we approach that? I think, first of all, we see there's so much uncertainty. So the thing that we now think is actually the best for Zalando is really focusing now on the profitability at the stage focusing on profitability and focusing on our cost side.

And I think even culturally this was good and important for us, because after 2 years of riding a high-growth wave at Zalando and like a lot of things that we have done is like where we just went for the scaling part of it, and we just -- we prioritize everything that it was capturing on the growth side.

I think for us, as a company, it's actually something very good and healthy now to go through a period where we are more faced with scarcity of resources, prioritize more efficiency measures as the MOV and so on. So I think fundamentally, it's -- I think it's a step now to go back a little bit in order to be prepared for the best opportunities when they present themselves. And I just want to put this as well out like that our higher level of mentality, how we approach now in general decision.

[Operator]

We'll take our next question, Michael Benedict from Berenberg.

[Michael Benedict, analyst]

Just a couple for me, please. First one, on minimum order value, if you see an improvement in your order economics without any notice or impact on the top line, why didn't you implement the MOVs in additional markets until now?

And then the second question on marketing costs. I think 8% in Q2. Is that a sensible level to assume over the course of the year as well?

[Robert Gentz, executive]

So yes, on the first question, on the minimum order value. So -- so maybe to answer that. So I think first of all, just what I just -- what I just said, like when we prioritize like our -- when we prioritize our projects that we're doing, like for us, the minimum order value was not -- in the past, it was not like the highest [ prio ] topic because essentially, yes, it helps you to generate more profits or to offset costs as we alluded to, but it doesn't really -- yes, it doesn't like necessarily, first of all, increase the customer experience.

So therefore, we didn't prioritize in the past. So I think now, given the more of the macro situation, I think those kind of projects that don't help us necessarily on the growth side, but this will help us to essentially be as well a more cash-generating business. They are the ones that we now price really higher than the other ones.

So it's not -- so that's the first piece on the answer. Second piece on the answer is obviously, with the increased cost inflation that we have seen on the logistics side. It made it even clearer that the minimum order value is now a project to pursue that we are able to continue to offer items below a certain threshold to our customers, especially as well to Plus customers. So that's why we now did it and not like 2 years ago.

The second question was on marketing costs and ratio for the second half of the year.

[Sandra Dembeck, executive]

I think on the marketing cost ratio, maybe we take a step back into last year. So last year, we had elevated levels of marketing as there was strong demand out there in the market. And we wanted to capitalize on that. This year, now that the demand is slower, we have basically returned back to a level that we previously had. And therefore, we feel like the 8% as it around the 8% is roughly what is the right number going forward for the remainder of this year.

[Operator]

We'll take our next question. [ Andre Reman ] from ODDO.

[Unknown Analyst]

It's [ Andreas ] here from ODDO. Two topics. One would be fulfillment costs, if introducing the minimum order value that you mentioned enough from your perspective. Or are you also thinking about charging fees for delivery for return to improve the unit economics in order to account for the growing relevance of sustainability? Or is that simply no option because that was your initial promise to the customer would be the first topic or question.

And then on Connected Retail. That was a big topic last year and I guess the year before. So how many of those partners are still there? And is that also from your perspective, a meaningful business going forward?

[Robert Gentz, executive]

Yes. Thank you for this question. So first of all, like as I said in the presentation, the minimum order value and as well other measures that we've done in the logistics infrastructure side, actually offset all the costs that we're seeing now from inflationary to -- on transportation costs. So it kind of nets it off.

When it comes to -- so to additional levers such as charging now for returns, we fundamentally believe that this is not the right approach because our approach is for -- is to make it as convenient and easy for customers to have -- address the merchandise coming to them. And there's a lot of -- and there's a lot of like reasons as well by customers, then in the moment when they touch it and when they feel it, don't want to have it. And this is fundamentally making it harder for them to return that would fundamentally decrease the customer lifetime value going forward. And it won't help in the long term as much.

So our investments are very much geared towards making unnecessary returns like size and fit and like the merchant is not coming as expected to prevent these kind of reasons by investing into technology, investing into date investing into product presentation. So that's for us the right approach going forward and as it always has been.

The second question on Connected Retail. So yes, we have seen some decrease in the volume in Connected Retail in the total volume that we are transmitting to partners, yet we haven't seen any churn in stores. So -- and why we have not seen any churn in stores because it's -- I think for the stores, it's very easy to have our software running into their stores and do this business side by side when they as well have customers in the stores. So there's still running out churn.

I think the more exciting pieces for us going forward is actually how we see that stores actually create locally relevant assortment in the markets that we're in. So we see, for example, in some countries where retailers actually upload merchandise that we don't have on our platform. And this already makes up 30% of the Connected Retail business so far.

So I think that's more the path that we're taking to use the store network even more to create merchandise, locally relevant that we don't carry at this stage.

[Operator]

We will take our next question. Jurgen Kolb from Kepler Cheuvreux.

[Jurgen Kolb, analyst]

Very good. 2 questions from my side, still open. One is on Highsnobiety. I was wondering if you could maybe elaborate in some more detail as to what your plans are with them, when will we see the first, say, combined campaign or what is in from your perspective with that acquisition?

And the second one, also going back to an acquisition you did in the past on the Swiss body scanning company, Fision. I was wondering how you have implemented this service already entirely? Or what is here the current level of expertise that you have gotten into your app and what's the impact that you've witnessed?

[Robert Gentz, executive]

Yes. Thank you. First of all, Highsnobiety. So I think fundamentally, as I alluded in my presentation, too, it's -- like Highsnobiety is much more a fashion authority, is much more like speaks to the CMO of the brands, why we mostly speak to the Chief Sales Officers or the CEOs of social brands. And I think this actually is a very good combination because it allows us to have access to brands in a very -- yes, in a very complementary way to us and actually allows us to understand more of what we can do on the storytelling perspective and what we can do to actually get the most exclusive assortment of these brands going forward.

And I think this is already happening. So we're already -- like we have a lot of like joint approaches to brands and actually thinking about and working with some of the brands of how we can actually tell their stories even more than on what kind of content can we bring and how we get access to this -- yes, to these drops that are -- like everyone is trying to get to.

So I think that's overall a big piece of what we are falling with Highsnobiety. The second bigger piece is selling the storage and producing content in such a way that we -- yes, that we get even more attention from our customers to tell stories on the fashion board in a very inspiring way. And here, we will have a release in the course of this year, where we make place on -- yes, on all properties much more for these storytelling perspective that we were creating now jointly with Highsnobiety.

So on Fision, on the acquisition, so yes, we are -- since the acquisition, I think we are very happy with the team and how we integrate as well their knowledge and their capabilities into our size and fit into our size and fit, and capabilities. There's no release yet that we have announced that, yes, that brings it all to market, but it will follow soon, and we will let you know once this release is remarkably enough, yes.

[Operator]

This conclude today's question-and-answer session. At this time, I would like to turn the conference back to the company for any additional or closing remarks.

[Robert Gentz, executive]

Yes. Thank you all for these great questions. And I would like to close by reiterating first of all that we expect a return to growth now and improved profitability for the second half of the year, because here, we are not no longer lapping pandemic peaks and our efficiency measures will show the full impact.

And just to reiterate, this outcome is a direct result of our action plan, which we keep executing on to adapt our business to the new reality and improve performance now going forward. And to close, our vision remains consistent and relevant to be the starting point for fashion. And we have a clear strategy and a clear direction. And we continue to invest through cycle to drive long-term value for our customers partners and shareholders in the long term.

And yes, with these words, I just wanted to close up this presentation, and thank you one more -- one more time for your questions. And yes, see you soon.

[Patrick Kofler, executive]

Thanks a lot. Bye-bye.

[Operator]

This concludes today's call. Thank you for your participation. You may now disconnect.