Zalando Se Ord

Dear ladies and gentlemen, welcome to the conference call of Zalando SE regarding the publication of the Q3 Results 2020. At our customer's request, this conference will be recorded. As a reminder, all participants will be in a listen-only mode, and after the presentation, there will be an opportunity to ask questions. If any participant has difficulties hearing the conference, please press star key followed by zero on your telephone for operator assistance. May I now hand you over to Patrik Kofler, who will lead you through this conference. Please go ahead.

Thanks for the introduction and good morning, ladies and gentlemen, and welcome to our Q3 2020 earnings call. My name is Patrick and I'm heading the IR office at Zalando. With me today is our CVO, David Schroeder. As always, we'll kick it off in a second with the prepared remarks by David, followed by the more interactive part of the session during the Q&A afterwards. I would like to ask you to limit your questions to two to allow as many people as possible to ask their questions. As always, this call is being recorded and webcasted live on our Investor Relations website, and a replay of the call will be available later today. David, I hand over to you now.

Thank you, Patrick, and good morning, everyone. Thanks for joining us. As usual, we'll elaborate on our strategic progress towards our starting point strategy. We will provide you with an update on our financial performance, and we will also discuss our upgraded outlook for the rest of the year. Before we dive into these details, however, let me reiterate that we are in a strong position both strategically and financially, which allows us to capitalize on the accelerated demand shift from offline to online, which has characterized this year so far. Thanks to the great work in our teams, we are able to further accelerate on our journey towards becoming a starting point for fashion. This is also evidenced by the five main messages that we would like to share with you today. First, we were able to fully capitalize on the continued strong online fashion demand momentum, resulting in an exceptionally strong and profitable growth in Q3. Second, we made further progress towards our starting point vision by winning almost 3 million new customers, further enhancing our customer experience and accelerating our platform transition. Third, we continue to invest into further strengthening our customer experience by acquiring mobile body scanning developer vision which will enable even better size and fit advice for our customers going forward. Fourth, reflecting our ongoing strong momentum, we upgraded our full year 2020 guidance and are well prepared to deliver a successful peak season. Last but not least, acknowledging that these are very difficult times for the fashion industry overall and offline fashion in particular, we reinforce our support for our partners as the second COVID-19 wave is hitting Europe. Let's now continue with a more detailed strategic update. Our starting point for fashion strategy has become even more relevant this year, as the needs of fashion consumers and brands are very much aligned with the key building blocks of our strategy. Looking once again at our three strategic priorities, which we communicated when presenting our strategy at our Capital Markets Day in 2019, and which we reiterated again at the start of this year, we were able to make significant progress on each of them in the past quarter. Starting with our strategic priority to grow our active customer base, we continued on the strong trajectory observed since April, also in the third quarter. Once again, we were able to welcome close to 3 million new customers to our platform, implying a new customer growth of almost 20% year over year. Today, we are proudly serving more than 35 million customers. Next, we were able to make progress along our priority to deepen our customer relationships. as evidenced by the continued increase of average order frequency. Over the past 12 months, we saw our customers shopping with us on average 4.8 times a year, which marks a new all-time high. This is particularly remarkable considering the significant inflow of new customers over the same period. Looking only at existing customers, the increase in frequency was even more pronounced. Last but not least, we were also able to drive the platform transition at an accelerated pace. We want our customers to enjoy endless choices and we would like them to say, if I cannot find it on Zalando, it probably does not exist. Our progress on this priority is well reflected in the strong performance of the partner program, which once again grew more than 100% year over year in the past quarter. The strong performance was also supported by our connected retail program, which contributed more than 6% to our fashion store GMB in Germany already. Let me now provide you with more details on the progress with regards to each of these strategic priorities. Once again, over the past three months, millions of new customers shopped at Zalando for the very first time. We attribute this development to two main drivers. First, we see a continuation of an accelerated demand shift from offline to online, although not as strong as in the previous quarter, given that offline stores were open again and consumers were able to spend most of their time outside. Second, our increased marketing investments, which were in line with pre-corona levels, allowed us to capture more consumer demand at positive ROIs over a 720-day horizon, entailing a significant marketing cost increase quarter over quarter. Our resulting active customer growth was generally broad-based across Europe. Nevertheless, let me provide you with two key examples of that growth. In Germany, our most mature market, we saw an outstanding strong increase in new customers by more than 30% year-over-year. In Italy, a country which is still at an earlier stage on the growth curve, we were able to welcome around 50% more new customers than last year. When looking at the quality of these new customer cohorts, we continue to see very similar characteristics compared to previously acquired cohorts, especially the ones acquired in Q2. which showed an improved reorder behavior as well as an improved customer lifetime value. Going forward, we are committed to fully capturing the current market opportunity through increased marketing investments, particularly also during the Q4 peak trading period, allowing us to create a more emotional bond with consumers and to further accelerate our market share growth. Next to growing our active customer base, we constantly strive to create deeper relationships with our existing customers, to become their starting point for fashion. In the third quarter, these efforts are well reflected in three highlights that I would like to share with you now. Firstly, following our announcement in February, we launched our pre-owned fashion experience within our main consumer destination, addressing the growing customer needs of decluttering crowded wardrobes and shopping fashion in a more sustainable manner. Combining pre-owned fashion with our unmatched convenience proposition, we have created a unique consumer proposition in the European pre-owned fashion market. Existing second-hand online channels are oftentimes characterized by a low level of convenience, trust and curation. At Zalando, customers can sell unwanted clothes to receive store credit and they can also purchase quality checked and highly curated pre-owned items from Zalando. At the same time, they can enjoy the same high level of convenience when it comes to payments, delivery and returns as for all other items on Zalando. The new experience has been launched in six markets, including Germany, France and Spain. In the upcoming months, more country launches will follow. Secondly, we redesigned the entire user experience to offer our customers a more compelling and emotional look and feel. From our app and website to push notifications and out-of-home marketing. We thereby aim to offer our customers an even richer overall experience that will further drive brand differentiation. Taking inspiration from clothing care labels, the redesign makes use of the symbolism as a way to create a distinct design language, reflecting the character of our brand. On top, we sharpened our welcome experience to make it even easier for new customers to take full advantage of our offer. While these first two examples revolve around recent customer experience improvements, we also continue to invest into our long-term customer experience vision. With the acquisition of Zurich-based mobile body scanning developer Fission, we made a further step to solve one of our customers' biggest problems, finding the right size and fit. In our industry, there are no reliable sizing standards neither between nor oftentimes also within brands that customers can depend on. As a result, online fashion consumers are left guessing whether items will fit them and must engage in a process of trial and error in order to find the right fit. At Zalando, we want to make a meaningful contribution to solving this challenge, to further improve the customer experience and to also reduce unnecessary waste deriving from size and fit related returns, which are driving around one in three returns today. We can already provide size advice for 50% of items ordered today, but with the recent acquisition of Fission, we can take size advice to the next level. Integrating the new technology into the Zalando platform will allow us to provide a highly personalized experience to existing and especially also new customers, as the body scanning app and virtual dressing room technologies allow consumers to generate precise body measurements and easily see how a garment would fit on their body by leveraging computer vision technology. We remain convinced that these and similar efforts targeted at deepening the relationship with our customers will further increase customer lifetime value by driving customer engagement, customer satisfaction, order frequency and spend. This brings me to our third strategic priority, driving the platform transition. Our platform transition is more than ever aligned with the need of our fashion industry partners to meet the increasingly digital consumer demand. The accelerated demand shift from offline to online has led many fashion players, especially those who are operating predominantly offline, to further accelerate their own digital strategy. By offering our connected retail program, which connects thousands of brick-and-mortar stores with consumers across Europe, Zalando has become part of the solution for many struggling brick-and-mortar stores. Our network of stores has grown to 2,000 active stores, over 10 times more than just a year ago. and these stores have already shipped millions of parcels to consumers this year. As a result, Connected Retail is becoming a more and more significant part of our business and already accounted for more than 6% of GMV in Germany in Q3. Doubling down on this tremendous success, we plan to invest around 50 million euros next year to triple the number of actively trading stores in 2021. Connected Retail has just been launched in three additional markets, namely Denmark, Norway and Finland, and is therefore now available across eight markets in total. With Austria, Switzerland, France, Italy and Belgium, five additional countries will follow in 2021. To continue to grow our European store network at a fast pace, we will significantly ramp up our B2B sales efforts by establishing local sales forces, engaging into B2B marketing and striking local affiliate partnerships. Our main focus when it comes to store acquisition will be in metropolitan areas to establish dense store networks through which we can create locally relevant choices and better, more sustainable convenience for our customers, enabled by our proprietary local logistics platform. Following this strategic update, and before I start to provide you with some more details on our financial performance, I would briefly like to shift your attention to our ongoing corona response effort. which is gaining in importance again as the second wave of infections is challenging Europe. While our decisive company-wide response effort has allowed us to emerge stronger from the first wave than we went into it, we have to realize that this health crisis and the following recession are far from over. Therefore, I would like to reiterate our three priorities on how we execute and even accelerate our strategy in times of rising infections. Like in spring, Our number one priority remains to protect the health and safety of our employees. We have reopened some offices this summer with reduced capacity as a voluntary alternative to working from home. At our logistics sites, where home office is not an option, we have invested heavily into a variety of safety measures, ranging from strict social distancing, mandatory face masks, to optimized ventilation and also including extensive on-premise testing and contact tracing capabilities. Going into fall, we have more than six months of learnings and we are confident that we are well prepared to navigate successfully through a second COVID-19 wave and deliver a successful peak season. Our second priority continues to be to defend the health of our business. As briefly mentioned at the beginning of the call, we believe that we are in a significantly better position than in spring. Thanks to the engagement and strong execution of our teams, we've been able to get through the first wave much better than anticipated, resulting in exceptional financial results in Q2 and Q3. And over the summer, we were able to raise 1 billion euros in additional capital, making us financially more resilient than ever and allowing us to invest through cycle. While in spring our primary challenge was the very steep decline in demand in March and the beginning of April, we now anticipate that our primary challenge will be securing sufficient supply and ensuring business continuity across the supply chain. Our third priority is to be part of the solution. We have realized at an early stage of the pandemic that our starting point for fashion strategy has become even more relevant, as the needs of our fashion consumers and brands are very much aligned with the key building blocks of our strategy. While we certainly find ourselves in a strong position and are also convinced that we will be able to successfully navigate through this wave, we are also aware of all the challenges that many of our brand partners and our industry overall are currently facing. As a consequence, we are reinforcing our support for our partners as the second wave is gaining momentum and new lockdowns have become a reality across many European countries. All of this is happening in the most commercially relevant time of the year, with Cyber Week and Christmas trading still ahead of us. We have thus decided to launch a second corona response package for our partners. This package aims at offering solutions for partners' most immediate challenges. namely decreasing footfall in their offline stores, limited online consumer reach and liquidity constraints in light of decreasing sales volumes. In order to support our partners in overcoming these pressing challenges, we will waive all commissions for connected retail sales to allow brands and stores to recoup lost offline revenues and to create a future-proof digital strategy. We will also match our partners' marketing investments via ZMS to increase the visibility of their brand and products across our European customer base and to drive incremental sales. And lastly, we will provide liquidity support through early payouts for connected retail and partner program partners. Over the past decade, our partners have supported us tremendously and helped us build Zalando to what it is today. We've grown together through our strong partnership, and we are now on our partner side in these difficult times. This concludes our strategic update. Let's now turn to our Q3 financials and start with a more detailed look at our top-line growth. Group top-line growth in Q3 2020 came in very strong, with GMV growing by 29.9% year-over-year to 2.5 billion euros. tracking significantly above our mid-term growth aspiration of 20 to 25%. Growth was fueled by a continued shift in customer demand from offline to online, outstanding growth in our partner program, and a very strong performance of Zalando Lounge. In Q3, we were again able to more than double our partner program GMV compared to the prior year. This also explains to a large degree the gap of around 8.3 percentage points between GMV and revenue growth. which is particularly well pronounced in the DACH region, where the platform transformation is most advanced. Now let's take a look at the development of each of the three segments. Our core sales channel Fashion Store saw more than 25% GMV growth in Q3 across both regions. DACH recorded a very strong 25.1% GMV growth, particularly benefiting from the platform transition. As already mentioned before, we saw strong growth in new customers in our most mature and home market Germany of more than 30%, driving GMV growth up to 30% in the quarter, the highest year-over-year growth rate since 2014. The strong growth in our home market has been particularly driven by a strong partner program as well as outstanding contribution from connected retail. Rest of Europe continued to outperform DACH with 28.7% GMV growth. The growth continued to be particularly strong in Southern Europe, supported by the ongoing strong new customer acquisition in these markets. Furthermore, we saw a continued outstanding performance of our off-price segment in the third quarter of 2020, recording revenue growth of 62.4% year-over-year, driven by our flash sale destination Zalando Lounge, thanks to a highly engaged customer base. The other business segments started to grow again after several quarters of decline, following the restructuring of our private label activities in early 2019, which had historically been reported in the other segment, but is now part of the fashion store. Growth in the other segment has been mostly driven by Zalando marketing services, which saw demand returning and external revenue growing by more than 30% after an initial hit following the brand's decision to cut back on marketing investments at the beginning of the COVID-19 pandemic. and by our integration businesses, TradeByte and Netwine, which benefited strongly from our overall partner program growth. These positive developments have been partially offset by our style-advised service salon, which suffered from lower interest in occasion-based shopping from consumers and the introduction of a styling fee as part of our ongoing efforts to make the offer more scalable. When looking at our key customer metrics, you can observe a positive trend in all of them. Site visits increased strongly by 26.8% year over year. Active customer growth continued to accelerate to 20.7%, the highest year over year growth since the fourth quarter of 2015. Customer order frequency reached a new all-time high of 4.8 orders per active customer over the past 12 months. And the average basket size again showed a positive development, increasing by 1.2% year over year. driven by a lower return rate and a change in product mix. As a result of these order frequency and basket size developments, GMV per active customer continued to grow by almost 5% over the last 12 months. Let's now turn to profitability. In addition to a very strong growth momentum, we were able to achieve an extraordinary strong adjusted EBIT in Q3 of €118.2 million, representing a 6.4% margin, which marks the highest profitability level ever in our structurally weakest quarter. The strong performance was enabled, next to the strong top-line performance, by substantial one-off effects caused by an ongoing benefit from lower return rate and the reversal of the inventory write-down of Q1 of 35 million. When looking at the regional profit distribution, we delivered strong profitability across DACH and rest of Europe. both being able to increase their absolute and relative profitability year over year. Especially the improvement in profitability in the rest of Europe is noteworthy, as we were able to increase profitability strongly, while at the same time we made deliberate over-proportional investments into customer acquisition efforts to drive growth and market share gains. Off-price and other businesses also increased their profitability, both in absolute and relative terms year over year. Let's now take a closer look at the main effects that led to this positive development of profitability in the third quarter. Gross margin increased 3.3 percentage points year-over-year, supported by the reversal in the allowances of goods on the back of a strong commercial performance throughout the spring-summer 2020 season. Additionally, further improvements were driven by better buying conditions and less price investments thanks to very strong consumer demand. Our fulfillment cost ratio improved year-over-year as a result of a higher level of utilization and therefore also improved efficiency across our logistics network and as a result of improved order economics benefiting from a lower average return rate. Our marketing cost ratio decreased slightly year-over-year. During Q3, we continued to step up our game on customer acquisition and engagement investments supported by our ROI-based marketing approach. to capture the full demand opportunity arising from the accelerated channel shift to online. In terms of marketing cost ratio, we are now almost back to pre-COVID levels as evidenced by the 2.7 percentage points quarter over quarter increase. Finally, our admin costs continue to improve year over year as a result of our increasing economies of scale, ongoing savings and cost efficiency measures. Turning now to our cash-related items, networking capital continued to be negative and even significantly improved year-over-year. There were mainly two drivers behind this development. Firstly, we saw a strong increase in payables, reflecting the strong growth of our partner program as well as our ramped-up marketing investments in Q3. Secondly, we recorded a relatively lower increase in inventories, reflecting both a good season start as well as delayed fall-winter inbound deliveries as COVID-19 negatively affects global fashion supply chains. CapEx spending is in line with our plan, but below last year's level as a result of our revised CapEx plan for 2020, as communicated during the Q1 earnings call in May. Similar to previous years, CapEx is backloaded again as larger sums are built towards the end of the calendar year. Mainly due to the outstanding operational performance, as well as lower CapEx, we recorded a very strong positive free cash flow of 213.1 million euros for the third quarter 2020, up more than €300 million from minus €88.7 million in the prior year period. As a result of the very strong operational performance, as well as the successful closing of two tranches of convertible bonds in early August, our cash balance amounted to almost €2.6 billion at the end of the third quarter. Let us now turn to our upgraded full-year outlook. Based on the continued strong consumer demand and our exceptional performance over the past two quarters, we upgraded our full-year 2020 guidance a second time since the outbreak of the COVID-19 pandemic as outlined on October 8. For GMB, we now anticipate to grow between 25% and 27% for 2020, in line with our performance year-to-date, but above our pre-COVID guidance of 20% to 25%. As a result of our accelerated platform transition and the increasing partner program share, we expect revenue growth to trail GMV growth and to come in at 20% to 22% this year. Driven by a strong business performance year-to-date, we also increased our full-year profit outlook and now expect adjusted EBIT in the range of 375 to 425 million euros. This development is supported by significant tailwinds from changes in customer behavior we currently experience. such as a reduced return rate, for example. At this time, it is difficult to foresee if and for how long these tailwinds will continue into next year. On cash-related items, we leave our guidance unchanged and continue to expect negative networking capital as well as capex of 230 to 280 million euros to fund our ongoing investments into our European logistics network and into our technology platforms. While our upgraded full year guidance reflects our general confidence and optimism for the remainder of the year, 2020 continues to be a year of unprecedented uncertainty. Although we are well prepared and confident for the upcoming peak season, we cannot completely foresee the future impact that COVID will have on both European consumer demand as well as global fashion supply chains. Let me close this presentation by reiterating that Zalando has a clear strategy and a clear direction. Our vision is to become the starting point for fashion in Europe and our key strategic priorities remain to grow our active customer base, to deepen customer relationships and to drive the platform transition. We expect the next 12 to 18 months to be characterized by a high degree of uncertainty as a result of the ongoing pandemic. But also to offer opportunities based on our strategy and business model. As we are currently finalizing our plans for the year to come, It is our clear ambition to capture this unique growth opportunity and to drive market share gains by continuing to grow multiple times faster than the overall European online fashion market. To enable this accelerated growth, we will increase our investments along our key strategic priorities while remaining in line with our mid-term margin guidance. Based on our strong 2020 performance and our strong balance sheet, we are prepared to invest through cycle and to drive long-term value creation in pursuit of our vision to become the starting point for fashion. That concludes our presentation. Let's now turn to Q&A.