U.S. Markets open in 8 hrs 12 mins

Edited Transcript of 1913.HK earnings conference call or presentation 1-Aug-19 12:00pm GMT

Half Year 2020 Prada SpA Earnings Call

Milan Oct 2, 2019 (Thomson StreetEvents) -- Edited Transcript of Prada SpA earnings conference call or presentation Thursday, August 1, 2019 at 12:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Alessandra Cozzani

Prada S.p.A. - CFO, IR Director & Executive Director

* Carlo Mazzi

Prada S.p.A. - Chairman

* Lorenzo Bertelli

Prada S.p.A. - Head of Group Marketing & Communication

* Patrizio Bertelli

Prada S.p.A. - CEO & Executive Director

================================================================================

Conference Call Participants

================================================================================

* Elena Mariani

Morgan Stanley, Research Division - Executive Director of Luxury Goods and Brands

* Erwan Rambourg

HSBC, Research Division - Global Co-Head of Consumer & Retail Equity Research and MD

* Luca Giuseppe Solca

Sanford C. Bernstein & Co., LLC., Research Division - Research Analyst

* Melanie Anne Flouquet

JP Morgan Chase & Co, Research Division - Head of European Luxury Goods and General Retail

* Nicky Ito

MainFirst Bank AG, Research Division - Analyst

* Paola Carboni

Equita SIM S.p.A., Research Division - Analyst

* Rogerio Fujimori

RBC Capital Markets, LLC, Research Division - Analyst

* Silky Agarwal;Citigroup;Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Alessandra Cozzani, Prada S.p.A. - CFO, IR Director & Executive Director [1]

--------------------------------------------------------------------------------

[Interpreted] Thank you. Good afternoon, everybody, and thank you for joining Prada First Half 2019 Financial Results Conference Call. I am Alessandra Cozzani, the group CFO.

First of all, let me introduce as usual the executive team on today's call our Chairman, Mr. Carlo Mazzi; our CEO and Founder of the company, Mr. Patrizio Bertelli; and Mr. Lorenzo Bertelli, our Head of Marketing & Communication for the group.

During the call, I will first go through the financial numbers, and then Mr. Bertelli will give us an overview of what happened in the semester and an update on the business. Afterwards, Lorenzo Bertelli will update you on our marketing and communication projects, and Mr. Mazzi will share with us some final remarks before the end of the presentation. After the presentation, we all will be pleased to take your questions.

Before going through the key figures of the group, I wanted to recall that, as you surely know, we are reporting our financial results under the new IFRS 16 accounting principles for the first time. Therefore, to provide comparable figures and more clarity, we have restated the H1 2018 numbers under the new IFRS 16. In the appendix, you will find the longer version of the P&L where you can see more details of the impact of this new accounting standard.

After this technical introduction, let me say that we are pleased with this set of results, which are in line with our and market expectations. During the semester, we have taken important steps that are impacting top line trends, notably the decision to end seasonal markdowns, but we are very satisfied that full price sales are progressively improving. We'll provide more details later.

Net revenues for the first 6 months of the year reached EUR 1.6 billion, up 2% year-on-year at current exchange rate and flat at constant exchange rate. EBITDA under IFRS 16 is significantly higher than it used to be. As a result, it stood at EUR 491 million, 31.2% of revenues, down 2% compared to the restated 2018 numbers.

EBIT was EUR 150 million or 9.6% of revenues, down 13% year-on-year compared to the restated 2018 numbers. The growth in sales was not enough to absorb the cost inflation given our continuous investment in the business.

Income tax for the period includes an extraordinary revenue due to the Patent Box tax benefit of EUR 77 million related to the 5 years from 2015 to 2019. Thus, net income for the period was EUR 155 million or 10% of revenues.

Turning to our balance sheet and cash flow. Our financial structure remains healthy as usual. As you may see, the look of the balance sheet has changed significantly due to the application of the new standard. After recognizing lease liabilities and the right of use assets for about EUR 2.4 billion, representing the present value of the residual future payments of our so-called brands in scope.

Operating cash flow reached EUR 137 million, which enabled us to self-finance the vast majority of the capital expenditure, which amounted to EUR 178 million, including a real estate investment that I'll describe to you in a moment. Net financial position ended negative at EUR 506 million following a EUR 146 million dividend payment during the period.

Now let's look at net sales trend through the different dimensions of our business. Let's take net sales by channel. The retail channel was down 3% at constant exchange rate, significantly affected by our strategic decision to phase out seasonal markdown sales. This decision had a negative impact of around 5% during the period.

Conversely, full price sales were positive and up 2%, progressively improving in the 2 quarters, respectively up 1% in Q1 and 3% in Q2. The wholesale channel increased by 14% at constant exchange rate, mainly driven by European e-tailers. Please note that the trend was not yet impacted by the recent rationalization decision, which will affect the second half of the year and the first half of 2020.

Looking at the net sales by geography, every region was impacted by the reduction in markdown sales with approximately the same magnitude, that I recall it was 5%. In Europe, we registered a very good wholesale trend supported by e-tailers. Full price retail sales were up mid-single digit driven by both locals and tourists.

Full price retail sales were also up mid-single digit in the Americas and Japan, mainly supported by domestic consumption. Both regions are gaining good momentum. In Far East, full price sales were stable since the area was negatively impacted by the social unrest and the ForEx headwinds in Hong Kong. However, we saw positive trends in mainland China, especially in Q2 '19. Our local advertising initiatives are creating buzz and boosted sales in the country.

Let's now turn to the net sale by product. Leather good were overall in line with H1 2018, and we expect an improvement in the category following the wholesale rationalization we announced in May. Ready-to-wear had a very positive performance thanks to a great success of the recent Prada Miu Miu collection, which drove high single-digit full price retail sales. During the period, we also saw positive full price sales in footwear, mainly driven by our sneaker collection and lifestyles proposal for both men and women.

Finally, looking at the net sales by brand. We are pleased to say that our design leadership continues to support sales growth. For Prada, we had largely positive full price retail sales throughout the semester. For Miu Miu, we saw stable full price retail trends since the negative impact of markdown was higher than the average. It was about 8%. We are delighted that the brand has had its 6th consecutive semester of positive organic growth in ready-to-wear.

Let's take a look at gross margin development. Gross margin remained overall stable in the period. As you can see from the slide, our focus on increased full price sales had produced a positive contribution of 70 basis points to gross margin, offset by a higher contribution of the wholesale channel in the mix.

Let's have a look at the EBIT margin evolution during the semester. Dilution of margin was due to the combined effect of continued investment in the business and the strategic decision to cut the markdown that heavily impacted the top line.

Operating expenses grew by EUR 19 million at constant exchange rate, or 2% increase year-on-year, mainly driven by higher communication costs following the increasing crucial importance of communication to effectively reach the customers.

We have also strengthened our organization structure, increasing our head count with more than 40 people since the beginning of the year, mainly in the commercial area. The impact of ForEx and hedging policy on the EBIT margin was pretty neutral during the period.

Let's turn to our CapEx slide. CapEx was EUR 177 million, including the acquisition of a strategic retail asset in Madrid for EUR 60 million. Without this investment, the CapEx of the period would have been lower than the previous year.

Net financial position ended negative at EUR 407 million (sic) [EUR 507 million] after paying EUR 146 million dividend and the EUR 60 million for the retail investment that I have just mentioned. The net working capital temporary cash absorption was directly correlated to the change in markdown policy. The net financial position is expected to improve in the second half of the year.

Now I give the floor to Mr. Bertelli for the business update.

--------------------------------------------------------------------------------

Patrizio Bertelli, Prada S.p.A. - CEO & Executive Director [2]

--------------------------------------------------------------------------------

[Interpreted] Good afternoon to all of you. Over the last few months, we have made very important decisions that will have to provide a short-term results in the second half of 2019 and in the first half of 2020 as to the distribution of our products through wholesale channels.

And also we have made important decisions on markdowns. We've decided to end markdowns as of January 1, 2019. And in the first half, that will have an impact equal to EUR 60, 6-0, million on our revenues. And had they been included in our current revenues, they would have meant about 5 percentage points of growth on our EBIT and on our growth.

And we've also started a rationalization process of our wholesale channel. And in the market, nowadays there are too many sales offerings, sales propositions and they are uncontrolled. And in order to rationalize the wholesale channel, we are complying with all EEC regulations, and we have forced our wholesalers to comply with such rules. They cannot -- they're not allowed to sell outside their geography.

And in doing so we are as a matter of fact reducing the amount of product available in the market, and therefore the opportunity to have easier access to parallel sales. So we are trying to prevent that. And we have thus reduced our -- the budgets for our wholesale customers, cut down by 50% for spring/summer 2020. And we have shared contractor with them aimed at protecting our products vis-a-vis uncontrolled actions that may happen in the market.

This will lead to greater consistency between the retail channel and the digital channels so as to be able to ensure that there are no gaps and inconsistencies and so that clients are led to buying through a dark channels. And this will -- this decision will be of paramount importance because the products will mainly be available in our stores and only through official channels.

This is a paramount action to protect our retail channel. And we are indeed engaging hefty resources to disseminate digital technology into our -- and embed it into our corporate culture. The market is evolving rapidly. Processes have to be lean and we have to use data in a much more sophisticated way because if not read or suitably processed, they cannot allow us to further boost our -- the group efficiency.

Sales. Based on the actions we've undertaken, we had the opportunity to see that sales were positively affected both in June, we're taking about full price sales, and of course, this impact could not fully offset the markdown cancellation.

We think that our stores can be much more profitable and they still have untapped potential to express. Probably we underestimated the wholesale action. And I think that Prada, over the next few months and over the next couple of years, will more and more become a brand relying on a channel that is 95% direct channel versus the 85% we have now so as to avoid all the issues we've faced and so that we can have total control over distribution.

The actions we are going to unfold with utmost focus are events. We're going to focus on events, popup stores. And popups have to become not a way of promoting our brand but rather a way of actually presenting our products. And the market focus will also be paramount and we will be following the development of our customer base. Not only we will focus on younger generations but also on a constantly evolving market, because information is shared at very high speed, and also the needs of customers are evolving just as fast.

On the product side, let me say that we will try to be very, very focused on novelties. We have decided to reintroduce Linea Rossa for certain areas because we think it fully meets the needs of a certain type of public, of audience.

Generally speaking, after ready-to-wear, where, as Mrs. Cozzani said, we have recorded growth, this is telltale evidence that Prada is the strongest brand when it comes to creating new lifestyles. And we are fully aware of the fact that the missed growth on the leather goods was mainly driven by the improper use of product offerings on the e-commerce channels through certain retailers that came up with products of any kind, with prices of any kind.

So we are fully confident that now the restrictions we are applying to the market of both wholesale and e-tailers will enable us to bridge the gap we still have with certain market conditions where we could not take action because the product offerings could not be controlled, were outside our control. Indeed, when it comes to our brand, it will attract the deserved attention somehow, because the Prada Group and the Prada brand is indeed a leading brand in the creation of new products, new strategies, strategies meaning also communication strategies.

Let me now hand it over to Lorenzo Bertelli, who will tell you about certain projects we have in the pipeline for both technology and communication. Thank you.

--------------------------------------------------------------------------------

Lorenzo Bertelli, Prada S.p.A. - Head of Group Marketing & Communication [3]

--------------------------------------------------------------------------------

[Interpreted] Good afternoon, ladies and gentlemen. Today, I will update you on the progress of our tech rollout, our newest marketing initiative, and the last steps we have taken to promote a more sustainable business.

Our aim remains to develop a best in class digital platform that reaches all consumer interaction points without losing touchpoints with our brand DNA, and we have continued to take significant steps this semester to achieve this.

Indeed, I am pleased to say that our tech rollout is progressing well, sustained by a continued investment in our technology capabilities and supported by newly formed partnerships. We can already rely on strong centralized functions in place, able to leverage data from across the world group, integrating information from our supply chain, manufacturing, retail, and marketing channels.

Thanks to the above, we are also pleased to announce that we are launching an enhanced version of the Prada website planned to go-live at the end of October. Thanks to new partnerships, we have boosted our analytics business, creating an integrated data infrastructure with advanced insight to support pricing, CRM, communication, and e-commerce.

We have partnered with Oracle to support our efficiency across our working process from financial planning, product assortment, and inventory management, amongst others, whilst to enhance our customer experience we have partnered with Adobe to develop a rise of the interaction between the brands and the consumer across all online channels.

This semester, we have also put a new structure in place, a new retail innovation department to develop an innovative group omnichannel experience as well as support our analytics function. The team will be in charge of innovative retail projects, store training, client service, and CRM.

In the first 6 months of the year, we have increased our focus on launching innovative and contemporary brand initiatives tailored to the local cultures within our main markets to drive brand engagement and to increase store traffic. We have introduced new high profile brand ambassadors. We also successfully drove brand excitement through a number of events tailored to each market, such as Prada Invites.

Following the success of the first Prada Invites, we asked architects Cini Boeri, Elizabeth Diller and Kazuyo Sejima to create designs using our iconic black nylon. Each designer produced items for the capsule collection, which was launched, in some cases by the designer, in different markets during major international design events.

Then Prada Mode in Hong Kong, the second international Prada Mode, a branded cultural team event featuring music, conversation, food, and fashion experiences alongside global cultural events, where in Hong Kong we took over the third floor of the Barrack Block of Tai Kwun.

Miu Miu Select; celebrities like Veronika Heilbrunner in Moscow, Chloe Sevigny in New York, Georgia May Jagger in London curated their own personalized collection of pieces from the new season, and their selection was available in stores for a limited period of time.

And also E-Miu-ticons to celebrate our (inaudible) in Hong Kong and Tokyo, artists took over Miu Miu stores for one day only to customize products, hand-drawing E-MIU-ticons or anything else customers wished onto selected t-shirts, sneaker and accessories.

Our recent show were very well received by the market. We chose Shanghai as our new location for the SS 2020 menswear collection normally held in Milan, generating a strong response locally. Following the success of last year's show, we had the Prada Resort Show in our piano factory location in New York, while we chose a new location for the Miu Miu Croisière show in Paris, the Hippodrome d'Auteuil.

This semester, we also registered higher traction across our social platforms. We have taken significant step this semester toward developing a more ethical approach to business, engaging with a new generation whilst maintaining our identity.

Reflecting changing times and shifting world, we launched a premier new project, the Prada Re-Nylon collection, with 6 of our classic nylon collection bags in regenerated nylon, which was obtained through the recycling and purification process of plastic waste collected from oceans, fishing nets, textiles, fiber waste. The collection was a success and was promoted through a content series with National Geographic for which we have already launched 2 of the 5 videos we created to support the collection.

It is a bold ambition, but our aim is now to use regenerated nylon for Prada's entire annual almost 1 million meters of nylon requiring by the end of 2021. This year, we have also announced that group will go fur-free starting with our SS 2020 collection. A new focus on innovative material will allow the company to explore new boundaries in creating design while meeting consumer demand for responsible products.

Thank you for listening. I will now hand over to Mr. Mazzi, who will discuss our sustainability strategy in more detail.

--------------------------------------------------------------------------------

Carlo Mazzi, Prada S.p.A. - Chairman [4]

--------------------------------------------------------------------------------

[Interpreted] Thank you, Lorenzo. Good afternoon, everyone. I would like to underline the point of sustainability, the corporate social responsibility in general.

Social responsibility is a core element of our group identity, deeply embedded within our strategy and is rooted on 3 areas of focus: people, environment and culture. In February, we appointed a Diversity and Inclusion Advisory Council in New York, whose member are leading figures in the art and academia worlds in part of prominent international institution.

With regards to our commitment to the environment, I am pleased to say that we have reached important thresholds in energy efficiency. You can see some figures we can provide you in the transparency. And I can add that since 2017, we have reduced our CO2 emission by 24% thanks to green energy used across our business.

I am delighted to announce that the third edition of Prada Group's annual conference on sustainability will take place this autumn in New York, as previously organized in collaboration with Yale and the Milano Politecnico universities. This year's event will explore themes such as freedom, equality and justice within the working environment and as part of a better development of society.

Regarding the outlook. To conclude, the choice we made this year to strategically review our wholesale channel and ending seasonal markdowns were necessary steps to build the future of the group despite their short-term impact. I mean that we have applied a greater control to our pricing policy to deliver a more consistent and clear offer for which leather goods is expected to benefit the most.

To face the rapid change in consumer behaviors, we are investing in the value of our work, enhancing quality, style and technology. As customer demands are always evolving, our digital transformation will continue to improve our responsiveness to changing consumer relations.

Finally, we are certain that our innovation skills, reflected in our ready-to-wear collection long-lasting solid performance, continue strengthening our brand's image and give us confidence for future growth. Thank you very much for having joined us today.

We will now open up the floor to Q&A.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) And your first question comes from the line of Silky Agrawal from Citigroup.

--------------------------------------------------------------------------------

Silky Agarwal;Citigroup;Analyst, [2]

--------------------------------------------------------------------------------

Firstly, on the like-for-like performance, can you please comment further on your like-for-like performance, especially how it has evolved? I understand the full price sales has improved first quarter versus second quarter, but if you can just share more color on the overall like-for-like performance through the half and, if possible, in July.

And two, I have a question related on markdown. I remember you mentioned in the last conference call that you had about 4 percentage points impact from markdown and you expected the impact to gradually fade through 2019. It seems that you have a 5 percentage point negative impact in first half of 2019. So maybe if you could give some color on when should we expect the impact of markdown to normalize, and also if you could please remind us of the contribution of markdown sales to the overall retail sales.

--------------------------------------------------------------------------------

Alessandra Cozzani, Prada S.p.A. - CFO, IR Director & Executive Director [3]

--------------------------------------------------------------------------------

[Interpreted] Talking about the first question regarding the like-for-like, of course I would comment just the full price sales because it doesn't make any sense to talk about the markdown trends. That is part of a decision that is not correlated to the underlying market trend.

I have already mentioned during my presentation that we have seen a progressive improvement in full price sales during the semester, with a Q3 that was better than Q1. If you want to have more color, I could add that June was particularly good. It was around mid-single digit. And July is progressing with more or less the same trend.

Coming back to your second question on markdown, yes, this semester the impact was about 5 percentage points in trend. That is more or less in terms of absolute value. We have lost around EUR 63 million of sales. The impact of this decision will be also impacting the second half of the year with approximately an impact quite similar to this.

Then starting from 2020, we will not have any more negative impact because the decision was taken this year. So from 2020, the markdown level of sales will be normalized.

--------------------------------------------------------------------------------

Operator [4]

--------------------------------------------------------------------------------

Your next question comes from the line of Erwan Rambourg with HSBC.

--------------------------------------------------------------------------------

Erwan Rambourg, HSBC, Research Division - Global Co-Head of Consumer & Retail Equity Research and MD [5]

--------------------------------------------------------------------------------

Wholesale was quite impressive in H1. You're saying you need to backtrack and restructure that business. Can you give us a sense of what the impact could be for H2 this year and possibly H1 next year before you start to lap that?

Secondly, I'm wondering if you can give us a bit more detail on Asia, Asia being flattish in contrast to other players in the industry. And so I'm just wondering if you could give us a sense maybe of how much Hong Kong contribution to sales is and how that has impacted, and maybe a bit of outlook on how this could affect H2 as well.

And then thirdly, if you can comment around inventories, I think inventories are up high single digit. And so I'm just wondering how that relates to your expectations for sales in the short term.

--------------------------------------------------------------------------------

Patrizio Bertelli, Prada S.p.A. - CEO & Executive Director [6]

--------------------------------------------------------------------------------

[Interpreted] This is Mr. Bertelli speaking. Sorry. We do apologize. You had 3 questions, so we wanted to know who was taking which question.

As to wholesale, let me say the following. The question -- I'd like to give you a philosophical answer to that question. So wholesale was of paramount importance for us in the '90s until 2008, 2010. They were important until when wholesale players had access to the parallel market, market of parallel sales. So instead of playing, sellers, in their own market, they started invading the whole world. They started invading the markets globally through all possible channels, and they did so deeply that they looted -- they contaminated the business.

So when it comes to Asia, let me switch to the next question you asked, we think we were deeply hit on the market for our direct channels given to what I've just said. And that's why we had to make very decisive decisions. From now to year-end, we've already sizably cut deliveries to wholesale.

Of course, there was a queue of previously placed orders, and we have to comply with that. But starting from 2020, wholesale sales have already been cut down. So the purchases for 2020 spring/summer, they were cut down by 50%, those purchases, so our buyers got less.

And we've also checked quantities and product categories for leather goods where you have the main actions in the parallel sales market stock. You know we are maniacs in inventory and stock control, so we don't have overstock as other players. Even though we have what we've witnessed so far, we've not used markdowns to cut inventory. We have 7 to 8 months’ worth of stock depending on peak times.

--------------------------------------------------------------------------------

Operator [7]

--------------------------------------------------------------------------------

The next question comes from the line of Luca Solca from Bernstein.

--------------------------------------------------------------------------------

Luca Giuseppe Solca, Sanford C. Bernstein & Co., LLC., Research Division - Research Analyst [8]

--------------------------------------------------------------------------------

I was wondering about the transition from wholesale to retail. And I understand the logic and the goal for physical distribution. Can you tell us where you stand on that same metric, wholesale versus retail, in digital? And do you anticipate that in the future it could make sense for you to switch or shift the balance from wholesale to direct retail, and mono-brand retail at that, as well in this channel as you're doing today in the physical channel?

And the second question, I was wondering if you could give us a bit more detail on sales trends by nationality and what you're experiencing in terms of organic growth with the major nationalities, the Chinese consumers, whether in mainland China and Hong Kong or in Europe or elsewhere, and the American consumers most especially.

--------------------------------------------------------------------------------

Lorenzo Bertelli, Prada S.p.A. - Head of Group Marketing & Communication [9]

--------------------------------------------------------------------------------

[Interpreted] Lorenzo Bertelli speaking. I'll give you an answer for the wholesale question concerning the digital channel, and Alessandra will answer to the other part of the question.

When we talk about the wholesale reduction, we are talking generally, so not only retail/physical, but also online, we'll say. And because at the end, what affects more the retail sales in terms of wholesale is through the digital channel because people go in the store, open the smartphone and look for a better price for the product. So this is what affects more the sales.

This doesn't mean that we don't want to keep a key wholesaler that can affect positively on the marketing point of view. I hope that I answered the question, and I will pass the word to Alessandra.

--------------------------------------------------------------------------------

Alessandra Cozzani, Prada S.p.A. - CFO, IR Director & Executive Director [10]

--------------------------------------------------------------------------------

[Interpreted] Good afternoon, Luca. I will take the second question related to the nationalities. Of course, as before, I would comment just the full price retail sales that are the only meaningful numbers that we look at.

And I have to say that every nationality is growing. The Chinese nationality is more stable, as we already mentioned in talking about Asia Pacific. And they are probably buying more at home rather than abroad also due to probably our activity that we have done there, but also the initiative taken by the Chinese government to repatriate shopping in mainland China.

--------------------------------------------------------------------------------

Luca Giuseppe Solca, Sanford C. Bernstein & Co., LLC., Research Division - Research Analyst [11]

--------------------------------------------------------------------------------

What about the Americans, Alessandra?

--------------------------------------------------------------------------------

Alessandra Cozzani, Prada S.p.A. - CFO, IR Director & Executive Director [12]

--------------------------------------------------------------------------------

[Interpreted] Positive. Positive. Of course, they are spending -- it's the other way around, so they are spending a lot also in Europe. And I have to say that they are also improving. They have improved in the second part of the semester, and they are also improving in July.

--------------------------------------------------------------------------------

Operator [13]

--------------------------------------------------------------------------------

The next question comes from the line of Nicky Ito from MainFirst.

--------------------------------------------------------------------------------

Nicky Ito, MainFirst Bank AG, Research Division - Analyst [14]

--------------------------------------------------------------------------------

My first question is on gross margin. I understand that second half last year and first half this year your gross margin was impacted by the hedging headwind. But if I think about the gross margin dynamics in the second half, most are positive. You will see the annualize of the incremental industrial costs you booked last year, the hedging headwind disappearing, and FX translation is likely to be positive. Channel mix is also positive. Markdown is also lower. So is there any reason we should -- so should we expect gross margin to get closer to 73% in the second half?

My second question is on Miu Miu. Just want to confirm, has Miu Miu turned loss making in the first half? And what's your view on the underperformance of Miu Miu? Is it structurally challenged because menswear is clearly outperforming? Would you reconsider relaunching menswear for Miu Miu? I think you did that 11 years ago.

And lastly on OpEx, I just want to reaffirm whether 45% OpEx growth in constant FX is still valid at this stage, given the weaker or the softer top line evolution.

--------------------------------------------------------------------------------

Alessandra Cozzani, Prada S.p.A. - CFO, IR Director & Executive Director [15]

--------------------------------------------------------------------------------

[Interpreted] Hello, Nicky. I will take the first question regarding the OpEx. I wanted to say that of course 5% this semester was including the exchange rate. So at constant exchange rate, the inflation rate was about 2%, so not very big, I have to say. We are expecting for the next semester a similar trend. And of course, our main objective is to have an increase in sales higher than this, and therefore an increase in profitability.

--------------------------------------------------------------------------------

Patrizio Bertelli, Prada S.p.A. - CEO & Executive Director [16]

--------------------------------------------------------------------------------

[Interpreted] I'd like to explain as to industrial costs. By way of introduction, let me say something. This is Mr. Bertelli speaking.

Let me say that after 2010, over the last 20 years, you can have different phases in time. From 2000 to 2010, luxury goods have developed -- quality products have developed. And then there was the need to have efficient technical facilities and structures to support the quality that was requested of these luxury products.

What happened in Italian industry in the manufacturing, in Italian manufacturing, many manufacturers that came to a mature age, 65, 70 years of age, they had no expectations, so they gave up their businesses because their children didn't want to step in. It could be footwear. It could be leather goods. It could be ready-to-wear. So they closed their businesses.

And all brands, none excluded, all brands, we are all forced somehow to acquire the qualified production facilities not to miss out on know-how and not to miss the opportunity to be able to keep on manufacturing also for the next 20 years or for the 20 years to come, but also relying on highly skilled manufacturing people and employees.

And we are leaders also in training young people in ready-to-wear, leather goods, and footwear because we have our own factories. We don't have just third party manufacturing. We have our footwear, ready-to-wear, and leather goods factories, so we can train our personnel in a very structured way. This is not a cost. I see it's not an added industrial cost. It's an investment we make for the next 20 years so that we can retain our quality standards, the quality standards we have to have.

And as to Miu Miu, no, we're not going to engage in men's collections. We're not interested in that. We think that the strength of Miu Miu is only women's collections. And the lines that were not attacked through parallel market actions, that is to say footwear and ready-to-wear, are growing nicely. And they're growing a lot, I should say. So we are somehow paying or bearing the brunt, so to say, of having been attacked through parallel market actions, or by online sales and parallel market actions with sales at all prices.

--------------------------------------------------------------------------------

Nicky Ito, MainFirst Bank AG, Research Division - Analyst [17]

--------------------------------------------------------------------------------

Is Miu Miu still profitable or break-even?

--------------------------------------------------------------------------------

Patrizio Bertelli, Prada S.p.A. - CEO & Executive Director [18]

--------------------------------------------------------------------------------

[Interpreted] Yes, it's positive. Slightly positive but positive nonetheless, but with a trend to grow decisively in a very positive way, definitely.

--------------------------------------------------------------------------------

Operator [19]

--------------------------------------------------------------------------------

The next question comes from the line of Melanie Flouquet from JPMorgan.

--------------------------------------------------------------------------------

Melanie Anne Flouquet, JP Morgan Chase & Co, Research Division - Head of European Luxury Goods and General Retail [20]

--------------------------------------------------------------------------------

The first one is coming back to APAC and Greater China. I probably missed information, sorry, on the way. But when I look at your reporting H1 in APAC and in greater China, it was under a lot of pressure. So I was wondering whether you could explain why that was the case in comparison to your peers in your view. So is it that this is where your markdown activities have been shrunk the most? What is actually going on in this market for you, and also in the exit rate?

The second is just a clarification. You mentioned that the markdowns impact had been 5 points negative in H1 and that it will be similar in H2. But as I recall, H2 last year already had a negative impact, so I was wondering what is going on. Is it actually just around and you expect less pressure in the second half and then you will fully annualize at the end of December?

My third question is on product categories. I'm trying to square the fact that ready-to-wear is the best performing category by quite some distance, which is pleasing as to the brand momentum and cache and fashion content. But it's probably where I would have expected the most markdown, so actually where you were the most disciplined. And therefore this category is probably up double digits at full price in the period. Therefore I'm wondering, in contrast, what is going on in handbags and what can you do to actually sort out these categories that should have had less impact from the markdowns rationalization.

And my last question is can you let us know or explain maybe a bit more how the management structure has evolved in the recent months at Prada Group, and how you see this evolving moving forward, notably in terms of your Prada marketing director, et cera?

--------------------------------------------------------------------------------

Alessandra Cozzani, Prada S.p.A. - CFO, IR Director & Executive Director [21]

--------------------------------------------------------------------------------

[Interpreted] Melanie, sorry for the delay. You had a lot of questions. I will take first the question related to the markdown. Probably I was not completely clear.

Let's say that in 2019 we have taken the last step to reduce markdown because we have decided to stop seasonal markdown. That's why the impact is more or less similar to in the first half and in the second half. But I want to repeat that, starting from 2020 we will not have any additional negative impact, and we will have a normalized level of sales to compare with.

Then I'll leave the floor to Mr. Bertelli for the other question more related to the business.

--------------------------------------------------------------------------------

Patrizio Bertelli, Prada S.p.A. - CEO & Executive Director [22]

--------------------------------------------------------------------------------

[Interpreted] Okay. Let's talk about China once again. We believe we've been particularly attacked by the parallel market. I believe that all brands with wholesale sales were much less heavily affected by this. Other examples could be provided of a different nature. So this is fundamental for me.

Coming now to footwear, bags, and ready-to-wear, if there is a product line which most sensitive to markdown, it is not ready-to-wear. It is footwear, for the reasons that go in the natural ways, footwear and bags. Ready-to-wear, and this is to confirm what we said before, starting from the beginning of the year is actually doing plus 9%, and these are full price sales.

So ready-to-wear is probably neglected in the parallel market because of sizes, complexity, etc. And that really bears witness to the goodness of our choices in terms of designs, etc. Since it is not massively attacked, we managed to carry out our policy in ready-to-wear.

And for footwear, apart from the case of sneakers, everyone is turning to the parallel market, whereas we decided to go back to making fewer sneakers and in particular to focus on formal shoes and lifestyle shoes, more diverse and less standard.

So there too, the parallel market is a very specific market. They target those companies that have a specific product so they can do some mass production. There are brands, for example, doing branded t-shirts, and they do business. Of course they do, but they're just selling branded t-shirts. So again, you have to look into the quality of the business.

Management; we're actually looking around for the fundamental functions that are essential for us to improve the quality of our management. We want to systematically work to introduce new young people, a new generation. We hired new people. For example, in communication they are going to join us. The same goes for product development. And all this is with a view to considering the next 10 years.

Next question, please?

--------------------------------------------------------------------------------

Operator [23]

--------------------------------------------------------------------------------

The next question comes from the line of Edouard Aubin from Morgan Stanley.

--------------------------------------------------------------------------------

Elena Mariani, Morgan Stanley, Research Division - Executive Director of Luxury Goods and Brands [24]

--------------------------------------------------------------------------------

This actually Elena Mariani from Morgan Stanley. A couple of question from me, and I apologize if maybe part of these questions were already answered but there was another call going on at the same time. On the rationalization of wholesale, could you clarify whether this is going to happen mostly by applying stricter policies and reducing supply to existing third party retailers or by cutting the number of third party suppliers? Could you be a little bit more specific because I remember that you've done quite a lot of cleanup in your wholesale channel in the past so this is a sort of like second cut. So I was just interested in understanding a little bit more about how precisely you are doing this rationalization.

And secondly, you've said that you want to control better your direct sales to third party online platforms. Again, could you be a little bit more specific on this? You are currently very well distributed in Asia, and part of those products sometimes even come from the gray market. Can you clarify on which platforms in Asia, Europe, or the U.S. do you plan to keep direct relationships with, and be a bit more specific about this initiative?

--------------------------------------------------------------------------------

Lorenzo Bertelli, Prada S.p.A. - Head of Group Marketing & Communication [25]

--------------------------------------------------------------------------------

[Interpreted] It's Lorenzo Bertelli speaking. I will answer for the platform question. As I said to Luca, we are looking for a key platform, and we already announced publicly about Secoo and JD, and we will see more to come.

And as I said, the focus is to take control of those channels in a positive way, a way to sell Prada in the Prada way. And so we generally think that it's a key point. And as I said, we have a good offer of Prada products on those platforms that, until now, were not in direct relations with us. And this is why also they affected more in the past and the first part of this semester the general sales (inaudible).

For the general solutions on the wholesale, I will let word to Mr. Bertelli.

--------------------------------------------------------------------------------

Patrizio Bertelli, Prada S.p.A. - CEO & Executive Director [26]

--------------------------------------------------------------------------------

[Interpreted] Let me reiterate what we decided to do and what we have formalized with wholesale. The first actions was to cut their budget by 50%. Their campaigns for 2020 were cut by 50%. And then we are carefully checking the quantities of the products that you mainly find in parallel markets to avoid a global overstock of certain products.

And as to certain platforms, we are going to close, end, terminate the relation if they don't comply with the contract items we set with them, price and positioning of our products, first and foremost.

At the industrial level, there's no consequence because, what our factories manufacture, we won't have to cut on our production resources. On the other hand, we will have to increase them because the work we will have to do will be more and more complex to comply with our brands.

--------------------------------------------------------------------------------

Elena Mariani, Morgan Stanley, Research Division - Executive Director of Luxury Goods and Brands [27]

--------------------------------------------------------------------------------

Okay. So if I understood correctly, it's a combination of limiting the supply and also cutting the number of partners, practically the ones that are not complying with your new policies.

--------------------------------------------------------------------------------

Patrizio Bertelli, Prada S.p.A. - CEO & Executive Director [28]

--------------------------------------------------------------------------------

[Interpreted] Exactly. They have to comply with our policies because work is a serious thing.

--------------------------------------------------------------------------------

Operator [29]

--------------------------------------------------------------------------------

And we are now on our last 2 questions. And the next question comes from the line of Rogerio Fujimori from RBC Capital Markets.

--------------------------------------------------------------------------------

Rogerio Fujimori, RBC Capital Markets, LLC, Research Division - Analyst [30]

--------------------------------------------------------------------------------

What kind of contribution from space should we expect for retail in the second half and in 2020, given your pipeline of retail projects?

My second question is could you give us the magnitude of the sales decline in Hong Kong in Q2 and how much Hong Kong accounts as a percentage of total sales? And my third question is on leather goods. Could you give a little bit more color on the performance of handbags and carryover versus novelties? Any color would be helpful.

--------------------------------------------------------------------------------

Alessandra Cozzani, Prada S.p.A. - CFO, IR Director & Executive Director [31]

--------------------------------------------------------------------------------

[Interpreted] Rogerio, I will take your first 2 questions talking about the space contribution to retail. In the second part of '19 and the first part of '20, I have to say that it's close to 0. We are not going to open stores. The retail (inaudible) will be stable. We are more working on relocation and refurbishment activity rather than expanding the retail space.

In terms of Hong Kong, your question was the contribution to group sales. That is about mid-single digit for the group. And then I'll hand over to Mr. Bertelli for the question related to the bags.

--------------------------------------------------------------------------------

Patrizio Bertelli, Prada S.p.A. - CEO & Executive Director [32]

--------------------------------------------------------------------------------

[Interpreted] Bag sales are stable. For carryover, carryover always represent an important part of our sales. We don't have the problem of the relationship between novelty leather goods and carryover leather good at the moment.

All we have to do is rationalize and strengthen our sales in our stores. And this holds true both for Prada Donna, Prada (inaudible) and Miu Miu, which are the only product channels where we were attacked quite strongly. As for the other products, ready-to-wear and footwear, for menswear too, they are all strongly positive.

--------------------------------------------------------------------------------

Operator [33]

--------------------------------------------------------------------------------

And our last question comes from the line of Paola Carboni from Equita.

--------------------------------------------------------------------------------

Paola Carboni, Equita SIM S.p.A., Research Division - Analyst [34]

--------------------------------------------------------------------------------

I have a question actually on the outlet channel with reference to your policy of definitely cutting markdown in your stores. I was wondering if you can share with us your current outlet business size, how many outlet stores do you have, and how are they performing in the light of the reduction in markdown you are applying in the primary channel. And also please, if you can specify whether all your comments to the same store sales growth were including the performance of outlets or not.

And a further one, please, on the inventory side. You commented that your stock is now about 7, 8 months. Can you give us a sense of how usually is your stock? So is this 7, 8 months something temporarily higher or a normal level, just to get an idea?

--------------------------------------------------------------------------------

Patrizio Bertelli, Prada S.p.A. - CEO & Executive Director [35]

--------------------------------------------------------------------------------

[Interpreted] I apologize. I'd like to know, the question on the outlets, could you better -- could you rephrase it? Could you repeat it for me? I didn't grasp it.

--------------------------------------------------------------------------------

Paola Carboni, Equita SIM S.p.A., Research Division - Analyst [36]

--------------------------------------------------------------------------------

Yes, no problem. I wanted to understand how much does your outlet channel account today for, and how many stores do you have and how is this channel performing in light of the fact that you are reducing markdown in your primary channel. And also please, if you can specify whether the performance of the outlets is included in your comment for same store sales growth.

--------------------------------------------------------------------------------

Alessandra Cozzani, Prada S.p.A. - CFO, IR Director & Executive Director [37]

--------------------------------------------------------------------------------

[Interpreted] I will take a portion of the question related to the outlet. Of course, the outlet channel is included in our retail trends.

--------------------------------------------------------------------------------

Patrizio Bertelli, Prada S.p.A. - CEO & Executive Director [38]

--------------------------------------------------------------------------------

[Interpreted] Mr. Bertelli speaking. Outlets are flat, more or less, depending on the policy we have in the different geographies. But it doesn't follow what we said for wholesale because outlets are fully controlled by us, so they follow the retail rationale and not wholesale rationale.

I would like to be sure I answered your question. Did I answer your question?

--------------------------------------------------------------------------------

Paola Carboni, Equita SIM S.p.A., Research Division - Analyst [39]

--------------------------------------------------------------------------------

Yes. To some extent, yes. But if you can also add some more details on how much does this channel account, or are you planning to have more outlet stores, for example, because of a no markdown policy in your primary stores? So some more color on that, please?

--------------------------------------------------------------------------------

Patrizio Bertelli, Prada S.p.A. - CEO & Executive Director [40]

--------------------------------------------------------------------------------

[Interpreted] Above and beyond the percentage figures, we've never disclosed them. Outlets go hand in hand with retail sales. So they are used instead of markdowns to somehow sell products that are end of series or when you run out of sizes.

So we have no intention of further expanding outlets. We want to further expand our retail channel, if ever. And we want to further strengthen our retail sales, which we think are of strategic importance vis-a-vis the outlet strategy. This is the answer.

On the question you asked on inventory, I think we have the inventory of an efficient company. If you ask other players, you will have a bad surprise. We're always around -- it's between 6.5 to 8 months, depending on the time of the year where you're looking at the inventory. And we are very well organized and very accurate from this perspective.

--------------------------------------------------------------------------------

Alessandra Cozzani, Prada S.p.A. - CFO, IR Director & Executive Director [41]

--------------------------------------------------------------------------------

Thank you for joining us today. Of course, Alberto and Cynthia will remain at your disposal for your questions for the rest of the day and then tomorrow. I will take the opportunity to wish you a very good summer break. Bye.

--------------------------------------------------------------------------------

Operator [42]

--------------------------------------------------------------------------------

Thank you. And that does conclude our conference for today. Thank you all for participating. You may now disconnect.

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]