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Edited Transcript of HM B.ST earnings conference call or presentation 27-Jun-19 12:00pm GMT

Half Year 2019 H & M Hennes & Mauritz AB Earnings Call

Stockholm Jul 1, 2019 (Thomson StreetEvents) -- Edited Transcript of H & M Hennes & Mauritz AB earnings conference call or presentation Thursday, June 27, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jyrki Tervonen

H & M Hennes & Mauritz AB (publ) - CFO

* Karl-Johan Persson

H & M Hennes & Mauritz AB (publ) - CEO, President & MD

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Conference Call Participants

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* Adam Gareth Cochrane

Citigroup Inc, Research Division - Director

* Andrew Hughes

UBS Investment Bank, Research Division - MD and Head of the Pan-European Non-Food Research

* Anne Critchlow

Societe Generale Cross Asset Research - Equity Analyst

* Atiyyah Vawda

Avior Capital Markets (Pty) Ltd. - Research Analyst

* Charlie Muir-Sands

Exane BNP Paribas, Research Division - Research Analyst

* Georgina Sarah Johanan

JP Morgan Chase & Co, Research Division - Analyst

* Rebecca Anne McClellan

Grupo Santander, Research Division - Equity Analyst

* Richard B. Chamberlain

RBC Capital Markets, LLC, Research Division - MD of Consumer Retail

* Simon William George Irwin

Crédit Suisse AG, Research Division - Director

* Jonathan Eley; Financial Times; Retail Correspondent

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Presentation

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Operator [1]

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Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to today's 6-month report for 2019 conference call. (Operator Instructions) I must advise you that this conference is being recorded today on Thursday, the 27th of June 2019.

I would now like to hand the conference over to your host today, CEO, Karl-Johan Persson. Please go ahead.

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [2]

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Hi, everyone. Thank you for joining us today. I'm very pleased to welcome you all to this conference call about H&M group's second quarter and 6-month results for 2019.

With me today is our CFO, Jyrki Tervonen; and our Head of Investor Relations, Nils Vinge. You will find the 6-month report on H&M dot -- hmgroup.com, Investor Relations. And before we start the Q&A session, I will give a brief comment about the quarter and current developments.

Our transformation work continues at a fast pace, and we can see clearly that we are moving in the right direction. We have continued the positive development of more full-price sales, decreased markdowns and we increased market shares. This shows above all that customers appreciate the improvements we are making in the assortment and the overall customer experience.

The third quarter has also started well. Our summer collections so far have been very well received. We estimate that the sales in June will grow 12% in local currencies compared to June last year. And we expect cost of markdowns in relation to sales to be lower also in the third quarter by approximately 1.5 percentage unit compared with the corresponding quarter last year. And this will be the fourth consecutive quarter with decreased markdowns.

In the second quarter, sales developed well in most of our markets. Growth was strongest in markets such as the U.S., where we grew with 17%; Mexico, 25%; India, 39%; Russia, 19%; and Poland, 11% in local currencies to mention a few. We also took market share in most markets, including in the U.K. and Sweden, where we grew despite challenging market conditions. Net sales for the group increased by 11% in Swedish kronor in the second quarter and 6% in local currencies. Our strong online growth continued with online sales increasing 27% in Swedish kronor and 20% in local currencies.

Looking at our industry. Fashion retail is going through a major shift. As you all know, with competition growing increasingly intense, new players are entering the scene. Many competitors are improving while others are having a tough time, leading to increased price and markdown activities in many markets. And we also see a big shift in customer behavior and customer expectations are moving constantly higher.

To meet this shift, we have made substantial investments, and we are transforming large parts of our operations. And we see that this is having an effect already. As customer satisfaction and sales have increased, the transformation work has been further intensified. In addition to investments in the customer offering, we have, among other things, made large investments in our tech infrastructure, AI and logistics. These initiatives involve costs that are dampening profitability in the short term, but they will benefit the company greatly in the long-term.

As we continue our transformation, we are driving change through a number of focus areas. And these areas are to create the best customer offering for all our brands. This includes the assortment. It includes the store experience, physical stores, online experience as well and to integrate the physical stores with online channels. We also want to make sure that we have a fast, efficient, and flexible product flow, which among other things, includes investments in the supply chain and building an AI model that is addressing the entire flow from trend detection to quantification to allocation and to price optimization.

We also want to make sure that we secure a stable and scalable infrastructure, our tech foundation. And then we want to add growth as well by expanding through our physical stores, the online stores and through external digital marketplaces. As we are accelerating our adoption to customers' changing behavior, we lowered the number of new stores net to 130 for this year in favor of more digital investments.

Looking ahead, we see this rapid change of fashion retail continuing. And so we are moving ahead at full speed with our transformation work. Many challenges and hard work remain, but we see that we are definitely on the right track. While costs have affected profitability short term, we are convinced that our initiatives and strong customer focus will contribute to gradually improved profitability and to a positive long-term development for the H&M group.

Thank you. And now we are happy to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question comes from the line of Charlie Muir-Sands at Exane BNP Paribas.

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Charlie Muir-Sands, Exane BNP Paribas, Research Division - Research Analyst [2]

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The first one relates to costs -- operating costs. You talk about them being managed tightly but obviously incurring some costs around the transformation. I wondered at what point we might anticipate expecting to see local currency cost growth begin to moderate, notwithstanding your strong sales momentum. The second question relates to that current trading. Clearly, 1 month is a relatively short period of time, and we don't know how you traded through the quarter last year. And I guess you're trying to take less stock into the end-of-season sale in August. But I wondered how we should think about that 12% in light of how the rest of the year might develop. And then my third question relates to CapEx guidance. Does the SEK 10.5 billion to SEK 11 billion constant currency guidance stand in light of your change of store and digital prioritization?

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Jyrki Tervonen, H & M Hennes & Mauritz AB (publ) - CFO [3]

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Yes, okay. Thanks. Let's start with the CapEx guidance with the last question you had. We will remain the guidance that we have said before, SEK 10.5 billion to SEK 11 billion for the full year. And that's -- the reason is even though we are decreasing the opening of stores, we have shifted over the investments to the digital part of our business. So the guidance remains SEK 10.5 billion to SEK 11 billion. And OpEx, we have a good cost control within the company in our operations. But as mentioned also in the report, we are having a lot of activities. We are investing a lot.

And of course, that will also be reflected in the OpEx growth. It's -- the SG&A growth rate in local currencies was approx 7 percentage units in Q2. I think it was the same in Q1. We believe that it will gradually become better, but exactly when, it's hard to say. But for sure, all these investments we are doing, they will pay off in the long term. So -- but exactly -- and the SG&A, it can fluctuate from quarter-to-quarter. But gradually, we believe they will improve. But exactly how and when that's a little bit difficult to say.

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [4]

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Yes. And of course, it depends on the second question as well what the selling will be. Some costs are fixed and some are variable. If we continue to sell well, cost in relation to sales will improve. We had a good start to the second half of the year. But it's 1 month and it's very important to remember as well in the second quarter, in certain -- some big markets for us, market conditions were not favorable, connected to external factors. But in June, it has been favorable in those big markets. So we're getting help in June. We didn't get help in the second quarter. The underlying performance, I believe, is better this year compared to last year. And we'll see how much better and how the coming collections will be received by customers. But we are positive that we are on the right track.

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Operator [5]

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Your next question comes from the line of Adam Cochrane at Citi. (Operator Instructions)

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Adam Gareth Cochrane, Citigroup Inc, Research Division - Director [6]

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One question, let's make it a good one. Thinking about the reduction in new stores, what exactly is it that you saw that changed your view during the period of the second quarter that maybe you haven't seen in the last or the prior 12 months, both in terms of increased closures and in terms of lower number of new store openings? And is there any geographic trend within that that you could try and shed some light on, please?

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [7]

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Yes. First of all, I think it's important to point out that we still believe in physical stores, and we have that opportunity to expand. And there will always be physical stores around and the stores we opened are good. I mean financial business case is connected to that obviously. We have adjusted. The adjustment is a combination of less -- fewer openings and also slightly more closures. We have decided in certain markets to hold back with new openings. We believe that in certain markets, rents are higher than they should be. So it's been a bit tougher in negotiations, or just not accepting certain levels that we are seeing. And so that's one reason. Another reason is that we are allocating more resources towards some of the digital initiatives that we have that we believe are really important and where we see good results.

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Adam Gareth Cochrane, Citigroup Inc, Research Division - Director [8]

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In terms of the digital initiatives, are you happy with the online performance that you saw in the second quarter? And would you be able to talk about how you are evolving the H&M Club offer both in terms of what the consumer gets and in terms of how many countries that you're now in, please?

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [9]

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We list some initiatives that we have. So we have a lot of initiatives going on connected to the digital part, so to say. It's a good growth. I mean 20% in local currencies, 27% in Swedish krona. We were expecting a little bit more. But it's also been compared to June where we had positive external factors a bit unfavorable in many big markets for us during the second quarter, so considering that good growth. But then we see a lot of improvement opportunities in improving the digital stores for all our brands connected to product presentation, navigation, site speed, deliveries, payment options, logistical investments that we're doing, so a lot of important areas that we need to invest in and where we are just allocating more resources to improve further.

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Operator [10]

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(Operator Instructions) And your next question comes from the line of Atiyyah Vawda at Avior Capital Markets.

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Atiyyah Vawda, Avior Capital Markets (Pty) Ltd. - Research Analyst [11]

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I have a question specifically relating to the operating profit in the Europe and Africa reporting segment. Can you maybe just explain what caused the decline there? And if possible, can you maybe give us some color on how South Africa's profitability in revenue has progressed over the last 6 months?

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Jyrki Tervonen, H & M Hennes & Mauritz AB (publ) - CFO [12]

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Yes. I think you're referring to the segment reporting in the report. And just to start, it doesn't reflect the underlying profit levels because it should more or less on a yearly basis, reflect should our subsidiaries not be (inaudible). This is based on OECD transfer pricing and the OECD model for transfer pricing. So this is based on a markup model and based on a budget per country. And so it could be different timing issue if we are not meeting the budget. So there will be sometimes timing difference. But it doesn't reflect the underlying profitability per segment. This is purely based on transfer pricing OECD model.

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [13]

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But specifically about the sales development in South Africa, we're happy with the development and we see double-digit growth in South Africa.

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Atiyyah Vawda, Avior Capital Markets (Pty) Ltd. - Research Analyst [14]

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Okay. And in terms of profitability, can you maybe give us some color there?

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [15]

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We don't want to go into details. But with that growth, we have had a good development as well.

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Operator [16]

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Your next question comes from the line of Simon Irwin at Crédit Suisse.

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Simon William George Irwin, Crédit Suisse AG, Research Division - Director [17]

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Could I just ask about your confidence that you're going to see full year EBIT in positive territory year-on-year at this -- if you're still confident that that can be achieved? And if so kind of what some of the metrics around -- particularly around cost growth in the second half would get you there?

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [18]

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Yes, still almost 6 months to go, good start to the second half. We aim for it and we have a good chance of delivering on that. So -- but as we all know, the market is very uncertain, a lot of factors can influence that. But we have a good chance of achieving that, yes.

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Simon William George Irwin, Crédit Suisse AG, Research Division - Director [19]

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Okay. And in terms of inventory obviously I note the lower markdown in your comments, about the composition of it continuing to improve. But it still keeps going up in absolute terms. And in terms of day sales, et cetera, we're still near record levels. Is there a stage when you will be able to kind of naturally trade that inventory down?

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [20]

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I think we will see. I mean we're still not happy with the levels. It's higher than what we want it to be. But the composition has improved the last 3 quarters. The -- this quarter, the inventory levels increased less than sales and the composition is better. Markdowns is down. It will be down by quite a bit for our estimate is for this third quarter as well. So we will see gradual improvement connected to better collections and to many of the investments that we're making in connection to the transformation work. So yes, it's heading in the right direction.

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Simon William George Irwin, Crédit Suisse AG, Research Division - Director [21]

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Okay. And you've given us obviously some -- a steer on markdown for 3Q. Could you also give us a steer on the impact of price and FX in terms of your [bought-in] margin for the period?

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [22]

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Yes. If you look at the external factors, especially the strong U.S. dollar, it had a big negative effect on purchases we made for the second quarter. We'll still be negative for the third quarter, roughly at the same level. Then of course, as we all know, there are other factors influencing the gross margin. But the external factors that we normally comment on will be negative and at the same level. And then as things stand now, it will be negative also for the fourth quarter but not by as much as for the third quarter.

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Operator [23]

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Your next question comes from the line of Olivia Townsend at UBS.

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Andrew Hughes, UBS Investment Bank, Research Division - MD and Head of the Pan-European Non-Food Research [24]

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It's actually Andy here. I've got a question on your percentage of sales at full price. Now I know of how retailers don't like generally giving this number out because it's a very sensitive figure. But in the past, some of your competitors, when they feel that they are at a low point in terms of performance, they suddenly become very happy to give us a number. Can you shed any light on what percentage of garments you do sell at full price? And if you can't do that, perhaps how far you are from your best year?

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [25]

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Sorry, we have to be a bit boring. We won't go into those details. Well, we are improving. We see improvements in markdowns, more full-price sales for several quarters. And we are confident that that will continue in the third quarter as well. But there's still potential, I mean to improve further. So although we're just moving in the right direction, big improvements year-on-year, we still think there's room for more.

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Andrew Hughes, UBS Investment Bank, Research Division - MD and Head of the Pan-European Non-Food Research [26]

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All right. So when -- I mean obviously you're talking about with your Q3 guidance, that will be the fourth quarter of markdown reduction. You don't think that's a problem in terms of markdown improvement for the next 1 to 2 years?

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [27]

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No, I mean there's still a lot of uncertainty and it depends on so many things. But we have initiatives in place and big potential to see further improvements, not just for the third and fourth quarter.

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Andrew Hughes, UBS Investment Bank, Research Division - MD and Head of the Pan-European Non-Food Research [28]

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So that big potential, you say, is just looking at where you are now compared to even the average over the last 10 years, you'd say there is still quite a big gap?

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [29]

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Yes, absolutely. There's a big gap. There's big potential but not only to historic levels, a lot connected to the investments that we have made in our logistical systems, improved buying methods, investments in AI and strong collections. So many different things that I believe will lead to more full-price sales and lower markdowns.

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Operator [30]

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Your next question comes from the line of Anne Critchlow at Societe Generale.

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Anne Critchlow, Societe Generale Cross Asset Research - Equity Analyst [31]

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I think you started the investment in the customer offering in the second half last year, in the first quarter and then it accelerated a bit. But what I'm trying to get at here is, should we expect less of an impact on the gross margin from this as we go from here into the third quarter and beyond? Or are you putting in just as much effort to gain on this on top of what you've done already?

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [32]

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I mean it's our business idea. It's very important for all our brands to have the best offering, to constantly improve. We have seen in the past being on the same level in this tough competitive environment, it doesn't work. So we constantly have to improve. And we have to give back to customers. And we want to be better than the competition, so we have to monitor what happens in the markets as well. In the third quarter, we will continue to invest but not as much year-on-year as during the second quarter.

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Operator [33]

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Your next question comes from the line of Jonathan Eley at Financial Times.

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Jonathan Eley; Financial Times; Retail Correspondent, [34]

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I was just wondering if you could tell me a bit about your loyalty scheme and how you plan to use that to sort of improve things like return rates and logistics costs. I was staggered by the number of members you have in that, 43 million.

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [35]

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Yes. We are happy with the Club or the loyalty scheme, and we're happy that members like it and many wants to join. That's great. In the short term, it will cost a bit more. In the long term, we believe it's good as we get a closer relationship with the customers, get to learn more and understand them better, so we can become even more relevant for them. And hopefully, in doing that, we can, I mean improve the selling as well and to lower returns and markdowns and many other things. So it's an important part that we are investing a lot in.

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Jonathan Eley; Financial Times; Retail Correspondent, [36]

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Okay. Are you planning any more changes to the terms? I think there's been some recently that -- prices sort of steer customer behavior in the way you'd like it to go.

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [37]

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Yes. It's something that we're constantly testing. And again, it's part of the total customer offering, so we're monitoring what competitors are doing as well. And then we -- and we will -- we'll see how we act.

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Operator [38]

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Your next question comes from the line of Georgina Johanan at JPMorgan.

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Georgina Sarah Johanan, JP Morgan Chase & Co, Research Division - Analyst [39]

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Perhaps just to help us understand how we might see the operating leverage develop in the third quarter. Presumably, the strong like-for-like trading in the current trading that you've called out was across both stores and online. I'd just be interested to know if that was quite consistent across both in the stores or back in clear like-for-like positive territory, please.

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [40]

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Yes, the selling has been -- was the question in June, sorry?

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Georgina Sarah Johanan, JP Morgan Chase & Co, Research Division - Analyst [41]

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In June, yes.

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [42]

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Yes. It has been strong in many markets and in stores and online. But again, it's important to remember, it's only 1 month and -- but it was -- it's good, absolutely.

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Georgina Sarah Johanan, JP Morgan Chase & Co, Research Division - Analyst [43]

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And perhaps just following on from that, if it's okay, just to understand sort of the cadence of the comparatives in the quarter. For example, was it a very easy comp on June last year and getting more difficult? Or was it broadly evenly spread?

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [44]

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Quite evenly spread.

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Operator [45]

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And your next question comes from the line of Rebecca McClellan at Santander.

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Rebecca Anne McClellan, Grupo Santander, Research Division - Equity Analyst [46]

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Just one question, please. Can you in any way quantify what the benefit to constant currency sales growth or like-for-like you're seeing thanks to increased full-price sales?

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [47]

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Sorry, I couldn't hear you that well. Can you say again?

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Rebecca Anne McClellan, Grupo Santander, Research Division - Equity Analyst [48]

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The impact of improved full-price sales within the mix, what benefit that could be having on your constant currency sales growth or like-for-like?

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Jyrki Tervonen, H & M Hennes & Mauritz AB (publ) - CFO [49]

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It's difficult to back that out exactly. But of course, with the improved full-price selling and less markdowns, it helps the net sales and the profitability, but it's -- we're giving you the reduction in markdowns. So that's at least something in the equation.

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Operator [50]

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Your next question comes from the line of Richard Chamberlain at RBC Capital Markets.

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Richard B. Chamberlain, RBC Capital Markets, LLC, Research Division - MD of Consumer Retail [51]

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I've got a couple of questions, please. The first one is just in the statement, you talk about the new online platform and logistics systems have not yet achieved full efficiency. And I wondered if you can just say when you expect those -- that full efficiency to come through. That's the first one.

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [52]

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Yes. It varies a bit from market-to-market. It will be a gradual improvement throughout the year. Sometime next year, I think we will be at levels where we want to be if you take all of those latest changes.

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Richard B. Chamberlain, RBC Capital Markets, LLC, Research Division - MD of Consumer Retail [53]

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Got it. Okay. And the other one was just on the -- you obviously showed a very strong sales performance in June. I wondered, well, a, how much that was helped by the H&M Club rollout to the U.S., Canada and Russia in May. And also were there any significant calendar effects affecting the sales performance in June, things like timing of public holidays in -- Christian holidays in Europe and so on?

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [54]

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No. If we look at June, it has nothing to do with the membership launch. I think the membership is good for the company in the long run. So it has nothing to do with that nor calendar effects. I don't think there's a positive calendar effect connected to June. But what I could say is that market conditions, especially weather, has been more favorable in big markets for us in June. But that was the opposite in quarter 2, where especially Northern Europe was -- summer came earlier last year and later this year. So there, we had the negative effect in Spain and some other markets in Southern Europe. It was positive in the second quarter, but -- so it -- whether -- we have to look at it over a longer time period. And so positive for us weather-wise in June, a bit negative in quarter 2, but underlying is -- underlying performance is better.

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Operator [55]

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(Operator Instructions) We do have a further question from the line of Charlie Muir-Sands.

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Charlie Muir-Sands, Exane BNP Paribas, Research Division - Research Analyst [56]

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I have actually two, but I'll ask them one at a time. The first one relates to your plans to offer pay later against invoice. I just want to clarify, are you using your own balance sheet to offer that to customers?

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [57]

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No. It's done together with Klarna, a partnership.

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Jyrki Tervonen, H & M Hennes & Mauritz AB (publ) - CFO [58]

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A partnership.

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Charlie Muir-Sands, Exane BNP Paribas, Research Division - Research Analyst [59]

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Great. And the other one relates to the rollout of RFID. I wondered if you could talk about the progress in the deployment and whether there are actually any customer-facing features which utilize that capability yet.

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [60]

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No -- yes, the rollout is going well. We are increasing the amount of stores with RFID and it's going ahead of plan. And that's just the first version. And then of course, we can use RFID in other areas of the business as well. But that's in the business development phase. Today, we have 15 markets. So more markets will be added and more stores will be added. And it's going according to plan.

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Operator [61]

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There are currently no further questions on the line.

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [62]

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Okay. Thank you all very much for participating in this conference call, and we wish you all a good day and a great summer. Thank you.

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Operator [63]

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Thank you. That does conclude the conference for today. Thank you for participating. You may all disconnect.

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Karl-Johan Persson, H & M Hennes & Mauritz AB (publ) - CEO, President & MD [64]

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Thank you.