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Edited Transcript of RMS.PA earnings conference call or presentation 11-Sep-19 7:00am GMT

Half Year 2019 Hermes International SCA Earnings Call

Paris Sep 20, 2019 (Thomson StreetEvents) -- Edited Transcript of Hermes International SCA earnings conference call or presentation Wednesday, September 11, 2019 at 7:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Axel Dumas

Hermès International SCA - Executive Chairman

* Eric du Halgouët

Hermès International SCA - EVP Finance

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Presentation

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Axel Dumas, Hermès International SCA - Executive Chairman [1]

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Good morning. Thank you very much for being here. I think we are the last to present our results of the CAC 40, and I hope the last will be the first. And as of 2020, in fact, we'll be publishing at the same time the income statement and results. And so, we'll have them before the summer, and for us too actually.

Delighted to comment the strong performance of the first half of -- first quarter of 2019 and no change in trend. That's how I've been named without any change in trend (inaudible) to the dynamics of (inaudible) craftsmanship, customer loyalty and creative expression, which is indeed the driving force of all the growth in our [materials].

The salient features of the (inaudible) 15% at current exchange rates. Growth is very homogenous in the first semester and 12% at constant exchange rates. The evolution of currency parity and this had a positive impact on the sales, but relatively limited on 3 growth points EUR90 million in value. The progression of sales in the stores of the Group was particularly solid, plus 13% at constant exchange rates.

By geographical zone -- all geographical zones have progressed in all the regions of the world without any change in trend. France, as you can see, plus 4% in progression, upward movement especially in the (inaudible) the provinces of Paris, in particular Europe plus 9% continues a beautiful performance, carried forward by the United Kingdom and Italy in particular.

Japan plus 10% -- you know the Japanese demography having a double-digit growth for Japan is good. And we have our new platform has been deployed [end of] summer and the same one that was in the US and China. And we've taken back our last concession, so [Nagitar] and [Isitang] was taken from the concessions.

Asia Pacific excluding Japan, plus 18% and the Group also benefits strong, the success of the openings we will be making. Sometimes it's just enlargement such as Shanghai [Pudong], Marina Bay Sands in Singapore. And in the digital platform we continue to increase our digital imprint by launching it in Singapore and Malaysia at the end of the year.

America's finally, plus 10%, strong progression despite a stronger comparison basis. And we have innovated our 36th store in New York in the Meatpacking district after Orlando and we've opened in Waikiki. And we have projects that are pursued in the US towards 2022, a new store in Madison because the one we have and we love very much is too small in terms of its sales.

So, all of this means the revenue by geographical area remains stable. Asia-Pacific has [gained a point] to the detriment of the other zones but remains well-balanced.

The revenue by sector, here again all the geographical zones are progressing. All the majors have progressed in the first semester with a strong dynamic. Leather and saddlery plus 12%. This is particularly strong with a sustained demand -- plus 12% with demand for all our models. That is really something quite impressive.

And we have an unchanged objective for the year where we see there's been a small acceleration of the deliveries for first half of the year, but we remain with our habitual objectives of the progression of leather goods and saddlery.

Ready-to-wear and accessories has continued its growth carried forward by fashion with men's ready-to-wear or women's ready-to-wear [or in] shoes, as well as the other materials of this division.

Silk and textiles is a positive dynamic, plus 4% with sustained demand in the diversity of materials. And here we have an investment program in our production site in Pierre-Bénite because we have a big project to receive two new printing lines carried by the success of Terre d'Hermès and its creation, we've launched Un Jardin sur la Lagune. Perfumes are growing plus 3% with a high comparison basis because we had Twilly last year in the midst of the year and the launch of Eau de Citron noir.

Watches plus 14% after some difficult years, but it already had good results last year and has continued its strong performance with the launch of [the] Galop watch which has met with great success in our sales.

And then the other [materials] plus 19%, in particular jewelry (inaudible) where we are growing strongly. So, we have these two areas of fashion going well and hard luxury, what you call, with jewelry.

So, all of this means that our breakdown of the materials is almost stable as compared to the first semester of last year where leather represented 50% of the activity.

Half year results, a strong progression, current operating income plus 15% at the same pace as the sales at -- rates, the net consolidated results with the restated with the Galleria that was -- we sold that old store last year that we were owners of in Hong Kong and the net result has progressed by 15%.

Recurring operating profitability, 34.8%, which is close to the last year record level after the application of IFRS 16 standard that I will let Eric comment upon because that has been his passion for the last one year. So, if you have any questions I'm sure he'd be able to answer you because he is probably writing a thesis on the subject.

Strong growth of sales has allowed us to have a leverage effect, which has led to this operating profitability despite the negative effect of the exchange rate. So, strong cash generation means we'll maintain a high level of restated cash of EUR3.7 million after the payment of the dividend.

First semester we have continued to grow our production capacity with the inauguration of Maroquinerie in Fitilieu, Isère, 17 leather manufacturing facilities, the fourth in Israel, which has a training center for the manufacturing. We are laying our first stone in Guyenne, Maroquinerie de Guyenne which will be completed in 2020, this is in Gironde. And we have a large extension of the Pierre-Bénite site for textile that I spoke about as well as the de Saint-Junien glove and leather facility, which is celebrating its 100th year of existence.

And finally, the Group inaugurated end of June it's new shoe workshop near Malan. And all of this allows us to continue to have a strong recruitment because, in the course of the first half of the year, we received 500 new persons, approximately, and at the end of June we stand at 14,751 employees.

Creation is the driving force of Hermès. We've had a very good reception of the ready-to-wear -- men's and women's ready-to-wear collections. And you can see the success in the figures. The new bags that we have launched, Hermès Twins, Hermès Clic-H or Picnic where we've been using wicker in our bags and have met with great success at the beginning of the year.

The launch of a new perfume, Un Jardin sur la Lagune, and this is added to the collection of Jardin. So despite its name, Lagune -- does a Lagune really smell good? Anyway, we decided maybe it is -- maybe it works (inaudible) [abroad], I don't know. Anyway, we've launched a new jumping saddle, Vivace, renewing with the tradition of winning the Gran Prix with Hermès saddle or Olympics as we hope for medals at the next Olympics.

And the Galop watch that I already mentioned, which was inspired by the object of our conservatory and the Hermès (inaudible) Museum, which at its launch has met with great success as well as the Arceau L'heure de la lune men's watch, which shows the moon in the northern and southern hemisphere on its face. And there's a Pegasus that is hidden somewhere because we like to put in horses whenever we can.

Communication has worked a great deal because we had a very important event in London which had a very great impact called Step into the Frame along the men's universe. Women's ready-to-wear show at the Garde Républicaine, a men's ready-to-wear show at the Mobilier National. The other is just the choice of our designers and creators. Silk Mix in Dubai, Petit h in Chengdu, incredible success with customers running in to take their unique pieces. Our sales associates were a bit doubtful.

The 10th addition of the Saut Hermès at the Grand Palais which we very much attached. Hermès at Work festival which allows us to show 10 artisans and their know-how has always met with great success every time we've presented it. And here we were in a museum in Rome. We received more than 30,000 or 50,000 people depending on the cities.

Then Hermès Heritage, which allows us to show the Hermès (inaudible) collection in more intimate spaces, sometimes in our stores which met with great success in Busan in Korea or even Singapore. And of course the collections of the home universe Milan Furniture Fair much appreciated.

The retail network in the US, we are opening in Orlando in Meatpacking in New York and we have (inaudible) Waikiki and we (inaudible) by enlarging the store in Amsterdam, a very beautiful store, and we are opening a store in Phuket. Expansion and renovation of the stores in Marbella which is doing well in Spain and Stoleshnikov in Russia and in Moscow and the new version of e-commerce being launched in Japan.

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Unidentified Company Representative [2]

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No one to the results. Let's hear from Eric. He will talk to us about I FRS 16, the new standard applying.

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Eric du Halgouët, Hermès International SCA - EVP Finance [3]

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Good morning, everyone. I'd like to begin, yes, by running you through the ways and means of applying IFRS 16 and its impact. This pertains to lease contracts and applies as of January 1, 2019. Just to remind you, the standard talks about booking a right of use and debt in the balance sheet.

For Hermès Group this only has to do with the property leases, particularly the fixed portion of store leases, which is a fixed rent as well as, if need be, the minimum guaranteed amounts for variable rent when that applies. We are doing a full retrospective calculation; therefore we restated the financial statements and half-yearly statements for fiscal 2018. The figures at the beginning therefore are fully comparable.

Though the impact is very slight on net income, applying IFRS 16 increases operating profitability -- recurring operating profitability by 0.04% for each half yearly period. Whereas the financial result includes a rental expense of around EUR14 million all in all. Balance sheet total increases by around EUR1 billion. We book a right of use under assets and rent liability under liabilities.

As to cash flow, cash flow has increased by the depreciation of rights of use to the tune of EUR95 million in the first half of 2019 versus the repayment of a rent debt. We've also specified our definition of available cash flow -- alternative indicator for performance -- which has been adjusted if you look at the cash flow chart. It has to do with our cash flow plus changes in working capital requirements minus operational investments and minus the repayment of these rent debts we just mentioned.

Now due to leverage effect, thanks to strong growth in sales, recurring profitability is near the record reached in the first half of 2018, in spite of the negative impact of currencies. Growth in revenue 15% at current exchange rates sees a positive impact of currencies, 3 points growth, which is EUR90 million.

Gross margin level goes down by 1.2 points. This is mainly due to the negative impact of foreign exchange hedging. We expected that impact and, to a lesser degree, the dilutive impact arising from conversion effects. Communication spend up slightly faster than revenue increases, representing 4.4% of revenues versus 4.2% in the first half of 2018.

Selling, marketing and administrative expenses shows leverage of 0.2% thanks to the good pace of sales. Other income and expenses stable in value. Around EUR200 million of this is appropriations to depreciation for fixed tangible assets, intangibles as well as rights of use.

Recurring operating income up by 15% at the same pace as revenue increases EUR1.144 billion in the first half of 2019. After factoring in net capital gains of EUR54 million resulting from the sale of the Galleria store in Hong Kong in 2018, operating income is up by 9%. Recurring operating profitability, 34.8%, near the record rate we reached the same period last year, 34.9%, in spite of the negative impact of currencies which we alluded to previously.

Financial results a net expense of EUR16 million versus EUR18 million expense in the first half of 2018. This is mainly due to interest payments on lease debt that we mentioned earlier, EUR13 million in 2019. Furthermore, payment for cash and cash on hand, proceeds of around EUR20 million is the equivalent of the expense relating to booking hedging instruments.

The tax rate in the first half of 2019, 34%, representing our best estimate of the tax rate for 2018, the full-year period. Increased tax rate up by 1.5%, growing from 32.5% to 34% pretax -- tax. This is mainly -- the increase is mainly due to the expense booked in 2019 for deferred tax assets in France. This relates to the expected drop in corporate tax rates in 2020. This drop is expected around 5 points down. The tax rate should go from 34.4% to 29%. That drop is currently still being discussed, though, for the new finance bill.

Net income for the Group up 7% compared to the first half of 2018. If we restate for capital gains after sales, net income of 15% at the same pace as current recurring operating income, and also at the same pace as the increase in revenues.

Half yearly net profitability percentage of revenue, 23%, which is similar to the first half of 2018, if we factor out the nonrecurring capital gains of sales on sales of assets which we booked last year.

Operating investments in the first half EUR170 million. Around half of these investments were to renovate and enlarge our stores and retail network, mainly this has to do with the San Francisco project, Hawaii, Meatpacking and Orlando projects in the US, also Moscow and Russia, Vancouver in Canada, as well as a location in China. Furthermore, the Group continues to make its investments in production capacity. In leather production, we mentioned this earlier, projects in Guyenne, [Montro] and [Luvier].

Now to talk about [tanneries] as well as soap and textiles with printing and weaving in Leon that division plus further investments in perfumes. We also invested EUR48 million in real estate and digital projects. This ties in with our continued rollout of our e-commerce platform.

Cash flow, EUR971 million versus EUR926 million in the first half of 2018. Change in working capital requirement, EUR88 million. The change here is mainly due to increased inventory which is increasing at a similar percentage as the increase in retail sales. After factoring in EUR170 million in investments we talked about earlier, as well as repayment of lease liabilities and financial expenses, EUR95 million. Free cash flow after adjustment is EUR618 million.

Lastly, after paying the dividend, EUR486 million, which was EUR4.55 per share, and a share buyback of EUR33 million, net cash flow restated, including EUR200 million in investments whose maturity is about three months, EUR125 million reaching EUR3.7 billion -- EUR125 million reaching EUR3.74 billion at the end of the period.

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Unidentified Company Representative [4]

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Thank you, Eric. Now the outlook. Well, we will try to continue in the same movement with the long-term strategy based on creativity, the control of our know-how and a singular communication. We are not changing our guidance, so I'll say it again with the [short- and the medium-term], despite growing economic, geopolitical and military uncertainties around the world, the Group confirms an ambitious goal of revenue growth at constant exchange rates.

The year 2019 is in line with the past years, strengthening artisanal (inaudible) with the freedom creation and innovation. In the second half of the year we will strengthen our production capacity, we've laid the first stone of the [Montro] facility on September 3. The network will be (inaudible) with the Xiamen store in China that is done; Iwataya Fukuoka, Japan; the San Francisco flagship in the USA; Stuttgart; Vancouver in Canada; as well as the opening of the Warsaw store in Poland.

And we celebrate collections through unique events such as Black to Light. You have the picture on the screen of the jewelry in the Faubourg. And especially in Dubai, Abu Dhabi and special men's universe event in Seoul. And now we would be absolutely delighted with Eric to answer to all your questions.

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Questions and Answers

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Unidentified Analyst [1]

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Hello, HSBC, I have three questions. First of all, maybe the Hong Kong situation. We saw that in August the flow of Chinese tourists to Hong Kong had gone down by 40%. Is it a good reflection of the sales of Hermès in that part of the world? And if that is the case, then is there a carryover effect on other countries? What would it be and what rates would you include in the estimates?

Second question, the USA market, we saw amongst your competitors very contrasted performance. You've made plus 10%. That's good (inaudible) average to have good performance, but getting (inaudible) more difficulty. What are your prospects that you expect from the American market in the second half of the year?

Third question for your financial -- for your CFO. I don't have a question for IFRS, but for the hedging. The telephone conference of the sales figure in July indicated that there's been a bit of impact of a currency effect in the second half of the year. What I don't really understand because the dollar has gone up since the end of last year.

Normally you should not have had as much currency gain. If the dollar remains where it is you shouldn't be exercising your option? So, in the second half of the year I'm expecting a positive exchange rate effect than a negative one, but maybe there's some stock effect that I am forgetting here.

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Unidentified Company Representative [2]

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I'll try and answer to the first two questions and a little bit of the third, and Eric will take over. Hong Kong, we are all following closely the events on a day-to-day basis and I'll make a three storied answer, as it were. The first Asia-Pacific is what we've published excluding Japan. Now there's not going to be any change in trend, less in Hong Kong would be recovered elsewhere. So, I don't see any change in trend for Asia-Pacific excluding Japan.

And two more precise answers of Hong Kong with (inaudible) you have two specificities. Firstly, that we have a very large Hong Kong-based customer, very loyal customers that allows us to lessen these results -- the impact thanks to the local share. That's very dear to us local customers. And we have very attractive products in particular thanks to our creation and lever.

So, we are in a dynamic which is sometimes more favorable in times of crisis than others. We call that resilience in Hermès. But after all it mustn't last too long. The climate is difficult and we are always very positive in Hong Kong. We have been in Hong Kong for a very long time.

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Eric du Halgouët, Hermès International SCA - EVP Finance [3]

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Currency hedging, we work on the basis of a 12-month period. We are finalizing our hedges currently for 2020 and of course there are inventory affects but everything happens between now and basically in a year will be fairly limited in the area of hedging whereas at the beginning of 2020.

Of course there are inventory effects, but everything happening between now and basically end of the year will be fairly limited in the area of hedging, whereas beginning of 2020 we'll start taking further hedging. So, it's over a sliding period and a sliding scale. So, we reaped the benefits a couple years back when the euro had gone up and down and so forth. So, we can say that it's spread out over a longer period for us than with the occasion of the spot market.

Guaranteed rates are set once and for all. You've got the guaranteed rates for the dollar. This year we are hedged at 1.18 versus 1.11 in previous years. And the yen, (inaudible) of the second major strategic currency, we are hedged at 1.31 versus 1.25. So it changes to the tune of around 5% to 6%.

The change is bigger in the second half than in the first half because in the first half of the year our subsidiaries bought products that they then resell in 2018 at guaranteed rates that were somewhat better. The deterioration effect, the negative effect was a slightly greater impact in the second half the year than the first half.

A second unknown quantity which impacted us in the first half is the dilutive effect due to the conversion effects that are very strong in revenues. If we look at percentage of profitability, that can have a negative impact. You can do your own estimates though and calculations as to the dollar effect in the last few months of the year or the yen as a safe haven. Is that any clearer?

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Unidentified Company Representative [4]

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Is the two hedging risk, one is conversion on the sales figure, 3 points that you see, and then there's the risk of a transaction from France, so we hedge recovered. For the US it's a complex market for this quite erratic, [suddenly] on the West Coast doing well and then you have suddenly the East Coast doing well. And all of a sudden you have a super week and then a week that's not as good.

There is a difficulty to see a basic trend and then you come to plus 10, so they must be doing their work well. And we do see that there is -- we think that in other results, other countries of the houses that are doing more or less well. And I think there is what we have called the flight to quality in these moments that are difficult and complicated. Those will have a good reputation and desirable products.

Things go well and for those who were too much in department stores -- [mass] department or to the (inaudible) offering more. But then you see the economic results are good and sometimes it's not so good. There is a volatility of the stock market when will be the announcement (inaudible) country from that standpoint, which -- where a week doesn't look like the next.

And we have a good project, Waikiki -- Hawaii is a beautiful store. Meatpacking store is great. It's one of the coolest stores in the USA. So, our sales associates were trainers and it's doing very well. So we are cool.

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Unidentified Analyst [5]

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Thank you for the laughter.

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Unidentified Company Representative [6]

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We were in San Francisco for the launch of the Apple watch, you recall.

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Unidentified Analyst [7]

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I would like to have your point of view on the transformation of the aspects of distribution and the changes. And maybe you could give us some idea on the transformation of the way in which you manage the business from inside of the Company.

Secondly, I see more competition in travel retail and I was wondering whether you had any projects, any ambitions because you've had a position here for many years. So, what do you and tend to do in this field?

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Unidentified Company Representative [8]

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Two subjects, the digital. Digital, we've been working on it for quite some time. And may I remind you, some will say that it is the tortoise and the hare. We were the first to open in 2002 the digital, because we felt that talking about culture, history, all of this on the digital had to be interesting (inaudible) we were traded.

So, we opened the first store with the perfume [styles] and scarves -- Internet in New York. And then we entered into the omnichannel. We had a slight change in organization as compared to when I took on the chairmanship. In the beginning I wanted to -- because I felt there was a need to put our structure up to scratch the different technologies. And maybe we were not fluid enough in the mobile.

And so, we created an Internet department where we [re-founded] everything. And it is this model that we are rolling out which is more like technological upscaling and opening of new markets on which we are launching and finishing the rolling out. And then we can reopen it, it works well. I would say that that is the rule of the 75%. We launched with 75% more customers floors, 75% more vision of the mobile, and 75% new customers. That's what the teams tell me anyways.

We are now really entering into the omnichannel where the communications part of the Internet was given to -- interested to the communication and Charlotte David who is next to you, you can ask her questions. With concentration of the resources, digital events, advertising to be more coordinated and the retail with Florian Craen who is in Vancouver with the opening of the store, who is also dealing with the digital site with -- for the implementation of the real omnichannel.

I never give objectives of percentage of sales on the digital because the customer will make it her way, look in the evening on the digital website and print what they want, go to the store or conversely go to the store, come back and buy on the digital. They do what they want.

So, the idea is to welcome the customer as best as possible be it on the digital or be it in the store, in the brick-and-mortar store. So we propose [broad dogs], we do tests to see what are the omnichannel objects that they need, which are either click to store, shop to store, click in-store, product locator. We are trying to really put in place a real digital structure.

Now having moved (inaudible) that we will see for 2019 and 2020 because it is launched is more -- it shows the scope of opening new countries that we couldn't opened before because the website was not working in Asian languages, for example. And we opened in China with good success and we continue with the scope effect and continuing to open thanks to the success by putting as many products as possible in it, so much so that the growth rate of the Group -- the highest in the Group is digital.

For travel retail, you've been following us for a long time so you've sometimes heard that old Hermès is not luxury. We don't like the word luxury, so that is fine by us. They are duty-free. Now (inaudible) is running into it and they've all [done their best]. Often when we open a store we're the only ones that is not very good for the commercial potential to follow.

There is a growth of airline traffic, beautiful airports opening everywhere. The latest one in Beijing which is there, we are all present. And there is a real dynamism, whatever be the material, be it cosmetics, us and the airport, we welcome with great joy our colleagues to share in this important manner.

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Unidentified Analyst [9]

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Yes, hello. I am from Morgan Stanley. I've got two questions. Firstly on leather, you talked about the success of the bags that you launched more recently like 24/24, the (inaudible) line and others. Could you confirm that your top-selling historic Kelly and Birkin, the portion of the top sellers continues to go down in your overall leather sales mix. That's my first question.

The second question, more for Eric probably. It has to do with the second half. I wouldn't talk about guidance, as such you don't give guidance. But could you come back to talk to us? In July you talked about the negative effect on your margin. You already talked about the monetary effect. But could you also talk to us about impact of paying out free shares and launch of beauty in 2020 and so forth impact?

The question -- in the second half -- could you talk about margin differences versus the first half? And might we end up coming back to more historical levels -- a change in 20 -- 200 basis points?

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Eric du Halgouët, Hermès International SCA - EVP Finance [10]

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We're first and foremost craftsmen and women at (inaudible). Our way of managing leather is quite straightforward because you hand make bags, you take 16 hours to make one. So, my margin for (inaudible) is not very big. It's the number of craftspeople that we can train and whose skills we can hone plus -- one year down the road we can say this. Plus unknowns like a big downturn can have an impact on first-half figures.

So, we know that sometimes there are unknowns. Then we have very sophisticated analysts like you where it's difficult for me to just say, well, the flu was a problem this year and there are little issues and so on and so forth. At any rate, this is a question of demand.

Demand is extremely strong for all of our different models. It's important to continue launching novelties. The novelties always take a portion, some production. So we can say that it is a real plus this year. We are selling our new items as well as the historic ones. So, there is no mix issue one versus the other.

We try to manage the hours of labor involved. When we talk about production we talk in euro terms. When we manage the Group we talk in terms of hours, how many hours? 16 hours allocated this way and that way and so forth depending on what's feasible and the skills every employee has.

Each year we try to make it possible for each artisan to increase the number of bags they can make and to be very versatile. Success was constant. When one bag dips down they can use techniques to make the (inaudible) to make other items. We've done this. We've also retrained and so forth.

We are talking about not task-related jobs; we are talking about leather workers. These are people who are craftsmen and women, not piece workers. So, we can say that -- plus you've got to think of sourcing the materials and so forth. We try to maximize the number of hours. The [up shovel] is set.

It is not really such a strategy that you might think of mix and historic product versus others. We love all of them. The Kelly, my grandfather designed it. The Birkin, it was my uncle that designed it. We love all of the bags, the new ones from the new designers. Often I hire these people, so we hope success for all of them. And then there's the production considerations, the know-how considerations, craftsmanship as well as sourcing materials.

Yes, Eric just reminded me, absolutely we will answer that question that you asked. We did talk about margin effect. This is an important point for all of us. The success of Hermès means the success of all of our employees as well. And the special feature of ours, we're a very diverse Company.

Finance people aren't the main people at Hermès, versus what you might think. The craftsmen and women are the most important employees of ours. They are over half of our employees. We do a lot of in-house production, a great deal. We are not like other companies that may have greater flexibility that outsource their supply chain.

A second thing of ours, the salespeople are also a major portion of our employees, plus we've got a few managers and a few finance people, but it is mainly artisans and salespeople. Thanks to them that we are successful. Think of it -- it's almost like banking. We can't base our forecast for future success on past successes. Nonetheless, we would say look at our growth of recent years; it has been substantial. This has been a real plus for us; it has been important.

And it was important for us to make the big share -- free share plan, democratic one providing employees with free shares. People got 24 shares, think of the 24 (inaudible) address. All of our 14,70o-some employees received 24 shares. This has an impact on the financials. And to convince you, it's really not about -- it's an investment really. It's not really -- I mean, we are booking this under general expenses, but it's more about CapEx.

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Unidentified Company Representative [11]

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Eric, are we jeopardizing the Group?

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Eric du Halgouët, Hermès International SCA - EVP Finance [12]

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Absolutely not, of course not. Specifically four points need to be factored in. We've talked about two of these -- currency effect I won't repeat -- a little bit of a bigger effect due to the inventory effect I talked about earlier. Second one, Axel talked about this proportion of leather. We've had great delivery since the first half of the year. Our annual target remains unchanged. The proportion of leather might go down slightly due to the strong deliveries in the first half.

Two further points we have to factor in. Firstly, proportion of communication spend is on the first half, we're in the neighborhood of 4.4% of sales, whereas in the full year period it'll be around 5%. So, with a step-up of events in the second half of the year.

Lastly, fourth point -- you mentioned a proportion of free shares. Axel talked about this. The marginal effects, EUR40 million more in the second half. EUR40 million versus revenue as you can gauge around 1% profitability. So, these are things you should include in your modeling.

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Unidentified Analyst [13]

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Hello, very fast, I've got two questions. Just briefly to come back to the currency effect, you said the impact would be greater in the second half. Could you give us the impact so far in as S1 -- I mean H1? Margin went down by 20 basis points. I suspect there's a strong operational impact, so I suspect the impact is greater.

The second question, could you give us an idea of the grand leather works debt on opening 2020? And could you also give us, conceivably, a little more information about beauty launches in 2020 or is it still early days for that?

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Eric du Halgouët, Hermès International SCA - EVP Finance [14]

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We were really ready for IFRS 16. But people are really asking about currency rates now. Don't ask us about IFRS 16 at the next meeting though. We won't answer. Let me answer about [Guyenne] seriously. Guyenne leather should be in the spring. We normally start a project when it starts, we're not absolutely sure of completion -- when it will complete.

We are continuing to make these leather works at a human size of around 300 employees, we don't want to be too big so we can know each other. We want some synergy though having some clusters in nearby areas, clusters of skills. We are boosting our setups in regions we don't have three other sites yet such as (inaudible), three leather sites, plus the training workshop -- plus the new change which is having an impact on capital expenditures.

We are doing top environmental quality leather work sites. Sometimes that increases cost slightly to make sure the buildings are more environmentally friendly. That is on the Guyenne leather site.

On to beauty, we present our prototypes in the first quarter of 2020. Things are speeding up. We are doing our photo shoots and our ad campaigns. We've got great feedback. This should have an impact. Cash flow established launch should impact in the first quarter of 2020, possibly toward the end of the year as well. But very little end of this year if we start some early deliveries maybe to some countries. But it will mainly be in 2020.

We are right on time, we're talking about the end of the first quarter, maybe slightly into the second quarter -- official launch. Initial deliveries will take place during Q1 at any rate -- currency.

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Eric du Halgouët, Hermès International SCA - EVP Finance [15]

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I'd repeat a point I made earlier. Most of the drop in gross margin, 1.2 points, is due to currency effects. Most of this is due to the guaranteed rates I talked about earlier. And then more marginally it is due to the dilutive currency effect and that's an uncertainty for the end of the year.

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Axel Dumas, Hermès International SCA - Executive Chairman [16]

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We will calculate this, absolutely.

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Unidentified Analyst [17]

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To come back on beauty, can we have an idea of the number of points of sale where you will position your beauty offering in the beginning? And in the medium-term -- you communicate less, but would you have a target in terms of the number of points-of-sale for beauty in the medium-term?

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Axel Dumas, Hermès International SCA - Executive Chairman [18]

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It's a bit early frankly to be able to tell you because it is a new media for us and at Hermès we are always very -- quite cautious. So, we'll start mainly with our stores in order to gain the experience, the return, the feedback, the training because it is a new [material]. And so, we start with auto and some big partners, we are looking at Harrod's in the US, in the beginning in Korea. All of this will be set in place and then the idea of course is to go in distribution.

Now with regard to (inaudible), we could have done 5 or 10 years ago the way digital is going to come in to play. Lipstick is something that is selling more and more on digital, so for the us we have of a cautious plan in the beginning, especially for the customer experience. The service in stores centered around spaces that we can really control things and have a handle over things and large cover vis-à-vis the digital.

And then if all goes well, that's what we hope, we will roll it out in the appropriate points of sale where we are already present through the perfumes where we already have the relations and contacts. But we want to do it gradually in order to have a full handle over the customer experience, the service that we provide and the quality of the feedback, the returns that we have in the beginning. So, it will be a gradual opening.

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Unidentified Analyst [19]

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Just to react to what -- Edward's question on the mix and the leather. When you open a new leather facility, how is their production organized, the model? Do you - are the artisans able to produce all the models? Or you have an organization per model -- specific model? Do you privilege today the new models in the new leather facilities as compared to the former -- the older facilities?

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Axel Dumas, Hermès International SCA - Executive Chairman [20]

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Okay, so you want our secrets. I will share them with you because I don't know whether the others will be able to do so. Simple. When we open a leather facility it's not just new models; we necessarily have tutors who we bring in and we (inaudible) but they didn't follow anyway. I will have in their leather facility in (inaudible) one day. Anyway, so what do we do?

To be a good (inaudible) craftsman for leather units seven or eight years. So, it doesn't all just add up and everything is not in -- I mean, to be able to forecast as well as that you need -- anyway you need seven or eight years because you need a double sort of qualification incentive model, but it's also the different leathers. And what we're very proud about is the diversity of our leather -- lambskin, cowhide, etc.

All of this is not treated (inaudible) in the same way. So, different leathers, different models. You need seven or eight years to be trained. You are always learning in (inaudible) anyway. When you are a craftsman you're always learning. But the way in which we deal with the newcomers is we give them probably the most difficult -- (inaudible) the one that has the maximum number of complicated know-how in it and which is often the Kelly because Kelly has a hard handle, difficult elements.

So, the idea is to give them to start with the bag that is the most difficult one to stitch. We start with the most difficult. So, you learn the most difficult and then you can actually rollout more easily. So, we believe that when we train our craftsmen and women we think of know-how, not model, know-how. We try and give them the know-how.

And for six months -- in the beginning they produce things that are unsellable. I mean we don't sell. But we train them on that which is the most difficult and the handle of the Kelly is super difficult. And sometimes they don't get it right and then we cut it. So, we take the most difficult to start with and it's the opposite what we were doing 8 to 10 years ago. But there is a big cycle.

We work on the multiplicity, the flexibility and the cutters as well. Cutting is a real know-how and working at the tables. You have those who stitch earlier could cut and vice versa. But the idea -- sorry, the question was unheard, it was a bit strong this -- it is an act of faith as we would say.

We're not teaching these people to do a task; we are teaching them a profession with lots of skills, lots of competencies and they are leather craftspeople who can do wonderful things and that is essential. And another thing that I really believe in that goes in the same direction, it's one person, one bag.

The artisan starts his or her bag and finishes it without changing the know-how. You get the same on the line, one person making the handle, the other making the front or the back. I'd probably gain in productivity. But this project, which is to say you are a craftsperson, this is your creation, you are going to market with your own sign because each of our craftsmen have their own mark and you need two to three years to get this mark. It's more difficult than getting a long-term contract.

So, they make something and it's desired all over the world. I mean, from A-Z, and that's part of the magic of the Hermès bag and that is what I drive to preserve. It has been 180 years that we've been doing things like this and it is not outdated, it is not archaic. It is really the respect of the human person and the work that they have put in and the work that they have accomplished and in the end the work that they can see that they have made.

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Unidentified Analyst [21]

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Juliette (inaudible). I would like to come back to your distribution of free shares. I didn't quite understand the amount and what it represents in total in terms of distribution for the Group and what is the timeline and what date will it be distributed? And when was the last distribution of free shares? Where was the free share location?

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Unidentified Company Representative [22]

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My answer will be as broad as possible, but let me say I'm not including all countries since there are many rules. This is a global very democratic system for paying out these shares. So, I won't give you all the details. But we are talking about paying out 24 shares per employee. How many are there? 17,000 -- 14,751 employees. You can calculate for yourselves how many shares that means all in all.

Now to acquire these, because the idea of having a vesting period, people stay on board. So, to vest takes four years to actually receive these. Now when was the last plan? Four years ago, 2016. 2016 was the last time we did this. A last point I'd like to make, currently as of today (inaudible) 75% -- 75% of Hermès employees worldwide have Hermès shares. We are very pleased to be able to say that.

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Unidentified Analyst [23]

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(Inaudible - microphone inaccessible)?

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Eric du Halgouët, Hermès International SCA - EVP Finance [24]

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Just over one is the answer to the unheard question. Now some people have more than one share, some can't hold them and so forth. But currently 75% of Hermès employees do have a share or shares. The most recent employee distribution plan was 2016. This is 24 shares currently per employee. We don't necessarily talk this up. We've been having these plans for years now, but we don't talk it up. We are very pleased, though, to be able to say that we have and have had these plans.

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Unidentified Analyst [25]

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(Inaudible - microphone inaccessible)?

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Eric du Halgouët, Hermès International SCA - EVP Finance [26]

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It takes time for these to vest, yes. Technically they actually receive them but it takes four years vesting period. You must remain an employee for four years to actually receive these. That is the vesting period. They know the number they get, 24, they are entitled to these.

But if they leave their employ here, if they go work and travel retail somewhere else for instance you lose the 24 shares, unless you remain on board with us for four years. But that's a theoretical. People don't actually leave. I'm just giving you a theoretical example, a possibility.

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Unidentified Analyst [27]

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If you don't mind, I have maybe three questions. The first one on Chinese customers currently. Are they showing some greater maturity? We've seen this among competitors where they tend to buy showy items. But are you seeing the Chinese customers change in terms of their consumption patterns? What is the change if there is one?

Then two other questions on things you said earlier. First of all, when you build a production site, manufacturing site or what have you, I understand maybe at various locations. But what are the criteria used to actually select a location for a new production site?

Next, regarding beauty, will you have the same price policy as for the other Hermès products or will the price ranges be different? Think of (inaudible) beauty; they've got lipstick for EUR70 or EUR80. The question of mine therefore is what will your pricing policy be for beauty products?

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Axel Dumas, Hermès International SCA - Executive Chairman [28]

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Regarding Chinese customers, let me give you the same answer that was given in 2013 and 2014. I believe that was the turning point in the market. It's a market we've continued to see good performance even during tough times for others with the (inaudible). Two points I'd make though, they go hand-in-hand.

First of all, how quickly Chinese customers have become aware of everything. They are very aware of our know-how, they are very aware of quality. They've had increased awareness very, very quickly. A second thing that's having an impact on the Chinese market, fairly specific, [about the fact] quick learning curve.

Also long-standing customers are on board with us plus they are very new, very young customers. People have access to resources at a very early age that are customers of ours may sometimes seem surprising (inaudible), but the very dynamic young people in China is very striking, the resources they have. Those are the two points.

They have very different taste of course. We've all got different taste. We can certainly say they are a very knowledgeable group of customers. They have a keen understanding of who we are. So, that's on the Chinese customer base.

To move on to beauty products, let's put it this way -- we always try to keep things at the right price. People may not think that but it's true. Beauty products we hope will be like with our perfumes, right in sync with the market. And of course we want to make beautiful objects. They are not going to be plastic but metal. Therefore the price will be appropriate I believe. I hope the right price in terms of the product we are offering.

But I would remind you nonetheless that our main rule of thumb at Hermès is that our prices don't depend on marketing positions but depend on costs. Our cost plus margin. So if we sell a bag that's highly desirable or if we sell a bag that is less desirable, the margin is the same at the end of the day -- unless Eric set up a provision on one of those bags. Anyhow, so the prices are done based on our costs.

You asked me a tough question about location. For a long time -- let me say that for a long time our production location were decided based on various things such as the leather director's mother's location. We had one in (inaudible) [so one of the things they are] (inaudible). We have three leather sites in (inaudible) where he comes from and we have one who is from Normandy and a couple leather sites now in Normandy. Our strategy previously has been highly dependent on the heads of leather departments and where their family is from, their mothers actually.

Now to add another layer to our strategy here, we'd like to set up sites where we have clusters of skills. We want them fairly near, maybe half hour's drive, have three sites located within a half hour of each other. That way we can get a grouping of skills. We are trying to establish greater synergy through (inaudible) we could mention in this respect with a cluster. We've got a tannery right nearby.

We are opening a new division near Bordeaux and Guyenne surrounding that location. Also Normandy, we are moving into a third site there. So, we are clustering. Once we've done the clusters we'll then go back to the strategy based on where your mother is located and sort of other sites there. Seriously though, this is why we are ending up being located throughout France, all different locations. There's one specific to us and Hermès will look at in every region throughout France.

Another point I'd like to make, something very important to us, this also means often we set up sites in very rural areas. Often we are the only employer for many kilometers. We train our people and we often set up in rural areas that have not had new jobs for quite some time and we employ people from the local areas. Very important, we're talking about employment areas or regions and we have a high impact when we set up other sites in these regions. And this is very powerful and very important to us.

There's a second consideration, something very important to us also. In addition to other sites we want to help people find new jobs. We hire leather people for these leather sites who have gone to leather training schools and we help them understand the style of stitching.

But in addition to these people we also have strong in-house training, which means we can hire people who aren't from leather schools who may have had a difficult background previously. Maybe they were in this area that area. Some of them maybe were cabinetmakers and so forth. We have someone who used to be a philosophy teacher that we've hired in (inaudible).

Once a quarter here also we're going to have a lecturer in philosophy for those who are interested after the workshop work completes. He wanted to branch out into a new area. Anyhow, we like to be in locations that are fairly rural settings, have a high impact. We also like to have many different employees from different backgrounds, different experience. That is important to us.

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Unidentified Analyst [29]

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(inaudible) Reuters. Was wondering what you thought about the future French law on the ban on destroying the unsold products in the future and how Hermès prepares for it?

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Axel Dumas, Hermès International SCA - Executive Chairman [30]

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I won't make any comments on laws and we'll see how they are voted upon and etc. and what remains in the end. The law was first made, at least that's what I understood in reading the press after the visit of an Amazon center. So, we are not really in the same vein as an Amazon center, but --.

Now you have to realize that at Hermès that we put 16 hours to make a bag for example. And with somebody who we've taken a long time to train and the most beautiful leather that you will find in the world. It's heartbreaking when you have to have destruction. We try to have zero destruction. We try to recycle what we can.

We ourselves -- the industry is based on recycling. The skin is what was thrown -- before being transformed into leather it was mixed with (inaudible). So, we try to use it (inaudible) in a durable cycle. That is why we take [cash flow] in a durable way and we've been doing this for years.

When unfortunately in the end, because we can't sell everything -- we dream of it, but I hope one day we push our customers to buy all our unsold products. If that could be a law, I don't know if that's the direction the law is taking. But there are some sectors of materials that are -- create more unsold products. It's fashion because there's sizes and everything doesn't sell and sometimes the canary color doesn't sell as much as navy blue, it's a pity.

So, we have to work on this to do recycling. There are beautiful (inaudible) that we can recycle. We are working on this. We have (inaudible) which is not because nobody wanted it and maybe we could re-create on it and up-cycle it. We make donations, we make a lot of donations where the voluntary employees actually come and remove all the Hermès signs and labels and then [remake] the product.

But I feel like saying that it is natural to come to this when we do things that -- and naturally and when we try to have a French law in an international market where you have big players and they were not French. And so, we look at it with interest and fear. But I trust (inaudible) people to find the right solution to the industry.

But often -- we love our products. I'm always sad when something hasn't sold. And we do everything for it to sell. But there is no notion of waste. Why Hermès made umbrellas at a certain point in time? Not our biggest sale, I can assure you because we had pieces of leather that couldn't be used for making handbags because they were too soft. And so, we said, what a pity to throw this. Let's -- because it's soft it's going to be great to cover a parasol or an umbrella. So we started to make parasols with leather.

The problem with the rain and -- but in any case we did this in order not to waste the leather. So I'm talking 1930, but the material -- the raw material that is so precious, the work of our craftsmen is so precious. In Japan they are living masters and we do everything we can, but if it's not the Hermès quality branded we don't sell it.

I'm not going to put on sale products that are not up to our quality because in the production process there may have been two or three hitches. We'll see how they do it at their law and pass their law and what is unsellable because they're not of quality because of this or whatever. Anyway, good luck to the law.

And may I conclude? We have something that is great, at least from my point of view. You may not agree, but for the long-term. But thanks to artificial intelligence, everybody (inaudible) like us is the freedom of purchase. Our purchases and our inventory, there's been great progression of sales with a working capital requirement that is low because our inventory is very well held. Why? Because there is a freedom of purchase, freedom of purchase.

Each store manager does their own assortment and that is something great. Those who are obsessed with the digital -- if there's one thing they always tell me is don't digitalize the podium. We have 800 people coming every six months in Paris and (inaudible) to present all our novelties and they each one choose what they want. It is their inventory, it is their choice.

First they make an effort to sell because they don't like to be wrong and it's the right match with the needs of the country, the needs of the store. So, with regard to those who produce a large handbag -- who sell and then see what sells, given -- see what sells. We have a store that draws the goods to itself.

So in terms of human motivation, the choice of creation and diversity between our stores and that of healthy management to [find inventory], not to have any unsold products, it's a very strong point. Therefore answering to your question, what is fantastic is what we've been doing for the last 180 years. And (inaudible) because of us because we've maintained it and because it's great [modality], this obsession not to waste.

We have had that obsession for the last 180 years; it is resonating today, the fact that we have a (inaudible) valuation that is really low because it is done by hand. That resonates even more. (inaudible) why don't you put machines in? No, there's a lot of value that are intrinsic to Hermès which today are -- and that is part of the success of Hermès for all these years is resonance with the -- which is the new generation requirements.

And we must continue this despite the size of what is -- when you have plus 12% per year you've got to absorb, you've got to do things, you have to remain humble. We make mistakes like everybody else. We (inaudible) things. We have the right to, but the values of Hermès are all the more relevant today. Yes please.

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Unidentified Analyst [31]

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(inaudible), Dow Jones. You spoke about the acceleration of deliveries in the first half of the year for leather. You also said that your objective, you had it for the whole of the year. You had a talk point some percent in the first half of the year. What is your objective for the whole of the year? And in the medium-term, given the production constraints that you have, what is the sustainable growth rate for leather?

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Axel Dumas, Hermès International SCA - Executive Chairman [32]

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It's difficult to answer to your question with precision. But I would say our objectives and we project ourselves at about -- let's say around 7%-8% in volume and around 3% in price to absorb the increase in production costs. So, all of this comes to about 10 and then you have good or bad prices. But we remain within the limit of our objectives -- the limits of our objective.

The big difference, and all of this evens out, before we had the month of December with Christmas that was counted for double. But today it's more spread out in the year. You've got the Chinese doing it, which in the first half of the year, February, which is a big sale time with a lot of gifts, you have the fashion week which comes a lot.

So, it's more sort of evened out. So, sometimes there are peaks and redistribution between semesters that can vary depending on the past performance. So, the objectives -- well, we haven't etched it in stone, but it is around 7%-8% in volume.

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Unidentified Company Representative [33]

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Actually, if there are no further questions, on behalf of the (inaudible) I'd like to thank you.

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Unidentified Company Representative [34]

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I've tried to tally up the full number of meetings earlier, but I'm not sure of the whole number. But let me just say to put things in perspective, you are the example of a long-term investment and that's very much in line with your strategy. So, I thank you once again.

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Axel Dumas, Hermès International SCA - Executive Chairman [35]

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Thank you. Okay, well, thank you. Have a great day. Bye-bye.

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Editor [36]

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Statements in English on this transcript were spoken by an interpreter present on the live call. The interpreter was provided by the Company sponsoring this Event.