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Edited Transcript of 2914.T earnings conference call or presentation 1-Aug-19 7:00am GMT

Q2 2019 Japan Tobacco Inc Earnings Call

Tokyo Aug 22, 2019 (Thomson StreetEvents) -- Edited Transcript of Japan Tobacco Inc earnings conference call or presentation Thursday, August 1, 2019 at 7:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Junichi Fukuchi

Japan Tobacco Inc. - Senior VP of Tobacco Business Planning, Corporate, Scientific & Regulatory Affairs -Tobacco Business

* Koji Shimayoshi

Japan Tobacco Inc. - SVP of Japan Tobacco International

* Naohiro Minami

Japan Tobacco Inc. - CFO, Executive VP of Communications & Representative Director

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Conference Call Participants

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* Hiroshi Saji

Mizuho Securities Co., Ltd., Research Division - Senior Analyst

* Makoto Morita

Daiwa Securities Co. Ltd., Research Division - Research Analyst

* Nobuyoshi Miura

Citigroup Inc, Research Division - Director and Analyst

* Ritsuko Tsunoda

JP Morgan Chase & Co, Research Division - Analyst

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Presentation

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Naohiro Minami, Japan Tobacco Inc. - CFO, Executive VP of Communications & Representative Director [1]

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I'm Naohiro Minami, Chief Financial Officer of the JT Group. Thank you for joining our conference. I'll start by covering the highlights of our consolidated financial results for the first half of 2019.

Please turn to Slide 3. Adjusted operating profit at constant FX, our main KPI, increased by 5.9% year-on-year. This robust growth was driven by pricing and volume gains, leading to 9.3% growth in the international tobacco business combined with cigarette pricing gains and reduced-risk products top line growth in the Japanese domestic tobacco business.

On a reported basis, adjusted operating profit declined 9.4% due to a negative FX impact, broadly in line with our initial full year assumptions. Operating profit increased by 3%. This is due to the onetime compensation gain related to the termination of exclusive license agreements for anti-HIV drugs in the Pharmaceutical business, which more than offset a decrease in profit from sales of real estate, an increase in amortization related to acquisitions and the decrease in adjusted operating profit.

Despite higher financing costs, net profit also grew 4.8% year-on-year, reflecting a lower effective tax rate due to onetime favorable factors in the first quarter. Regarding the full year analysis of our consolidated and business segment results, please refer to our earnings report. Let me now review the performance of each business segment.

I will start by explaining the market trends of the Japanese domestic tobacco business. Total industry volume declined by about 4% year-on-year. Excluding the impact of the 1-day difference in delivery days versus the previous year, it declined by about approximately 3.5%, which is relatively moderate. Industry volume for ready-made cigarettes, or RMC, which includes cigarettes and little cigars, declined about 7% year-on-year. But after adjusting for the delivery days difference, it declined circa 6.5%. The RRP market size is estimated to represent circa 22.5% of the total industry volume in the first half. Please be reminded that total industry volume and RMC industry volume includes the estimated volume of little cigars from this quarter onwards. Little cigars are products with a format similar to cigarettes rolled in tobacco-based paper. Low-priced little cigar products are emerging as a result of ongoing down-trading after the last price revision.

Next, on Page 5, I'll talk about our performance in the first half. Our RMC volume declined 7.5% year-on-year. After adjusting for the delivery days difference, it declined 6.9%. Competition in the value price segment grew intensely due to, as I mentioned, down-trading after the price increase. Although Camel is capturing this trend, JT share in the RMC category declined slightly versus last year.

Our RRP volume increased 0.6 billion year-on-year, reaching 1.4 billion units. We estimate our share in the RRP category around 8% on an offtake basis in the first half. Having said this, we are encouraged by the trend of Ploom TECH+. Since its nationwide rollout from mid-June, Ploom TECH+ is the growth driver of our RRP share, now reaching circa 10% within the category during the month of July. On the other hand, Ploom TECH's share momentum has decelerated and decreased its share in comparison with the share in the limited area it was sold in, in the first half in 2018. Regarding Ploom S, we have decided to deliver it to consumers nationwide from August 5, 1 month ahead of the initially planned September.

The quarterly results of Q2 versus Q1 are shown on the right side of the slide, where we can see sequential improvements, our RMC share of the segment, our RRP sales volume and JT total share increased.

Next on Page 6. Moving on to the financial results in the Japanese domestic tobacco business. Core revenue and adjusted operating profit increased 3.7% and 5.5%, respectively, driven by RMC pricing gains and RRP sales volume increase. Total marketing investment is almost flat compared to the previous year as we reallocated investments between RMC and RRP.

Next on Page 7. Let's move on to the international tobacco business. Total shipment volume increased significantly by 8.2% year-on-year, mainly driven by the contribution from last year's acquisitions in Russia and Bangladesh. On an organic basis, our performance was solid, almost flat compared to the previous year, despite a decline in total demand across the markets. As shown on the slide, our strong organic results are bolstered by continued market share gains in our key markets, mainly driven by our 4 GFBs.

Next is Page 8. Now are the financial results in the international tobacco business. Adjusted operating profit at constant FX grew strongly by 9.3%, driven by positive volume contribution and solid pricing, while investments continued notably in M&A markets and RRPs. Pricing gains were realized in many markets, and most notably, in the ones listed on the slide.

Next is Page 9. On a Japanese yen basis, adjusted operating profit decreased by 13.5% year-on-year due to unfavorable currencies, which overshadowed our solid business performance. The negative FX impact was JPY 48.8 billion, mainly due to weaker Iranian rial and Russian ruble, partly offset by a stronger U.S. dollar against the Japanese yen.

Next, on Page 10, I'd like to focus a little more on the current situation in Russia. First half cigarette industry volume came in stronger than expected, despite the challenging market dynamics. As a result, we are revising our assumption for the full year industry volume decline to minus 6% to minus 8%, which is slightly better than our initial guidance. Positive pricing momentum continued with excise tax increase fully passed on since January.

Our total and GFB market share in the second quarter reached 39.6% and 25.5%, respectively. GFBs continue to gain market share with Winston, the #1 brand in Russia, showing resiliency and holding market share in the quarter at 16%. LD, the #2 brand in the market, is growing, and its market share in the quarter reached a record high, 9%.

Donskoy Tabak's integration is on track and respected brands grew market share, 0.6% versus the previous year, driven by coverage expansions, and ongoing integration benefits are expected to continue. In addition, we have strengthened our leading position by becoming #1 in the highly competitive compact format category, a format, which is smaller than a standard size cigarette, and #1 in the large and growing value price segment, now representing 70% of total cigarette industry volume. JT Group now holds a 33% share of the value price segment versus 24% before the acquisition. We have also increased our presence in the growing flavor on demand segment. So overall, our business in Russia remains very strong, and we will continue to do so. Lastly, the Track and Trace system, which aims to track elicit trade, is being implemented. As a result, from July 2020, all products sold in Russia will be required to comply with the new regulation.

Next please look at Slide 11. We would like to turn to the pharmaceutical and the processed food businesses. In the Pharmaceutical business, both revenue and adjusted operating profit decreased due to the termination of the exclusive license agreements for anti-HIV drugs in Japan. In the processed food business, despite solid performance of staple food and seasoning products, revenue decreased due to lower sales of other products with low profitability. Adjusted operating profit increased due to pricing, improved product mix and cost reductions, despite increases in materials and logistics costs.

Please look at Slide 12. I would like to mention the adjustments to the full year forecast for the group. Consolidated AOP at constant FX remains unchanged. In more details, the Japanese domestic tobacco business adjusted operating profit has been revised downwards due to a lower sales volume assumption for RRP. Currency-neutral AOP for the international tobacco business has been revised upwards, reflecting solid performance in the first half. In the Pharmaceutical business, AOP has been revised upwards, driven by the better-than-expected results in the first half at our subsidiary. On a reported basis, the AOP, OP and profit have been revised downwards as the negative impact of foreign exchange is expected to expand. There are no changes in the forecast for the processed food business.

Slide 13. In the Japanese domestic tobacco business, core revenue in AOP has been revised downwards due to the change in RRP sales volume assumptions. JT RRP sales volume assumption has been revised from JPY 5 billion to JPY 4 billion, considering lower Ploom TECH demand in the first half.

In RMC, the assumption for sales volume has been changed from a decline of circa 7.5% to approximately minus 8% as the expansion of the RRP market and intensified competition in the value price segment exceeded our initial expectations. Changes related to the assumptions of the Japanese market are described on the left side of the slide. Total industry volume is expected to be resilient.

Now we would like to spend some time on little cigars. In this down-trading environment, little cigars, which are sold at relatively low prices compared to cigarettes, are starting to grow volume and competition is intensifying with new product launches. To respond to these market dynamics, we will launch 2 little cigars in mid-September, as previously announced, strengthening our competitiveness in the value price segment. We also expect our little cigars as well as Camel to capture consumers of former third-class cigarettes, which will be sold out after October.

Going back to our revised forecast. Core revenue has been revised down to JPY 580 billion, mainly due to the lower RRP sales volume assumptions. We have also revised our AOP downwards to JPY 200 billion. The downside is coming from a decline in marginal profits directly tied with slower RRP sales volume as well as negative factors linked to the top line, such as an increase in conversion costs per unit for RRP manufacturing and a decline in profits from devices and accessories. We will reduce costs by more than JPY 10 billion, but this will not be enough to offset this downside.

Slide 14, please. I would like to pause here and describe the next moves in the Japanese domestic tobacco business with a particular focus on RRP. In the second half of 2019, we will continue to optimize marketing investment as well as reallocating them within RRP. As you can see on the graph, Ploom TECH+ have been steadily gaining consumers by expanding sales area in 6 prefectures and then nationwide, performing in line with our expectations.

Compared with Ploom TECH, Ploom Tech+ has higher retention rate from trials and approximately 50% of trial users are coming from competitors' consumer base. On the other hand, the level of awareness of Ploom Tech+ is around 60%, which is lower compared to competitors' products and consumer understanding of its product features is even lower. Therefore, there's room for more growth by building more awareness and by prioritizing Ploom Tech+ when allocating marketing investments in the second half. In addition to investments in device sales, we are developing new flavors as well as stronger taste offers responding to consumers' feedback.

Regarding Ploom Tech, the retention rate of its users have been low, especially among the occasional users. This led to the revision of our RRP sales volume assumption, but it has core users who appreciate the benefits unique to Ploom Tech. We will implement efficient marketing measures, specifically targeting these customers.

Following 2 consecutive years of downward revisions for Ploom Tech sales volume, inventory management is becoming a challenge that needs to be properly dealt with. Flexible manufacturing planning, which can respond to the volume volatility is a key to this issue, and we are working on it.

Lastly, on Ploom S, we will start nationwide distribution in August, and we will strive to increase awareness and trial through promotional activities.

At the beginning of the year, we shared our plan for the Japanese domestic tobacco business, which was to return to sustainable profit growth from this year on. Based on the first half results, this will be extremely difficult to achieve in 2019. However, we remain steadfast focused on growing our profitability. Therefore, we will revisit top line growth initiatives and assess cost management capabilities in accordance with top line volatility.

Slide 15, please. Next, let's move to the forecast for the international tobacco business. We have revised upwards our AOP at constant effects, reflecting favorable results in the first half, while our reported AOP has been revised downwards due to the larger impact of negative FX. We have revised positively the total and GFBs shipment volume assumptions to increase by approximately 5% and by a mid-3% range, respectively. Constant currency, core revenue and AOP have been revised as shown in this slide, reflecting the solid momentum in the first half, as I explained in the previous slide.

Currency-neutral AOP has been revised upwards by USD 50 million as incremental revenue will be partly reinvested in activities such as reinforcing our leading position in Russia as well as to extend Logic Compact geographies in order to drive mid- to long-term profit growth.

Forecast for AOP, on a yen basis is now JPY 338 billion, down from the initial forecast. This is because Iranian rial, Turkish lira, euro and other currencies are expected to depreciate against the U.S. dollar beyond the initial guidance. With regard to U.S. dollar-Japan yen exchange rate when compared to the previous year, the U.S. dollar was stronger against the Japan yen in the first half. However, we still expect weaker U.S. dollar to the Japanese yen for the full year. Under the revised assumption, we expect the U.S. dollar to further depreciate against the Japanese yen.

Please move on to Slide 16. To summarize, the first half results were solid, driven by pricing gains across both tobacco businesses. The full year target for the group AOP at constant FX remains unchanged from the initial forecast as the revisions within each business offset collectively. While profit has been revised down due to the additional negative FX impact, the annual dividend remains on schedule to JPY 154 per share, and the interim dividend is JPY 77.

In closing, let me share my perspective on our future. We have confirmed that the momentum from conventional tobacco products is built on solid foundations, and they will continue to be a main driver of our profit growth. RRP is expanding globally, and particularly, in Japan. So we believe that this category will be the future growth driver.

The RRP market in Japan is the most advanced and most competitive market across the world. And this competition has been intensifying as the growth of RRP market slowed down recently. In RRP, we are determined to overcome this fierce competition and build a solid presence even if it takes time. Aiming to maximize mid- to long-term profit, we will invest in RRP, while paying attention to returns on the investment.

The international tobacco business is showing solid performance, driven by conventional tobacco products, and we are confident that our total tobacco business will deliver profit growth in the mid to long term.

Lastly, our policy is aiming for stable and sustainable growth in dividend per share remains unchanged. Thank you for your attention and your interest in the JT Group.

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Questions and Answers

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Operator [1]

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Thank you very much. Now we would like to move on to Q&A. Naohiro Minami, CFO; Junichi Fukuchi, Senior Vice President of Tobacco Business Planning, and Corporate, Scientific and Regulatory Affairs; as well as Koji Shimayoshi, Deputy CEO of JTI, will be taking your questions. (Operator Instructions) Because of time, we would like to limit the number of questions to one question each. For those who have an English question, we will take your questions through e-mail. We have sent you the e-mail address beforehand, which is jt.ir@jt.com. Please send your questions to this address. We are currently in the process of receiving your questions.

Thank you for waiting. We would like to now introduce the first person. Miura-san from Citigroup, please over to you.

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Nobuyoshi Miura, Citigroup Inc, Research Division - Director and Analyst [2]

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This is Miura from Citigroup. I have a question about international and your RRP strategy. In yesterday's release, you were talking about Compact to go into 12 more countries. So it seems that you're accelerating the speed of rolling this out. So can we hear about your strategy for RRP as well as the growth potential you're feeling? That's it for myself for Logic Compact.

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Koji Shimayoshi, Japan Tobacco Inc. - SVP of Japan Tobacco International [3]

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This is Shimayoshi from JTI. Hello, thank you for your question. So our strategy for international RRP, is, first of all, just to acknowledge the current market trends. When you look at the global market with a bird's eye view, we have IQOS in Japan, we have JUUL in the U.S. Apart from these markets, in other markets, we are not able to see that much of the substantial RRP growth. So this is not one singular trend we're seeing across the board on a global basis.

However, looking out into the future, there are a variety of forecasts out in the market. And with regards to our company, globally, pretax-wise, our sales is exceeding JPY 20 billion. In the next 5 years, we believe that this is going to more than double. There is a potential of that happening. So with that trend in place with regards to our market position, there is PMI, JUUL, BAT and we are #4 in the market. So that's a fact.

Looking out into the future. It's a market that may grow substantially, and we don't want to lose out. And we are not being pessimistic about our opportunities. And of course, we're not satisfied with where we are right now. So to go into details a little bit more. First of all, for T-Vapor, which is heat not burn products, the business model is somewhat similar to the RMC business model. So we need to strengthen our presence for RRP, and we need to think about earnings growth for the company, which means that in each market, we will look at the profitability of RMC and also decide on what kind of sales promotion investments we need to make for RRP.

On the other hand, for E-Vapor products. Relatively, the entry barrier is lower compared to T-Vapor, represented by JUUL. There are many new entrants coming into the market. For the time being, we will look at and compare the profitability between RRP and RMC. We will also look at market share as we are considering our strategies of entry.

Furthermore, by market, whether it be regulations or consumer needs or taxation systems, RRP, there is no one singular system in place. So what kind of products should be introduced in what kind of markets, we would like to consider all the conditions in a comprehensive way. For example, in the case of Japan, E-Vapor cannot be sold literally, and that is why we are selling T-Vapor products. And from RMC users, one of the motivations why they are transitioning to RRP is due to consideration to the people around them. And that is why the low-temperature category is promising.

However, when you look at Russia, for example. For Russia, in St. Petersburg as well as Moscow, which are the large cities, as well as the rural areas, when you look at the customer profile, they are price-sensitive and also the motivation as to why they shift from RMC to RRP is slightly different. However, when you look at Russia alone, the main driver of transition is due to health content.

So first, we would like to roll out -- we are rolling out Logic Compact in cities like Moscow, but obviously, we are watching closely the trends of IQOS, too. The global portfolio we have, whether it be for E-Vapor or for Ploom TECH, which is low-temp, and also Ploom TECH S, which is high-temperature category, now we have a wider array of products in place. So we would like to act with speed as we roll out our products across the world.

And in each of the markets, the conditions vary. So we would like to look at how competitive landscape looks like, and we would like to be able to respond with agility with our products. Currently, we are putting priority on Japan and introducing our resources into Japan because of the size of the market. And this policy is unchanged.

However, we have a good product portfolio in place, and we will continue to make improvements, and we would like to leverage this product portfolio as we strive to legally rollout the RRP business overseas as well.

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Nobuyoshi Miura, Citigroup Inc, Research Division - Director and Analyst [4]

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I understood your story very well. But when you talk about speed, you may think you're acting speedily. However, in the market, some people wonder who is JT in the RRP market, meaning you are not well-known in the RRP category. So if you were to make improvements, for example, when you look at expense execution. I don't know how to put this, but for Q1 and Q2, you are spending expenses. However, I think that it's not dynamic enough. You're not investing as much in scale. I think you need to invest much more money so that you could accelerate your speed. Isn't that possible?

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Koji Shimayoshi, Japan Tobacco Inc. - SVP of Japan Tobacco International [5]

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So this is Shimayoshi again that will take your question. With regards to speed of measure of implementation, when you look at Logic Compact, we gave you guidance at the beginning of the year, but we gave you guidance that we're going to roll it out in to markets, including U.K. And then for Logic Compact, in the markets that Logic Compact is in, we did market research, and we were able to identify that it's sufficiently competitive against other competitive products. So compared to the beginning of your guidance, we have decided to introduce it in the double -- 2x more markets.

So with regards to -- we do understand it is the driver of earnings growth for JTI. So we would like to look at how our profit growth is going to be for the year. And like I said, we talked about core revenue growth, but as we see growth, we would like to invest into Logic Compact growth. So that is how we're planning our year out currently. We do fully understand that our presence is low, but we would like to speedily try to grow the business as much as possible.

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Nobuyoshi Miura, Citigroup Inc, Research Division - Director and Analyst [6]

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You talked about IQOS in Russia earlier. But in Russia, the RRP market is about a little bit over 1%. And I think your forecast is that it will reach 3% for the fiscal year, but over the mid to long term, what kind of image do you have in your heads? Can you share that view with us, how much do you think IQOS is going to be a threat in the Russian market?

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Koji Shimayoshi, Japan Tobacco Inc. - SVP of Japan Tobacco International [7]

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So this is Shimayoshi once again. So for Russia, as you know, it is a market that is extremely important after Japan. So rather than RRP on a stand-alone basis. It's a matter of RRP and RMC on a combined basis to -- is what we are thinking about in order to grow our earnings.

So first of all, the medium- to long-term outlook, total volume is expected to decrease due to tax increases, but we will still like to strive for earnings growth. And we have been running simulations, and we believe that the Russian market has good potential. That's my first point.

However, having said that, there are 3 factors that we need to closely monitor. First is total demand or total volume, and RRP trends is the next one. And last is the -- we need to well handle distribution because we're doing horizontal integration as well as vertical integration. And these are the 3 factors that we need to closely monitor. So RRP basically needs to be compared against these trends. So the scale of RRP -- we expect the growth is going to be low single digit. And currently, it's trending in line with our expectations. So it's a limited impact on RMC total volume.

However, we are also watching IQOS trends. We are also expecting that there might be accelerated growth for RRP as well. Even more, for smokers, there are 4 motivations why RMP smokers switch to RRP. One is because they are health conscious. Next is price because RMC prices continue to increase. Third is consideration to others, as well as the product itself is the fourth. So that is basically the motivation factors that can well explain the transition.

So when you look at the Russian market, compared to other markets, people who are more conscious about their health. And that's the reason why they switch over to RRP. And that's why we have rolled out Logic Compact. The difference between Russia and Japan is when you look at the price factor, RMC products in Russia are more expensive in price. It' RUB 90 for low-end products, which is about 1/2 of the high expensive products. So when you look at stick products, it is right in the midpoint of the RMC price points. So people who are price conscious, don't call you value brands, with the receptacle or the place where we would like to capture low-end RMC-preferring customers.

But basically, we would like to grow earnings through both RRP and RMC. So that is the pillar of our strategy. But of course, we are not that optimistic about the future either. So including Japan, there are other RRP markets, including competitors, we would like to continue to watch consumer trends and also leverage our learnings and launch new products, not only Logic Compact, but we would like to do this with speed. So I think I've been repeating myself, but I would like to conclude my remarks here.

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Operator [8]

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Next, we would like to hear from Tsunoda-san, JPMorgan.

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Ritsuko Tsunoda, JP Morgan Chase & Co, Research Division - Analyst [9]

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I am Tsunoda from JPMorgan. I have a few questions regarding the domestic tobacco business. Cost reductions, particularly, you said that more than JPY 10 billion of cost reduction has been pursued. But what are the contents of this? How did you reduce the cost? Is it related to the top line? Or is it because you became cost-conscious, and that is why the top line did not grow? Or does it have really nothing to do with the top line growth and it is all about indirect costs, maybe, I don't know. So if you can just let us know how -- in which areas you reduced the cost, please?

The next part of my question is about the future in terms of volume. I understand that you have a target going forward, but how are you going to support these goals in the future with your costs? Furthermore, this fiscal year, you have recorded figures, that means that you were not able to hit the bottom last fiscal year. So I'm wondering, regarding the profit of the domestic tobacco business, when will be the bottom? Will it be this fiscal year? Is that something we can say as a forecast or not, please?

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Junichi Fukuchi, Japan Tobacco Inc. - Senior VP of Tobacco Business Planning, Corporate, Scientific & Regulatory Affairs -Tobacco Business [10]

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Hello, I am Fukuchi from JT. I would like to answer your questions. Regarding the current domestic tobacco business, I'd like to explain the status. Currently, the RRP sales plan is from JPY 5 billion to JPY 4 billion -- JPY 4.6 billion. Regarding this, Ploom TECH is the one that is short of our plan. And that effect has been reflected in this downward revision of the stick volume. I'd like to explain the status of Ploom Tech.

Now last year, Ploom TECH had started to be sold in the convenience stores nationwide from July. And in the fourth quarter, we went through various campaigns, and we were able to have a lot of users take the device into their own hands and try them out. And the Ploom TECH users currently can be divided into 3 categories we are seeing. So these are customers who actually tried Ploom TECH as their main product. And then there are the 2 users who have that and also RMC. And then also, there are the cigarette smokers who occasionally smoke the Ploom Tech. These 3 types of customers we acknowledge.

So for the people who are usually cigarette smokers and occasionally use Ploom Tech, this is the type that we have not been able to penetrate into very well. And this is the impact that is lagging on during the first half of this fiscal year as well. Originally, in regards to the RRP volume -- cigarette volume, we are trying to manage the total -- the cost. And that's why we're going to reduce the cost by JPY 10 billion, reflected in our numbers. But we have revised this to JPY 200 billion as a result.

So what were really the cost reductions that we pursued, to your question? Well, we tried everything and anything, from general managerial costs, more efficiency in production costs, reduction in production costs, for sales promotion costs as well. We looked at the current Ploom TECH situation and also the Ploom TECH+ situation as well and set our priorities much more clearly so that we can manage our costs in total. And all in all, as a result, we were able to reduce the cost by JPY 10 billion.

Going forward, to achieve JPY 4.6 billion in the future, regarding RRP, I'd like to talk about our future perspective. For Ploom Tech+, it is basically in line with our plan. From the mid-June timing, we have started to roll this out nationwide. And the penetration rate is very good, and it's reflected in the numbers compared to Ploom Tech.

For the customers who actually use Ploom Tech+, when we look at the whole number of the customers, half of them are coming from competitor users. So that's why we have high hopes for Ploom Tech+. So one point is that Ploom Tech+ sales is basically in line with our plan, I mentioned, but in reality, the device sales plan and the refill sales plan, when we look at these 2, we are actually seeing a short in the device sales progress right now against our plan. But then again, it seems like when you look at how many sticks -- capsules they use, capsules they use for Ploom Tech+, it seems like they're using more capsules than we expected. So we always look at the combination of the device and the number of capsules, so that's why we're saying that our status is good although the Ploom Tech+ awareness is low compared to IQOS, our competitor. So this is the area where we need to take more initiatives so that we can make many of our trials successful.

And in terms of customers' reactions, they talk about the kick that they get, and they also want more flavor expansions, too. So this is being considered as we speak. There are some good virtues about Ploom TECH that has succeeded in from PloomTech+. These are some of the features that we like to communicate through our marketing activities. And what with all of these initiatives, we would like to achieve 4 billion pieces.

For Ploom S, this is rolling out nationwide from August 5. And we hope that we have a very good start from this date on. This is how we would like to proceed with our business in the second half of this year. As we mentioned at the beginning of this fiscal year, 2019 will be the bottom for the domestic tobacco business. But unfortunately, when we look at the reality today -- excuse me, we mentioned that 2018 will be the bottom, but that will not happen. And we're seeing how we can lift up the performance in 2019, and also how we can further manage costs as well. These are all being considered as I speak right now. And based on our considerations, we would like to reflect it into our business executions going forward.

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Ritsuko Tsunoda, JP Morgan Chase & Co, Research Division - Analyst [11]

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So it seems like when it comes to the downward revision of our sales volume, this is due to Ploom TECH. Ploom TECH is one of the reasons why you revised your figures downward. So then how about Ploom S? I understand that the national rollout has not happened yet. So have you left that as planned in the beginning of the fiscal year?

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Junichi Fukuchi, Japan Tobacco Inc. - Senior VP of Tobacco Business Planning, Corporate, Scientific & Regulatory Affairs -Tobacco Business [12]

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Yes, the numbers are maintained.

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Ritsuko Tsunoda, JP Morgan Chase & Co, Research Division - Analyst [13]

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So then if there is no change. That means if we have a downside in Ploom S, that would become the next risk wouldn't it?

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Junichi Fukuchi, Japan Tobacco Inc. - Senior VP of Tobacco Business Planning, Corporate, Scientific & Regulatory Affairs -Tobacco Business [14]

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Yes, regarding Ploom S, we have just started to plan ourselves, and so we need to make sure that we sell it well, obviously, towards the national rollout, we have some campaigns in the pipeline already. So we're looking forward to its results.

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Ritsuko Tsunoda, JP Morgan Chase & Co, Research Division - Analyst [15]

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Understood. So currently, it might be difficult for you to make a comment on what I'm going to ask now. But as an indication, it would be great if you can let us know the profit level of domestic tobacco business. Because this fiscal year, will it be the bottom, is the question. Or with your growth strategy, et cetera, will we need more time is my question. In other words, will we continue to spend some time figuring out where the bottom is or when it is? What do you think about this?

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Junichi Fukuchi, Japan Tobacco Inc. - Senior VP of Tobacco Business Planning, Corporate, Scientific & Regulatory Affairs -Tobacco Business [16]

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The strategy of the company will be executed as we have been steadily and top line growth is difficult in the current situation, and we look at this reality of -- seriously, and we need to make sure that we have a mid- to long-term growth that can play out. Now the backbone of our strategy is to look at the total market share, including both RMC and RRP and also having both low-temp and high-temperature for RRP. This strategy has not changed, but the environment continues to change so quickly that we really need to speed up our process between planning and execution.

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Operator [17]

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Next is from Mizuho Securities, Saji-san, please.

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Hiroshi Saji, Mizuho Securities Co., Ltd., Research Division - Senior Analyst [18]

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I have just one question. For the domestic business, and the part where you revised down, which was JPY 15 billion, JPY 1.6 billion was the downward revision degree. And you did a cost reduction of about JPY 10 billion. And then you did the downward revision. And also, you were talking about negative factors, such as processing costs, as well as duty-free, as well as for the devices that is with processing fee. So I was wondering, apart from the downward revision of JPY 1 billion downward revision for sticks, what other negative factors you have accounted for?

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Junichi Fukuchi, Japan Tobacco Inc. - Senior VP of Tobacco Business Planning, Corporate, Scientific & Regulatory Affairs -Tobacco Business [19]

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This is Fukuchi that will take your question. Like you mentioned in your question, this time around, we revised down from JPY 5 billion to JPY 4 billion for RRP. So it's down by JPY 1 billion. So that's one factor. And more than JPY 10 billion of cost reduction was conducted. And then why is it going to reach JPY 200 billion? So to give you the breakdown, like you mentioned already, sales volume declined, the conversion cost per unit has been deteriorating and device accessory sales has been sluggish as well as duty-free sales in Japan has also been a negative factor.

To go into further detail. For conversion cost per unit increase due to sales decline, our plan was JPY 5 billion. And we're talking about JPY 1 billion. So for RMC, if we have JPY 75 billion as a plan, and if it's JPY 1 billion going down. We don't have the percentage, but it's 5 -- it's JPY 1 billion out of JPY 5 billion is 20%. So the impact was far larger compared to what the figure I mentioned earlier. And for refills, people need to buy the device as well as accessories if they want to smoke our RRP products. And because of sales volume, devices and accessories had a negative factor as well. Also for duty-free, the number of inbound tourists, it wasn't a major change there, but rather, from January 1, this year in China.

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Hiroshi Saji, Mizuho Securities Co., Ltd., Research Division - Senior Analyst [20]

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Is it the EC law?

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Junichi Fukuchi, Japan Tobacco Inc. - Senior VP of Tobacco Business Planning, Corporate, Scientific & Regulatory Affairs -Tobacco Business [21]

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Yes, the e-commerce law in China was revised. So in wake of that, China needs inbound tourists. Their consumption pattern changed somewhat. At duty-free in Japan, there were plans to sell through duty-free in Japan, but that has been impacted due to this regulational change.

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Hiroshi Saji, Mizuho Securities Co., Ltd., Research Division - Senior Analyst [22]

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So conversion cost device, duty-free, it's going to hit you by JPY 10 billion or more, and they're all going to be negative factors.

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Junichi Fukuchi, Japan Tobacco Inc. - Senior VP of Tobacco Business Planning, Corporate, Scientific & Regulatory Affairs -Tobacco Business [23]

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Well, we won't go into the details of the actual figures.

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Hiroshi Saji, Mizuho Securities Co., Ltd., Research Division - Senior Analyst [24]

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So is devices going to contribute negatively in a large way as well?

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Junichi Fukuchi, Japan Tobacco Inc. - Senior VP of Tobacco Business Planning, Corporate, Scientific & Regulatory Affairs -Tobacco Business [25]

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Well, totally, the conversion cost impact, accessory, devices and domestic duty-free, this adds up to this amount. But we're not going -- we cannot give out the breakdown, unfortunately.

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Hiroshi Saji, Mizuho Securities Co., Ltd., Research Division - Senior Analyst [26]

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I understand. Also, this might be related to the Japanese tobacco business. But are you going to use any money to activate the domestic tobacco business? Are you going to provide more return to shareholders?

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Naohiro Minami, Japan Tobacco Inc. - CFO, Executive VP of Communications & Representative Director [27]

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This is Minami speaking. Money doesn't have a color but, in principle, are basically -- we are in a net debt position. And the debt capacity will increase when we receive income. Therefore, so it's a matter of how we are going to utilize the debt capacity for investment purposes. Basically, our priority will be business investments, mainly in the international business. And then, of course, into RFP, both in Japan as well as abroad. So we would like to make investments to contribute to medium- to long-term growth. So that is our first priority.

At the same time, as mentioned earlier, for our shareholder return, our basic policy is steady payout of dividends and increasing dividends. That is how we are managing our financials. In addition, moreover, Mr. Fukuchi talked about cost management. This fiscal year, unfortunately, due to a variety of factors, we weren't able to control it completely. And we regret it in a large sense. Unlike the RMC business, a special product through special routes of procurement needs to be in place for our RRP. And the volume of the business also increased this year. And overall logistics as well as lead time, it's different from the RMC business.

So preparation, when you're preparing for the next year and planning for it, you need to plan differently from the RMC business. And just to say this in hindsight, 2020, including contracts and so forth, the preparations you need to make as well as medium -- mid-period control is something that we haven't yet mastered for RRP. And we had some uncontrollables during this term that we weren't able to respond to. So from the planning stage, including contracts, how are we going to control the business is something we need to strategize about 1 more time because we were focused on making something or holding a certain level of inventory, we were too concentrated and focused on those aspects.

But in line with market trends, of course, there may be some lead time, but we need to ensure that we have better control over the business. So it might be exaggerating to say we need to go through a transformation, but we do need to make some change so that everything is accounted for in the plan. And during the middle of the term, we will be able to adjust flexibly when needed. So we need to look at the results, and reflect on it and change in a speedy way. So I've gone on and on, but that concludes my remarks.

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Operator [28]

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Now we'd like to take the question from Daiwa Securities. Morita-san, please.

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Makoto Morita, Daiwa Securities Co. Ltd., Research Division - Research Analyst [29]

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Yes, I'm Morita from Daiwa Securities. Regarding the domestic tobacco business, RRP, I have some additional questions. I've been listening to this Q&A rally. And regarding Ploom TECH, Ploom TECH+, Ploom S, these items, it seems like it's difficult for us to become the #1 position and going beyond IQOS. I'm starting to feel that it's really tough to become number one. And you say that you will pursue this with a sense of speed, take new actions. And will you be launching one initiative after another next year? What really is your approach in launching Ploom, the series? Because the discussion so far seems to just stay in the area where we just say how good Ploom TECH+ is and how better Ploom S is in what way. But I'd like to see a more high-level answer regarding your approach to the market, please.

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Junichi Fukuchi, Japan Tobacco Inc. - Senior VP of Tobacco Business Planning, Corporate, Scientific & Regulatory Affairs -Tobacco Business [30]

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I'm Fukuchi from JT. With a sense of speed, we need to execute our initiatives. That is very important, as you say. In the mid to long term, in the RRP category, we're aiming to become #1 in Japan. This is the flag that we have held up and we're not going to bring it down.

Now looking at the current situation regarding Ploom TECH+ and Ploom S, the performance, we need to think of our next executions, what additional initiatives we can take going forward, while getting a good return, while controlling the costs. And by doing so, we want to grow this category. The most important thing is to have a sense of speed and to have agility in responding to these market requests with flexibility. In the past few years, regarding Ploom TECH, we have learned a lot, and we need to utilize these learnings. As Mr. Minami mentioned, we have all these learnings that we would like to reflect into our future actions regarding Ploom TECH+ and Ploom S, and there are other products that may be launched in the future. This is what is very important. In other words, strengthening R&D is important as well. This is how we'd like to continue to expand this category so that we can become #1 in the RRP category in the mid to long term.

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Makoto Morita, Daiwa Securities Co. Ltd., Research Division - Research Analyst [31]

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If you can give us more color on what you were saying, it would be helpful. Because you're saying that you're going to aim for #1 in RRP. What really is the missing link right now that hinders you from doing so? And how are you going to overcome this bottleneck, please?

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Junichi Fukuchi, Japan Tobacco Inc. - Senior VP of Tobacco Business Planning, Corporate, Scientific & Regulatory Affairs -Tobacco Business [32]

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Yes, this is Fukuchi again, I would like to answer. In the overseas business section, Mr. Shimayoshi mentioned a few of these remarks. When it comes to RFP, the customers choose it for very different reasons, and it's very important to focus on this. In Japan, while customers overseas look at the price and health considerations when they choose RRP, it's different in Japan because one of the most important thing is the social consideration and the fact that we're losing more and more places in which to smoke. So there will be more needs for RRP products in this country. It's really about how well we can listen to the customers and reflect their demands onto the products and services that we cater in the future. Also, we need to learn about the characteristics of this business and have the sense of speed in executing accordingly. There's no silver bullet in achieving this. We really need to take steady and sincere measures to react and respond to the customers' demand one by one but with a sense of speed.

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Makoto Morita, Daiwa Securities Co. Ltd., Research Division - Research Analyst [33]

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I'm sorry for being so repetitive. But let me ask a little bit more. You said that one of the key factors is social considerations in Japan. But -- and that's why you have the low-temp type of products, I think. But it's not showing as much progress as we anticipated. So maybe we can say that the key value of the RRP in Japan is not just social consideration, maybe there's other needs. Have you not tried to approach the market through other needs?

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Naohiro Minami, Japan Tobacco Inc. - CFO, Executive VP of Communications & Representative Director [34]

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This is Minami. Obviously, currently, IQOS is #1 in this market. This is a very clear fact. And obviously, we're thinking of measures to reach them and exceed them. So that we will do. And that's why we launched Ploom S. As IQOS did in the past, with Ploom TECH, we are rolling this out with tenacious efforts, continue to communicate to the customers so that they understand the features and the benefits of the product. But at the same time, getting their feedback and reflecting that into the next products to be developed.

But what kind of products -- what are we going to launch? I cannot give you information about what products we are working on right now. But in our business operating process, we're trying to be consumer-centric as much as possible so that we can respond to customers' needs. It's a very steady and square thing to do, but we believe that it's some key activities that we must pursue.

So having said that, we have not been able to deliver the results, and the performance is not really showing what we have talked about. But still, we think we need to stick to the initiatives that I just mentioned in order to get the leading position in this category. Otherwise, it will be difficult in any other way, we believe. That's why, as I mentioned in my presentation, that we need to commit to this category and be prepared to fight through, so that we can get a total growth in both RMC and RRP. This really is the only path that we believe is the one we should pursue. There is no product that we can launch tomorrow catering to all needs of the customers, but we would like to take their opinions, one by one over time, so that we can break through and make sure that we show clear results as a response to consumers' needs. I'm sorry that my answer is conceptual.

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Operator [35]

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Thank you very much. Now we would like to conclude the Q&A session because of time. We would like to now conclude the 2019 Second Quarter Results Teleconference. I'd like to thank everyone for your participation.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]