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Edited Transcript of IMB.L earnings conference call or presentation 5-Nov-19 9:00am GMT

Full Year 2019 Imperial Brands PLC Earnings Call

Bristol Nov 7, 2019 (Thomson StreetEvents) -- Edited Transcript of Imperial Brands PLC earnings conference call or presentation Tuesday, November 5, 2019 at 9:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Alison J. Cooper

Imperial Brands PLC - CEO & Executive Director

* Dominic Brisby;Division Director, Americas, Africa, Asia & Australasia

* Joerg Biebernick;Division Director, Europe

* Mark D. Williamson

Imperial Brands PLC - Non-Executive Chairman

* Matthew R. Phillips

Imperial Brands PLC - Chief Development Officer and Executive Director

* Oliver R. Tant

Imperial Brands PLC - CFO & Executive Director

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Conference Call Participants

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* Adam Justin Spielman

Citigroup Inc, Research Division - MD and European Tobacco and Beverage Analyst

* Alicia Ann Forry

Investec Bank plc, Research Division - Consumer Analyst

* Celine A.H. Pannuti

JP Morgan Chase & Co, Research Division - Head of European Food, Home & Personal Care and Tobacco and Senior Analyst

* Christopher Wickham

Equity Development Limited - Analyst

* Edward John Hargreaves

Investec Bank plc, Research Division - Analyst

* Gaurav Jain

Barclays Bank PLC, Research Division - Research Analyst

* Nico Von Stackelberg

Liberum Capital Limited, Research Division - Research Analyst

* Robert Amos Rampton

UBS Investment Bank, Research Division - Associate Analyst

* Sanath Sudarsan

Morgan Stanley, Research Division - Research Associate

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Presentation

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [1]

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Good morning and welcome to our preliminary results presentation. I'm joined by Oliver Tant, Chief Financial Officer; Matthew Phillips, our Chief Development Officer. Mark Williamson, our Chairman, is also with us. And in the front row, we have Dominic Brisby, Director for Americas, Africa, Asia and Australasia; and Joerg Biebernick, Director for Europe.

There is no doubt this has been a challenging year. Results have been mixed. We performed well in places but underperformed in others, and that's disappointing. However, I think it's important to step back and consider 2019 in context.

Our Tobacco business has grown revenue by just over 1% and profits by around 2%, driven by a strong U.S. performance and resilience in Europe. This is in spite of a tough trading environment for our AAA division and a difficult year from a share perspective in 2 of our most profitable markets, Germany and the U.K.

Our tobacco value-creation model is very much intact. Tobacco continues to produce high-margin sales growth. And we're well placed to deliver sustainable profit growth and strong cash returns in the years ahead.

Our vapour investment has not yielded the returns we expected. The environment hasn't helped the sector, with a high degree of regulatory uncertainty and volatility surrounding the category, particularly in the U.S., which slowed markedly in the fourth quarter.

We saw a slower second half category development in Europe, although we've established and maintained leading share positions across a number of markets. It's also clear there are areas where we need to improve. We've got some things strong, and there are clear learnings coming out of 2019, which are helping us adapt our approach and reshape our investment in 2020 to drive a stronger performance. We've driven trial and created the category in some markets, but loyalty is lacking, and this is the priority to address in 2020, together with a focus on the category and market combinations that offer the greatest opportunities for sustainable, profitable growth.

The outcome in 2019 for NGP reaffirms the need for an agile approach in a fast-moving environment. We laid out bold ambitions, galvanizing our team around the significant growth opportunity of NGP. In hindsight, we set the initial ambition too high. But while the journey and speed of travel may change, the destination doesn't. The evolution of the global nicotine market is inevitable. NGP remains a significant growth opportunity and one which I believe we are well placed to benefit from.

We've reset our investment plans, still investing in trial, but our focus on providing a differentiated consumer experience to grow brand loyalty increases. We will continue to leverage our strong retail positions, while also developing closer relationships with consumers online. And we will be introducing an enhanced product and brand refresh ahead of blu 2.0 later in 2020. And given the current high-profile health concerns, we're also focused on promoting the right regulatory framework for vapour, one that raises product standards, providing assurance to smokers and better visibility of returns for us. And beyond vapour, we continued to strengthen our multi-category approach and would extend our presence in heated tobacco and modern oral nicotine in more markets during the year.

I'll come back to talk through our approach in 2020 after Oliver has taken you through the key drivers of performance in 2019. Oliver?

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Oliver R. Tant, Imperial Brands PLC - CFO & Executive Director [2]

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Thank you, Alison, and good morning, everyone.

While 2019 has been a challenging year, we've seen a good underlying performance in tobacco, which was offset by challenges in NGP, where vapour has been growing at a slower rate than expected.

Tobacco net revenue was up 1.1%, benefiting from strong pricing, despite tougher trading conditions in our AAA division. This supported good growth in tobacco operating profit, although this was more than offset by higher investment in NGP, resulting in a 2.4% decline in group adjusted operating profit.

EPS benefited from a lower interest charge and lower tax rate, driven by a more favorable mix of profits. Cash conversion of 95% was slightly higher than initially guided due to the timing of working capital flows, mainly in Logista.

Let me start by explaining the key factors which drove a different EPS outturn from our trading update. This was predominantly due to NGP-related costs, principally the crystallization of the supply chain contract termination costs we referred to in our trading update as well as a higher level of provision for slow-moving stock. In addition, the contribution from other income was lower than we guided in September with a more prudent valuation of our investment in Auxly. These factors were partially offset by a slightly lower effective tax rate.

Tobacco volumes declined 4.4%, with second half volumes benefiting from shipment timings in the U.S., a recovery of Middle East volumes and the resolution of distributor disruption in Southeast Asia. The tobacco valuation model continues to deliver and price rises in higher-value markets supported price mix gains ahead of the volume declines. We grew Tobacco net revenue by 1.1%. This includes a benefit from the U.S. trade [pool,] ahead of an expected MPI, which we subsequently saw in October, but lower revenues than expected in Australia, with an upside rephased into 2020.

NGP net revenue grew by 48% overall, with trading revenue up 137% adjusting for last year's IP income of GBP 70 million.

Overall, at constant currency, revenue grew by 2.2% and 3.9% at actual rates, including a 1.7% benefit from FX.

Adjusted operating profit last year benefited from GBP 80 million of other gains, driven by the sale of our head office and our OTP brands business in the U.S.

For 2019, other gains of GBP 10 million arise from the gain on the value of our investment in Auxly. We therefore have a drag of GBP 70 million to profits and earnings in 2019.

Underlying tobacco operating profit grew by GBP 145 million or 4%, supported by positive price mix and savings from our cost-optimization program.

Profit in the AAA division was impacted by tougher trading conditions. We saw lower price mix and increased investment in Australia, combined with pressure from growing cross-border duty-free volumes in Saudi and key account price discounting in Russia.

Profit on last year's IP income was GBP 62 million. Adjusting for this, losses in our NGP business were higher at around GBP 110 million.

Let me now turn to providing some more detail on the factors that have influenced this movement in our NGP profitability.

We have clear ambitions to drive significant growth from NGP, and we invested in A&P to build brand awareness and in overheads. The higher investment delivered an additional GBP 54 million of gross margin, which fell short of our expectations. Some of this investment was affected, supporting good performances in some European markets and Japan. However, some of it did not drive the desired outcomes. We've learned a great deal from what works and what doesn't, and this is informing our investment reset for the coming year, which Alison and the team will cover later on.

Another consequence was that we put in place a supply chain that was geared for a much higher level of growth. We've reevaluated our European supply chain, resulting in contract termination costs and a higher provision for slow-moving inventory. The impact was an additional GBP 112 million of loss for these items.

In the first half of 2020, we'll be continuing to invest behind consumer offtake. However, as we reduce levels of trade inventory, this will impact the level of sell-in such that spend will represent a higher proportion of net revenue in the first half.

I also want to take the opportunity to highlight some of the key adjustments between adjusted and reporting operating profit in 2019. The amortization of acquired intangibles is lower than last year as the charge associated with the Altadis acquisition has now rolled off. This was more than offset by a goodwill impairment and disposal costs of GBP 525 million on the Premium Cigars assets. The main reason for the impairment are differences in the holding -- in holding the business for sale versus on an ongoing basis. But the payment also reflects tax and other transaction costs as well as a revised expectation about the timing of U.S. trade embargoes being lifted.

Post impairment, the value of net assets held for sale is GBP 1.1 billion. We expect that the impairment will be significantly offset on completion by the recognition of cumulative FX gains of between GBP 300 million to GBP 400 million, both of these are noncash items.

We also included in the P&L a charge for GBP 144 million for restructuring costs. We've recognized a fair value adjustment on the acquisition consideration of Von Erl as we settled the outstanding contractual terms with a vendor during the year. This is the final payment as part of the Von Erl acquisition.

Finally, in Russia, new legislation was introduced in 2017, retrospectively limiting the amount of production that could take place in respect to new excise tax increases without being subject to the higher rate. This has been applied across the industry in Russia and a number of other manufacturers have already made announcements in this regard. We have made a provision for a claim of GBP 139 million before possible corporation tax recoveries.

We've listened to feedback around our adjusted performance measures and are changing our approach. We've already sought to give better visibility on our other income where we recognize the benefit of profits from the sale of assets, including brands and property. However, we're now moving -- removing significant items, focusing adjusted profit measures on underlying business performance.

Going forward, we will continue to pursue similar opportunities as part of our effective management of the asset base, particularly where we're able to generate additional cash flow for shareholders. We've also carefully considered the treatment of restructuring costs and have concluded that we will continue to exclude them from adjusted measures for just one more year until the current program is concluded in 2020. Thereafter, we will reconsider the treatment of any future restructuring activities.

Noncash amortization of goodwill and intangibles and movements on derivatives will continue to be excluded from the adjusted profits.

We had another good year on cash delivery, with cash conversion at 95%, slightly higher than our original guidance, driven predominantly by working capital flows in Logista.

Net CapEx was around GBP 100 million higher, with the majority driven by NGP spend related to increased capacity for heated tobacco and the implementation of track and chase in Europe.

Cash restructuring costs decreased year-on-year due to the first cost-optimization program ending in 2018. Management of the debt portfolio enabled continued reduction in net finance costs, which were around GBP 40 million lower, while our effective tax rate was 19.1% with slight reduction due to more favorable mix of profits.

We generated around GBP 400 million of post-dividend cash flow, which enabled investment in Auxly, the ongoing share buyback and around GBP 300 million of debt reduction at constant currencies.

Looking ahead, we expect post-dividend cash flow to be lower in 2020, excluding any assumed proceeds from divestments. This is principally due to the cash outflow around the Von Erl acquisition and the expected settlement of the Russian tax provision, both of which I referred to earlier. Both of these are one-off, and we therefore expect a stronger underlying cash performance in 2021.

We have also around GBP 90 million of existing share buyback, which we expect to materially complete before the end of this year, which will affect next year's cash flow.

The slight reduction in the effective adjusted tax rate this year was due to a more favorable profit mix. The adjusted tax rate was lower than the reported rate due to a number of adjusting items having no or limited associated tax. We expect our effective adjusted tax rate for this financial year to be around 21%. This is due to legislative reforms in a number of jurisdictions and the expiry of certain tax arrangements. The effective rate for the group is sensitive to the geographic mix of profits and reflects the higher combination of rates in markets such as the USA and lower rates in others such as the U.K. The rate is, obviously, also influenced by future legislative changes.

As ever, we will seek to mitigate the impact of any changes, but do ultimately anticipate a degree of upward pressure on the adjusted and reported rate over the medium term.

Thank you. And I'll now hand back to Alison.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [3]

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Thanks, Oliver.

Our Tobacco business remains resilient as we continued to focus on Asset Brands performances in our priority markets. Good results in Americas and Europe more than offset tough trading conditions in AAA, and we achieved share gains in 6 out of 10 priority markets, including the U.S.

As Oliver explained, AAA had a difficult year from a financial perspective, driven largely by volumes in the Middle East and the timing of the excise windfall in Australia. We expect a stronger performance in AAA in 2020.

The tobacco business overall continues to achieve high margin sales growth and is well placed to deliver sustainable profit and cash returns in the years ahead.

Although revenue from vapour was lower than anticipated, we have made good progress in a number of areas. Our current iteration of myblu is now available in 16 markets and is the market-leading pod device in Germany, Spain, Italy and Japan. And in the U.S., our second half activity helped to reverse share declines, although expected returns were diluted due to the volatile environment and category slowdown.

2019 also saw a successfully launched modern oral products in Europe and test launch Pulze in Japan. All of this provides the strength and platform for growth from which to develop in 2020.

The vapour environment has changed significantly in the last year, particularly in the U.S. and is evolving globally. And we are evolving as we learn from 2019 and focus on 4 key areas in order to build a successful NGP business.

First, from a consumer perspective, growing offtake in the U.S. and leading retail shares in Europe and Japan demonstrate that myblu is competitive. However, the product and brand experience aren't sufficiently differentiated, and hence, the space is characterized by high consumer churn. Loyalty is a broader category issue, and it's a clear opportunity for us to transition away from this dynamic.

We will be improving the blu experience in 2020. This includes a device enhancement, combined with a brand refresh and investment increasingly focused on building brand loyalty to establish a differentiated premium vaping experience.

In terms of markets and channels, we expected more from the existing large vape markets and initially focused on leveraging our tobacco distribution capabilities. However, there has been slow consumer adoption of closed systems products in markets such as the U.K. and France where open systems dominate. The current proposition isn't compelling enough to transition vapers away from open systems.

In 2020, we're choosing to focus on markets where pod-based systems are more likely to grow and grow more profitably. And we are reducing our level of investment in retail, increasing our emphasis on online and building brand loyalty via more personalized relationships with consumers.

From a category perspective, we successfully expanded our nicotine offer with heated tobacco and modern oral, which we will build on this year as we grow our understanding of the increasing preference for smokers to use a repertoire of nicotine products. And we're also stepping up our regulatory engagement activities to encourage higher products and marketing standards, which are critical for creating a more stable and orderly market.

Over the past year, regulatory ambiguity in the U.S. has clearly contributed to a volatile and uncertain market for vaping. And we need to be able to freely communicate the potential benefits of vapour products and address any misconceptions among consumers. We also want differentiation between the responsible and irresponsible players in the industry. A clear regulatory environment is critical to restoring consumer, retailer and investor confidence and underpins a better return on investment as we evolve our portfolio to build an additive and profitable NGP revenue stream.

As I mentioned, we have a broader NGP portfolio and are selectively investing for growth in 2020. Pulze performed well in trail with positive feedback from consumers who have expressed high intentions to continue using it. We're now extending distribution nationally with 2 of Japan's major convenience chains and are also considering our options for future rollout into other markets. And although starting from a low base, the growth of modern oral nicotine has been encouraging. New Skruf white variants have been launched across Northern Europe in Germany, Denmark, Austria and Switzerland, and we have plans to expand further in 2020.

Dominic and Joerg will now run through a divisional overview before we take your questions. Dominic?

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Dominic Brisby;Division Director, Americas, Africa, Asia & Australasia, [4]

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The Americas delivered a further strong tobacco performance, with cigarette share growing by 10 basis points to 8.8%. We delivered share gains in our value brands, such as Sonoma and a solid performance from Kool and Maverick. This more than offset Winston, which was slightly down, though by less than the rate of market decline for the premium discount segment.

In mass market cigars, we also delivered increased share with Backwoods and Dutch Masters, supporting overall growth of 50 basis points. Second half volumes benefited from shipment timings with additional volume of around 700 million stick equivalents ahead of the recently announced price increase. Excluding this, we still performed better than the market with volumes down 5.3% versus a sector decline of 5.5%.

Tobacco net revenue grew by 6.8% on a constant currency basis, reflecting strong pricing and a mix benefit from mass market cigars, where revenue was up 17%.

The NGP market has been highly competitive, characterized by a widespread device discounting and a high rate of churn. Our increased investment supported growing consumer offtake, with myblu weekly pod sales now 80% greater than they were at the start of the year with strong growth in Q4. Reported NGP revenue for the year was down 30%. Excluding last year's IP income of GBP 51 million, revenue increased by 5%, impacted by the general category slowdown, lower sales of our disposable products and increased competition. Adjusted operating profit was 2.6% lower, with strong growth in tobacco profits offset by losses in NGP, the prior year benefits of IP income and the sale of our OTP business.

Excluding the benefits in the prior year, operating profit was up 6.7%. Given regulatory uncertainties, we have reduced our existing investment, whilst at the same time, focusing our efforts on continuing to refine the brand proposition, aligning it with smoker insights.

In July, we launched a new media campaign centered around smoker satisfaction, which allied to more targeted customer engagement, specifically in key accounts, helped improve our share trajectory. We will have a measured and scalable approach in 2020, focusing on investments that are proven to deliver.

The high degree of churn we've seen demonstrates the need to adopt a more sophisticated and consumer-centric approach to investments, which focuses increasingly on building loyalty post purchase. We're currently re-platforming our e-commerce facility, which will help a more personalized experience for blu consumers. From a retail perspective, NGP is a key focus of the ITG Brands sales force, and we're engaging earlier with retailers to secure better visibility and more impact in store.

We are also evolving consumer promotions, which encourage greater engagement with the brand. As Alison mentioned earlier, higher regulatory benchmarks around products and marketing standards are fundamental to creating a more stable and orderly market. We will continue to work closely with the FDA to promote the responsible behaviors critical to ensuring the right environment for vapour and will finalize our PMTA for blu, which will be submitted before the May 2020 deadline.

Full year tobacco volumes in AAA were 5% lower, with ameliorating declines in the Middle East and Southeast Asia contributing to a stronger second half performance. We grew our share position in all our priority markets.

Australia share growth was driven by P&S, which achieved around 6% of the market in its first year. Investment behind the brand and a mix headwind from the overall growth of sub-economy meant that revenue was down for the year. We grew share in Russia by 7 basis points, supported by Davidoff Reach. However, financial performance was impacted by increased competitive price discounting in key accounts.

In Saudi Arabia, our performance was affected by an increase in lower-price duty-free volumes from other GCC markets. Despite this challenge, the launch of Davidoff Evolve, which achieved 2.9% share in 6 months, and the rejuvenation of West with a fresh seal pack supported share growth.

In Japan, our performance was positive with share growth of 25 basis points in tobacco as well as strong revenue growth coming from 0 nicotine myblu. We have also begun to build distribution of Pulze.

Thank you. I will now hand over to Joerg.

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Joerg Biebernick;Division Director, Europe, [5]

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Thank you, Dominic. Good morning.

In Europe, we are balancing financial returns with optimizing share positions in priority markets, ensuring continued revenue growth in the right markets with the right brands. Our performance demonstrates the resilience of our tobacco business, with financials driven by strong pricing and cost savings.

Tobacco net revenue was up just under 1% and profit just over 3%. Share continues to grow in Italy and now also, for the first time since 2012, the Spanish Blonde segment, but was down in the U.K. and Germany, impacted by the timing of [our] price increases. In the U.K., we're addressing this through further brand development and regional focus to leverage the success of our new fine-cut brand Riverstone.

In Germany, we are looking at options to ensure that our superior value for money position is more transparent to consumers. We will also be making portfolio changes to Gauloises and West, while introducing new campaigns for Davidoff and JPS, celebrating its 50th anniversary this year.

In NGP, we grew net revenue by around 300% to GBP 131 million. We've consolidated our leading share positions, particularly in Germany, Spain and Italy, following the build out of myblu in the first half. We have also had successful launches of our modern oral nicotine formats in Germany, Austria and in Scandinavia.

Alison alluded earlier to the relatively slow adoption of closed system products in well-developed vaping markets. Adult vaping use is relatively high in the U.K. and France, which are 2 of the largest markets outside of the U.S. However, the popularity of open systems and their obvious value advantage means demand for closed systems hasn't been as strong as we'd expected. In the U.K., therefore, although the blu brand is well established with strong consumer awareness, myblu has around 6% share of the vape market compared to around 18% for the brand in total.

By comparison, in markets where the open systems are less developed, we have been successful in establishing the closed system category, achieving leading market share positions with greater growth potential in the short term.

So what does this mean for 2020?

Similar to the U.S., we are increasing spend on post-acquisition engagement and brand loyalty as well as activities that support availability and trial. From a market perspective, we are focused on growth in Germany, Spain and Italy, while strengthening returns in France and the U.K. We will continue to grow our presence in modern oral, building on the growth achieved in Germany, Austria and Scandinavia. From a corporate affairs perspective, we're increasing our engagement with government, advocating for the introduction of strict but sensible regulatory guidelines to ensure the orderly development of the category.

Thank you. Now back to Alison.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [6]

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Thanks, Dominic and Joerg.

So looking into the coming year, tobacco will continue to be resilient, delivering modest revenue growth, high margins and strong cash flows. As you've seen, given the increased uncertainties in vapour, we've moderated our near-term growth expectations, resetting and reprioritizing investment behind the markets and categories with the best prospects of sustainable, profitable growth.

We remain focused on managing the operational and regulatory challenges associated with the rapidly evolving category, including actively petitioning for the enforcement of higher product and marketing standards for vapour.

We're taking a more cautious approach to our outlook for 2020, with revenue and earnings per share expected to grow by low single digits, excluding the impact from any divestments.

Our new capital-allocation framework adopts a balanced approach between further investment in growth opportunities, ongoing balance sheet deleverage and the progressive dividend. We're focused on driving stronger performance in 2020, optimizing the profit and cash generation from tobacco and improving growth in NGP with greater discipline and a more tightly focused business model that will create long-term value for shareholders.

Thank you. We'll now take any questions that you have.

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Questions and Answers

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Nico Von Stackelberg, Liberum Capital Limited, Research Division - Research Analyst [1]

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Nico Von Stackelberg from Liberum. Can I please have an update on the Premium Cigars sale? So there was some disclosure in the report today. So I'm just wondering if you could clarify the rough size and time frame and what you sort of are thinking. And on that front, there is notes and stars regarding further asset disposals. Could you give some more color on what you and the Board are thinking around potential future disposals?

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [2]

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Okay. So first of all, on PCD. Clearly, it's in a -- can you all hear me, by the way? Let's try it, first of all. It's easier to do without hands free. Clearly, we're at an advanced stage. Otherwise, we wouldn't have reclassified the asset as held for resale within the accounts, but it's a complex deal, as you'll be aware, with various government bodies involved as well. Just trying to deal with the finalization of the deal. So it is at an advanced stage, and we hope we're going to be concluding it shortly, but I can't give a specific timescale, but we're very actively working to get it concluded. In terms of the other asset disposals, I think at this point, this is the end of the program for now as we've done PCD. That doesn't say that we will be looking at assets and seeing these are the small opportunities to sell them. But at this point in time, I think it's fair to say that, that'll be the end of the program for now, but we will keep opportunities under review.

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Alicia Ann Forry, Investec Bank plc, Research Division - Consumer Analyst [3]

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It's Alicia Forry with Investec. Three questions, please. One, on the cigar impairments. It is a pretty large number and a significant change versus the previous carrying value. So I'm just wondering if you could explain a bit more the specific criteria behind that. And is there a risk that other tobacco assets might be written down as well? And then secondly, NGP margins, in the past, you've said, over time, shouldn't dilute the group. In light of the increased competition that we're seeing in vapour now, I'm curious if this has changed your outlook for longer-term profitability of these products. And presumably, in the near term, gross margins have been affected. Any color you can give on that is helpful. And then finally, modern oral. It's an area that several companies are getting into right now. Just curious your early learnings about that, the types of consumers who are using it, where might it be taking share from and what retail channels does it sell best in? Any detail you could give us at this stage would be very interesting.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [4]

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Okay. Thank you. So Oliver, if you pick up on the oral nicotines and the impairment.

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Oliver R. Tant, Imperial Brands PLC - CFO & Executive Director [5]

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Cigar impairment. I mean, it is obviously a large number. I think the first thing I would say is that with the vagaries of accounting, actually, the cumulative foreign exchange gains that we've made on an asset that is essentially a dollar-denominated asset, aren't reflected in that impairment number. But we've drawn attention to the fact that there's GBP 300 million to GBP 400 million of gain that will arise on completion of the transaction based on our current estimates. And therefore, the true underlying impact to our net assets is significantly lower than the number that's reflected in these results. That's just the way the accounting standards work.

We -- what's driving the impairment? Well, firstly, I think probably worth highlighting 3 things. The first of which, when we look at carrying values from an impairment-test perspective internally, we obviously do it on the basis of the cash flow value to us and the businesses implicit within a much larger tobacco group. When we're selling with various purchases, they may well be buying that asset on a stand-alone basis. And as a result, they will encounter additional costs in order to own that asset that we wouldn't bear because we absorbed them synergistically within our existing cost structure. I mean, secondly, we don't -- we obviously have to make a provision for the tax associated with its disposal and the associated costs; thirdly, with the transaction. So they would, in large part, account for the rest of the difference. We obviously, as a Board, look at impairment across the rest of our assets on a regular basis, and we have done that again this year. That is subject to audits through the audit process as well. And we remain comfortable on the basis of the cash flows that our existing business drives that we have significant headroom against our CGUs.

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Joerg Biebernick;Division Director, Europe, [6]

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On then -- on oral. So I'll say, generically, the consumer is 18 to 30 skews male, urban, relatively digitally savvy and uses the product on an occasion basis. If I look at the sort of the broad trends within European markets or within Scandinavian markets, you see traditional snooze products tending to be in slight decline. The category as a whole of oral nicotine in growth, but that growth being driven by the modern formats. So we've done -- we've grown well in Norway, in Sweden, Germany, it's growing really well. Austria, we've basically created the category. And we've done test markets in the U.K. So we're excited about the potential in the category.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [7]

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We've got one more question from previously, which is the NGP margin development. As I mentioned earlier, this -- the developments in NGP is coming at different pace to our original anticipation. So yes, we do see margins improving over time, but that's pushing out a bit further now in terms of the timescale we're looking at. But a lot of what we're doing in 2020 is looking at really solving for the shape of that profitability. If I look at some markets around retail margins, we've been working on those through '19, but they're still too high in a number of markets. And therefore, we're going back in on that in 2020 to really try and get those retail margins lower in terms of those discussions because it's still an important channel, that's where smokers go and that's where you can interact with them in terms of vaping products and NGP products in particular. So that's one aspect we're looking at on the profitability.

And then secondly, it's around how do we rebalance the investment behind trial while generating loyalty because it's all very well-generating trial, but if you're getting too high churn rates behind that trial, clearly, you're not getting the sticky consumers that we need. And therefore, that's what we're looking to rebalance through 2020 to really focus on how we get loyal consumers, particularly with blu, and that's where the investment is being refocused. And both Dominic and Joerg talked about the post-purchase experience, which is a key element of it. But what we found is that smokers need really work -- to foster work with them in terms of helping them with the transition to vape, and that's what we're focusing on now and through 2020, which again will improve profitability as we improve that loyalty over time. So those are really the key focus areas. Environment shaping clearly will help too, as I've mentioned. That has to help consumers, but it also helps the ROI.

Go ahead. Sorry, we -- let's go there first and then we'll come back. Okay. Thank you. Back here.

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Gaurav Jain, Barclays Bank PLC, Research Division - Research Analyst [8]

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Gaurav Jain from Barclays. I have 3 questions. So first is on the U.S. cigarette market and the trends over the last month. Are you noticing any difference in the states where e-cigarettes have been banned like Massachusetts versus the rest? And I appreciate that there has been a pricing increase in the last month. So it might still not be visible, but is there any way for you to figure out the underlying trends? The second thing is the impairment charges in NGP on the inventory sort of write-down. We will get FDA flavor, the e-cigarette band sometime this week or next week. So is that all accounted for or you might have some further inventory write-down? And the third thing is on these new disclosures, the way you will do that. So now yesterday, you -- or today, you disclosed that IP revenue and EBIT was GBP 70 million revenue and GBP 62 million EBIT in FY '18, which did not recur in FY '19. But in the disclosures that you will have going forward, it still seems it will be part of the core operating or the adjusted operating EBIT. So is there a plan to remove that also on a go-forward basis?

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [9]

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Okay. I'll ask Oliver to pick up on the stock -- the slow-moving stock and the IP shortly. But Dominic, do you want to talk about the U.S. market developments and the implications of EVP balance in how we're seeing it.

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Dominic Brisby;Division Director, Americas, Africa, Asia & Australasia, [10]

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So as you know, last year -- last financial year, the U.S. market declined by about 5.6%. It's worth perhaps spending a bit of time just talking through the different elements of that 5.6% and what caused that decline. So there was about 2.6% of structural decline. We've seen about 2.6% structural decline every year for the past few years, and we'd anticipate that will be the same next year as well more or less. About 1.3% of that 5.6% was cross-category switching. So people moving largely to vapour but also to other nicotine categories. Macroeconomic decline accounted for about 0.2%. And FMC price changes as well as state excise tax increases, we estimate about 1.5%. So in total, about 5.6%.

Now we've seen a great deal of volatility over the past couple of months in terms of e-vapour market size and particularly, naturally, in some of the states that have banned it or that have banned flavors. But actually, overall, across the market, it's been far more volatile than we're used to and far more volatile than we've predicted. So looking forward in terms of what we'd expect for this financial year, for FY '20, most of those elements we expect to be broadly similar to what occurred last year. So in terms of the structural decline of 2.6, the macroeconomic change -- the macroeconomic impacts and the state excise tax and pricing impacts. The question is around the 1.3% of switching to vapour. And I think at the moment right now, it's too early to call, given that where vaping flavors, where vaping has been banned, quite often, within a fairly short period of time, it's come back to where it was before as consumers have found ways to buy from other states and ways to get their products and other ways. Therefore, we still think that our assumption of an FMC market decline of between 5% and 6%, probably slightly closer to 6% than 5%, still remains correct. But within that 1.3%, which vapour has accounted for in the past year, that's where there's a higher degree of volatility. Therefore, there will remain more risk associated with that number than there were with the others.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [11]

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Just one further point on that as well. I think it's also worth emphasizing, and Dominic did mention it in his -- when he was speaking as well that there may well be some volatility and short-term pain in the U.S. around the environment. But actually, once the FDA start to get to grips here, once we start getting through and into the PMTA process, that is going to change, and we have better visibility to a stronger regulatory environment in the U.S. than we do in other markets currently. So it will improve over time for those of us who can really stand behind our products, have the science to back our product and can really make a business of this in the U.S. within a much more orderly environment. So I think it's an important point to take away. The U.S. is volatile right here, right now. We're navigating that, I think, particularly well in terms of the regulatory aspects and our conversations with the FDA, and it will get better.

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Oliver R. Tant, Imperial Brands PLC - CFO & Executive Director [12]

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And Gaurav, in relation to your other 2 points. So on the flavor -- the potential for flavors ban, at the moment, the provision doesn't reflect the impact of the flavors ban. A possible reason for that judgment was the uncertainty around the shape and form that, that would take, and therefore, the impact that it might have, what impact repurposing of that stock might be able to achieve, whether there would be any contagion effects. And we have no clarity that, that is absolutely the action that the FDA is going to take. And we're talking about tens of millions at max, nothing more than that in terms of an adjustment, depending on the shape of anything that emerges in that regard.

As it regards IP disclosures, I think the intention that we're not really expecting any significant IP income stream and certainly in the current year, that doesn't mean that we won't see IP in future years, but I think the approach we would adopt because it is very clearly part of the exploitation of the assets that we bought at the time, we always intended that to be a core part of our trading activity. It's just lumpy in nature that we will draw it out in our disclosure where there was any significant component there from.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [13]

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Adam? Sorry, we did say -- go ahead. You're right.

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Adam Justin Spielman, Citigroup Inc, Research Division - MD and European Tobacco and Beverage Analyst [14]

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A few questions -- sorry, it's Adam Spielman here from Citi. A few questions from me. Some of them are sort of very mechanical. You talked about sort of 2 accounting-ish ones. Let's suppose you sold your -- you've given guidance, low single digit, that excludes disposals. Hypothetically, if you dispose of cigars retrospectively the first of the year, so without the whole cigar business, Premium Cigars, what would that guidance look like? Any sort of quantification of that would be very helpful, both in terms of growth and I suppose in the dilution effect. So that's the first, hopefully, simple one.

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Oliver R. Tant, Imperial Brands PLC - CFO & Executive Director [15]

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Well, at the moment, we're not disclosing the details of the shape of our cigar business in aggregate. But actually, the impact -- the scale of that business as a proportion of the totality of our operations is relatively small. And therefore, any impact in terms of the momentum is relatively limited as well. I think that's all -- we'll talk more about it when we get to the point in time where we've executed the transaction if that's all right.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [16]

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[I'll also disclose what we'll do] with the disposal proceeds as well as part of that evaluation.

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Adam Justin Spielman, Citigroup Inc, Research Division - MD and European Tobacco and Beverage Analyst [17]

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Any thoughts about that?

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [18]

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Well, that will clearly be an element of the disposal proceeds that will go to pay down debt. We have -- we want to at least maintain where we are in terms of debt metrics, but also we want to move to -- between 2 to 2.5 guardrail over time as well. So that will be part of the evaluation that we jump to debt, we'll evaluate the balance in time.

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Adam Justin Spielman, Citigroup Inc, Research Division - MD and European Tobacco and Beverage Analyst [19]

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And buybacks as well.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [20]

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Yes.

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Adam Justin Spielman, Citigroup Inc, Research Division - MD and European Tobacco and Beverage Analyst [21]

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Okay. So I answer -- I interpret your answer as low single-digit EPS downgrades, but the growth rate the same. Without being precise, is that the sort of thing we're talking about?

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Oliver R. Tant, Imperial Brands PLC - CFO & Executive Director [22]

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In the context of the guidance we've given, yes.

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Adam Justin Spielman, Citigroup Inc, Research Division - MD and European Tobacco and Beverage Analyst [23]

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Also, you said you're going to have new accounting on sort of adjusted EBIT and, I guess, adjusted EPS as well. Any quantification of that? I mean I may not -- I mean it may all be in the appendices, but if...

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Oliver R. Tant, Imperial Brands PLC - CFO & Executive Director [24]

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We've set out the implications of the revised basis on our historic numbers in the appendices, so you've got those there.

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Adam Justin Spielman, Citigroup Inc, Research Division - MD and European Tobacco and Beverage Analyst [25]

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I apologize for not looking there. Okay. Two questions, perhaps more interesting questions. NGPs, in the past, you gave this guidance that it was going to grow really fast, clearly hasn't. How should we -- or I guess how do you think about the potential growth of NGPs now given everything we know? Clearly, lower than it was a year and a bit ago.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [26]

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Yes. As I mentioned when I was speaking, the NGP opportunity is still very significant. And yes, there's some big revenue numbers out there in terms of NGP potential, but our focus has to be more around how we develop that profitably rather than just realizing revenue numbers. We invested a lot in '19. It did not deliver the level of revenue that we anticipated off the back of it for reasons that I've articulated through this morning around the churn aspects, yes trial, but not the loyalty, particularly from a vaping perspective, which has been the main feature of '19, as we anticipated. So NGP growth, absolutely. Additive growth, absolutely. We still see a very robust Tobacco business for Imperial. And therefore, this is still very much around that dynamic that we talked about before. But clearly, this is coming later than we anticipated and not to the degree in the short term that we anticipated. But I do think the focus -- we're taking the business to look more closely at the profit opportunity. The growth pockets where we can create a sustainable business will create a much more robust framework for growing this going forward. And that's what we've learned through '19, that's what we're executing through 2020.

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Adam Justin Spielman, Citigroup Inc, Research Division - MD and European Tobacco and Beverage Analyst [27]

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In 2020, will it even be positive growth? I mean, I could...

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [28]

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What, for revenue?

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Adam Justin Spielman, Citigroup Inc, Research Division - MD and European Tobacco and Beverage Analyst [29]

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Yes.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [30]

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Yes. Yes, it will still be positive growth. It will be second half loaded, we believe because we got some stocks we're working through ahead of the enhanced 2.0 launches. But even so, we should be seeing revenue growth in 2020. And also, now we're not just focusing on blu, we're very much looking at the O&D the opportunities, which we've had some good initial experiences with, and that's a very profitable category, as I'm sure you're aware. But also HT now. And we've got some things in Japan that we're rolling out. We've got launches planned in other markets as well during the year. Now that would just be beginning to build through 2020, but it will start to contribute as well.

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Adam Justin Spielman, Citigroup Inc, Research Division - MD and European Tobacco and Beverage Analyst [31]

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And then finally, would this business work if you didn't have NGPs? I mean I know you're going to tell me we can do both, but let's just think about tobacco. Let's suppose that, I don't know, in a year's time, the Board of Imperial says, we just can't be bothered. It's going to be cash negative for years on end, we're just going to do tobacco. Could you maintain the sort of 1% revenue growth and a little bit of margin growth and just return to a much more predictable, dare I say, boring but stable business that arguably will be worth much more than GBP 0.06 for you?

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [32]

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As I think I've probably said too many times this morning, we see a very resilient tobacco model. And therefore, modest growth from that resilient model, I think, is very achievable for us over a number of years. I think for NGP, the challenge is it -- is for it to stop being a drag and to start contributing more. And therefore, what I was talking about just now in terms of that management of the revenue growth but looking to, therefore, manage what that means from a bottom line perspective and take that into more positive territory over the next couple of years means it will be additive to both top and bottom line over that period of time. But for now, we're going to pace down the growth while we reset that investment model.

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Nico Von Stackelberg, Liberum Capital Limited, Research Division - Research Analyst [33]

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Nico again from Liberum. On Slide 13, you talk about free cash flow post dividend expected to be lower than FY '19. I was just wondering, well, the guidance has been quite soft in general for earnings and that's -- salute to that because it's good to set the bar low and overachieve, but I can't tell what that is and what that roughly means. So if you can give me just, I guess, a ballpark or a low hurdle to clear from there so we can be sure that the dividends covered by the free cash flow would be useful. I know that you're doing -- talking about free cash flow post dividend, but that's my main concern. You want to do just one at a time? Is that easier? I have 2 more questions.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [34]

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Yes. Do that one, sure. Yes, go ahead.

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Oliver R. Tant, Imperial Brands PLC - CFO & Executive Director [35]

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Well, I mean, the cash -- in answer to your question, the cash flow will cover the dividend obligation in the context of FY '20. The cash generation, I guess, is slightly lower for a number of reasons. One, some of the one-offs that I referred to will actually pay out in terms of cash outflow in FY '20. So the Russian tax item, the payment will be in '20 and the Von Erl payment is in '20 as well. So if you add those back, we have a more substantive net position.

We also had some -- an excise duty regime in Australia, which gave us some inflow benefit, and we talked about our performance in Logista in the context of this year. So those are affecting aspects of that cash flow as well which will unwind in 2020.

By the time we get to '21 and '22, we're expecting it to rise significantly again. And we will be looking at a series of initiatives to improve the shorter-term cash flow because we do believe we've got some opportunities that we have yet to exploit in terms of our working capital management.

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Nico Von Stackelberg, Liberum Capital Limited, Research Division - Research Analyst [36]

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Well, then excellent. The next one is on Von Erl within the adjusted operating profit. I just want to be completely clear because when I looked at the disclosure, I think it said derivatives would still be included in adjusted operating profit. But just to be clear, Von Erl goes into a separate below the adjusted operating profit line to separately break that out those types of charges, correct?

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Oliver R. Tant, Imperial Brands PLC - CFO & Executive Director [37]

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Yes. Yes.

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Nico Von Stackelberg, Liberum Capital Limited, Research Division - Research Analyst [38]

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Okay. Just -- we just want to be 100% clear. Good. Easy one. All right. And the final one. Okay, so a lot of the vapor growth in the U.S. market has been incremental, it hasn't necessarily been taking from the tobacco market. And I guess what I want to know is given that the vapor market is going to be less vibrant, we all know that tobacco-flavored vapes don't taste as nice as some of the flavors. I guess the question is what is the migratory path of the incremental vape users? Where do you see them going? Is there a substantial opportunity to win these customers into some profitable market such -- profitable segment, such as mass market cigars, maybe Kool? I'm not sure if you're doing any specific activations in order to capture the people switching from vapor into tobacco, which is likely to happen, to be completely frank.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [39]

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Yes. It's a natural alternative, yes. So we're looking -- actually, we got a piece a work going on in the U.S. at the moment specifically on this, which Dominic can comment on briefly, to really look at this whole repertoire point with smokers in the U.S. And with the evolving environment, yes, we've got a cigarette business that's working well for us. Our mass market cigar business still delivers amazing growth for us. And you may know, we've had some constraints on backward supply because they share growth in the natural vapor segment there, which are coming off in 2020, so that's very positive for the growth there as well. Vaping, I think, is going to reshape as regulation kicks in. But also, I think the FDA are still open to putting flavored products through the FDA process. So that's still one that needs to evolve and see how that plays out as well. And you've now got heated tobacco being tested. You've got oral nicotine as well. So there's a real repertoire here of tobacco products that we're doing a very specific piece of work on to decide how we want to prioritize that going forward. I don't know if I've totally covered off the answer now, Dominic, but...

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Dominic Brisby;Division Director, Americas, Africa, Asia & Australasia, [40]

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You have.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [41]

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Yes. Okay.

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Nico Von Stackelberg, Liberum Capital Limited, Research Division - Research Analyst [42]

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Okay. And I guess, the final sort of follow-up question on that is can you give us an update on is the entire portfolio ready for PMTA or will definitely be there in time for the deadline? And also, is there a modern oral opportunity for you within the U.S.? And is that prepared as well?

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Matthew R. Phillips, Imperial Brands PLC - Chief Development Officer and Executive Director [43]

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Yes. We are ready. We're going to be submitting PMTA by the deadline, by May. We've got a variety of products that we're going to be putting through, including sort of free base offerings, Nixx, all variety of strains and flavors and tobacco and menthol us well. O&D, absolutely, there is an opportunity, which we're exploring with the FDA right now. And we hope to be able to submit an application on that in the same sort of time frame, and also heated tobacco. So we've got of a variety of irons in the fire.

I mean, I'll just go back to your previous question briefly. If you look at the experience of JUUL, in particular, when they withdrew their flavors and the migration that took place to tobacco, menthol and mint, I'm not convinced that the move away from vaping of existing consumers is going to be as dramatic maybe as some people are thinking. But there are going to be fewer Players, and therefore, the ones that have their products through PMTA process are going to be at a benefit from the dynamics going forward.

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Sanath Sudarsan, Morgan Stanley, Research Division - Research Associate [44]

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Sanath from Morgan Stanley. Two questions for me. First one, on guidance. You had previously indicated in September that there was a gain you were expecting in Australia because of the timing effect very much in 2020. So your guidance, does that include this number from Australia? If so, how material it is? Or what could it be without Australia flag again?

And the second one, on Slide 22, you had the market share positioning for blu. In some of the markets, like Germany Italy, Spain, looks very strong. Can you just walk us through why you're being very successful there? Is it because you are the first mover? Or what's been different in those markets versus other markets?

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [45]

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I think Joerg would love that question, won't you? In terms of the Australia gain, absolutely, it's factored into our numbers for 2020. But I think you -- if -- you also have looked at the fact that we had quite an uplift in the U.S. as well given the trade pull at the back end of the year, so there's going to be some offsetting factors around that as well. But all of that is factored into our guidance, which is more cautious guidance for 2020.

Joerg, would you like to talk about blu in Europe? Get a microphone.

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Joerg Biebernick;Division Director, Europe, [46]

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Thank you very much for the question.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [47]

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Grab a microphone first.

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Joerg Biebernick;Division Director, Europe, [48]

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Do you hear me? All right. Perfect. So first of all, we are successful in Germany, Italy, Spain and also in the U.K. and France not because there's a lack of competition. In fact, now -- by now, vape, JUUL and JTI with their offer with Logic have been very aggressive as well. Nonetheless, our exit share in fiscal year '19 was 27%, 28%, which is about twice the size of the next best competitors. So we're still larger than those combined. And I think the reason is, number one, we have extremely good executional capabilities in the European markets that I mentioned. So we've been very good in activating, not just building distribution and activating the brand at the point of sale where the smokers go. The second thing, we very early have used the learnings that we generated already in fiscal year '18 that it's important to build a brand and not just focus on trial and product. So we've been best investing heavily in the mass advertising, especially in big metropolitan areas, in a tiered approach. And that is now paying dividends because we have built leadership awareness and trial rates through that. I think the product experience is competitive. I think Alison mentioned that already. It's probably not yet sufficient to make it sticky. I think that's going to be the potential for 2020 where we're going to focus a whole lot more on repeat loyalty. But we've essentially built a leadership brand through our efforts in the last year.

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Robert Amos Rampton, UBS Investment Bank, Research Division - Associate Analyst [49]

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It's Robert Rampton from UBS. Two questions from me. In terms of next year, you've said you expect it to be weighted towards 2H. Can you help us understand the shape of NGP investment? You've already flagged pipeline fill for the next generation.

And then my second question is given you've got 3D flavors and Nixx and so on in the pipeline, it strikes me that perhaps part of the churn for the -- part of the reason for the churn could be the product. I mean is there an argument to be made for waiting on the NGP investment until you've got maybe more competitive products on the market?

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [50]

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Yes. So first of all -- actually, just a comment on the products. The point Joerg was making there is well around our European shares. And the 27% he was highlighting is effectively European share across the 5 major markets in Europe and is a significantly leading share ahead of the competition. So we have a competitive product. We're not happy with that though, we want to have a much more differentiated product, and that is the focus in 2020 to get that launched into market. So we look at the consumer experience. It's not just about the product, though, it's about the whole engagement with the product, the branding of the product, all those aspects. So there's a brand refresh coming through. We have an enhanced device that we'll be pulling through as well in 2020. But all of that is then focusing on, ultimately from a experience perspective, the launch of 2.0, which will be a very significant step change in the experience and will incorporate a number of those innovation work streams that you've seen and we've talked about over the last year or so. So yes, we do want to get the product more differentiated, but it's not just about the product, it's got to be about the whole brand experience and also how we take smokers with us on the journey to start using blu and then to continue using blu and making it part of the part of their lifestyle as they make that transition.

In terms of the weighting between H1 and H2, yes, we are reducing our investments as part of the reset behind NGP in 2020. It's fairly evenly split half on half, though, because we are still going to be focusing on driving that consumer offtake and customer loyalty throughout the year. But as we destock some of the current myblu ahead of the launch of the newer products later on in the year, the sales will be not proportional to that effectively, which is what's going to impact the H1/H2 phasing.

Adam, in the middle?

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Adam Justin Spielman, Citigroup Inc, Research Division - MD and European Tobacco and Beverage Analyst [51]

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You've said a couple of times you're going to enhance the brand and enhance the product. Can you give us a sneak preview as to what that -- I mean it's easy to say but I imagine quite hard to do. What does it really mean to enhance the brand?

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [52]

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I mean, effectively, it's refreshing the brand proposition. So there's been extensive work now, in-depth consumer work, over an extended period of time to really position blu in a way that we really think will work from a smoker proposition perspective. I don't know, actually, is it worth either one of you just commenting on some of that work on what we've been doing because I think it's good to really get under the skin of it? Joerg maybe -- yes.

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Joerg Biebernick;Division Director, Europe, [53]

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Yes. I think maybe the easiest analogy I can give you is we realized very quickly that when you are a smoker trying out blu, it's not just trying out a new product as if you're switching from Pepsi to Coke or so, but it is really more analogous to joining Weight Watchers or a gym. It's changing a habit, and an ingrained habit for many, many years in some cases. So what we learned is that the brand shouldn't stop there at this very moment, at the first moment of truth, but actually, that's when the brand journey is starting. So essentially, we want to take consumers, smokers, by the hand and not only tell them, how do I say, not only remove problems because all of a sudden there are choices to be made, the right mix strength, they never had to choose that, the right flavor, that the battery is working, that the pods are working, but also reward them positively and replace, frankly, some of the dopamine hits that smoking gives you during the day, i.e., when you get a fitness watch, it just tells you, congratulations, you ran your first mile under 6 minutes, you've been 3 days exercising in a row, et cetera, et cetera. So we're thinking really about a comprehensive way to bring the brand to life post purchase, that's significant.

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Adam Justin Spielman, Citigroup Inc, Research Division - MD and European Tobacco and Beverage Analyst [54]

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Like via Bluetooth, I guess. And how is the product going to be?

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [55]

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Yes. Not only, but clearly, there's -- yes.

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Adam Justin Spielman, Citigroup Inc, Research Division - MD and European Tobacco and Beverage Analyst [56]

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Not only. So how is the product going to be better then?

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Matthew R. Phillips, Imperial Brands PLC - Chief Development Officer and Executive Director [57]

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Let me give you some examples. So this bit applies to heated tobacco as much as it would to blu. So once you get the product out with consumers, you get feedback very rapidly in terms of what are the likes and the dislikes. So from a blu perspective and myblu perspective, one of the frustrations is the battery life and the speed of charging of the battery or maybe the haptics of the product, the touch and the feel of the product rather than the actual engineering of the product itself, and that gives us the ability to be able to upgrade the product. Now from a blu perspective, we've got upgrades that are going to coming during the course of next year, but then we've got a bigger innovation, which I'm not going to talk about, which will come later in 2020.

If I take it to the heated tobacco platform, we've been in the market 6 months and we're already identifying the upgrades that we want to be bringing through, which will be done very rapidly. But then we've got 2 bigger upgrades that we will be bringing through later in the course of 2020.

So there are smaller and then there are bigger ones that we're going to bring through. And the smaller ones, you can sort of drip through a bit more easily, the bigger ones take a bigger reset.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [58]

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But from a U.S. perspective, the focus has to be much more on the brand and the experience we're building with the brand because, clearly, we have limitations as to how quickly we can bring innovations of the product, as everybody has, on to the U.S. market.

Okay. Chris first, yes. It's Chris here at the front.

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Christopher Wickham, Equity Development Limited - Analyst [59]

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Chris Wickham, Equity Development. I was just wondering if you could remind us what the actual spend is of people when they're purchasing pods. What's the average weekly spend on products in sort of -- just in your key markets?

And then secondly, I mean, if you have a sort of richly imagined future but maybe only 4 to 5 years out, where do you see that we would be in terms of the regulator, the acceptability, what markets? I mean within 5 years, are we going to be going forwards again rather than backwards?

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [60]

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Okay. So I think what best to do from a market perspective, do you want to comment briefly on Europe in terms of spend?

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Joerg Biebernick;Division Director, Europe, [61]

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It's about 4 pods a week and it's about GBP 12.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [62]

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And it's pretty similar in the U.S. as well around the 4-pod level. It's that sort of quantum.

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Christopher Wickham, Equity Development Limited - Analyst [63]

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So they're probably spending GBP 12 a week?

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Joerg Biebernick;Division Director, Europe, [64]

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Yes. The average consumer is spending about GBP 12 a week right now.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [65]

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So that's part of the opportunity here in terms of a better repertoire point. What we found is that smokers still smoke quite a few cigarettes, and this is maybe -- satisfy more occasionally when they can't smoke during the day. As we build out the experience and loyalty, that's where you can see the opportunity also to increase that lifetime value, which is low at the moment.

Sorry, the second, the regulatory environment. Do you want to comment, Matt?

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Matthew R. Phillips, Imperial Brands PLC - Chief Development Officer and Executive Director [66]

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Well, just how we see it, developing.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [67]

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Does it get better?

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Matthew R. Phillips, Imperial Brands PLC - Chief Development Officer and Executive Director [68]

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Does it get better? Yes.

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Christopher Wickham, Equity Development Limited - Analyst [69]

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I think just where you have venues where you can start to vape and where you might not be able to vape but actually start to being able to vape.

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Matthew R. Phillips, Imperial Brands PLC - Chief Development Officer and Executive Director [70]

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Yes. I mean there are a number of countries where vaping is allowed, yes, Japan is an example. It's no nicotine, but they've specifically called out vaping is not sitting within their public places ban that they're bringing through. I -- as you look at the bigger regulatory environment, I think there's 2 or 3 things coming down the tracks which are going to set the agenda for NGP more broadly. You've obviously got -- in the U.S., you've got the flavors guidance enforcement that we're expecting any time soon and is already late. I think that's going to provide some stability to the U.S. market, particularly to retailers so that they know what they can and can't order. And then you've got the PMTA process in the U.S., which currently is still set at May 2020, but because it's America, it's being legally challenged by all sorts of people. So we're sticking -- hopefully, it stays at May 2020. So that will do a lot to stabilize the U.S. marketplace and remove a lot of the players that are not able to meet the standards that are required.

On a global level, you've got the WHO is looking at regulating the whole of NGP through its Consent of Parties session, which is in 2020, and that's going to be very influential for the whole macro regulation of NGP. So we're heavily engaging already in terms of what we would like that to look like. We want the standards lifted very, very significantly. On vapor in particular, we think that the signs and the ecosystem of a closed device is greatly preferential to the open systems, and that that's therefore something that regulators should be very mindful of. Also taking note of some of the pulmonary illnesses that have been emerging in the U.S. and actually using that as a vehicle to -- for regulators to be able to understand why closed systems are different. So I think it will be less than 5 years before we get some stability, but it will be noisy in the short term.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [71]

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But I think from a context perspective as well, where we have gone into governments who've previously banned vaping, with our science, with some recommendations about how they should think about it, the important opportunity this is for smokers, we've had some success. I think Saudi. New, Zealand, we've actually had the bans overturned, and those markets are now open for vaping products produced now in New Zealand. We're looking at a launch in Saudi as well.

Where are we going now?

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Gaurav Jain, Barclays Bank PLC, Research Division - Research Analyst [72]

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I have a couple of follow-ups. So one is on the U.S. cigar side and the regulation change which is happening. So can you talk about what part of your portfolio is flavored cigars, sweet cigars and tobacco cigars? And what part already has marketing orders? And how many -- what part of your portfolio doesn't have marketing orders today?

And second, can you talk briefly about your investment in Auxly? And how should we think about it?

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [73]

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Okay. Do you want to talk about the mass market cigar portfolio, what we've done on it? Yes.

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Dominic Brisby;Division Director, Americas, Africa, Asia & Australasia, [74]

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A significant amount of our mass market cigar portfolio has flavors, although bear in mind, a number of these flavors are grandfathered, so we have old specifications for them. I think the interesting point around mass market cigars is we've done quite a lot of consumer work, both qualitative and quantitative, in terms of what consumers would do if their current choice of flavor were not available. So for example, if -- hypothetically, if you smoke Russian cream-flavor Backwoods, if that was -- which is a very popular SKU, if that were not available one day, what would you do? The answer is in almost every case, you'd smoke another variant of Backwoods. So actually, even if certain flavors are not possible to continue, the smokers are far more committed to the brand than they are to the flavor. Therefore, we think we're in reasonably good shape going into any change that may occur.

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Matthew R. Phillips, Imperial Brands PLC - Chief Development Officer and Executive Director [75]

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In terms of Auxly, we've put some very strong guardrails around the kind of companies that we would be interested in partnering with in the cannabis space. And that included a great management team, it included not being involved in combustible cannabis products, it involved a very high duty of care and focus on science. So a similar mindset to the way that we consider the requisites for handling tobacco. So they're very focused on derivative cannabis products rather than 1.0, as it's called, the combustible type. Their products will be on market in the next month and -- as soon as legalization is -- the gate is passed. Their execution has been fantastic to date. They've got all the required licenses from Health Canada. They're one of the first to actually get those licenses. They've got a good great distribution partner in the Canadian market and they've got international aspirations. So they are a fantastic partner as we sit here today. Conversation is already starting with Nerudia, our innovation arm, in terms of how we can develop products together for the future. So it's very exciting. But for us, the duty of care and focus on the science is of absolute prerequisite importance. And it's -- yes, it's exciting. It's -- but it's early stages.

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Gaurav Jain, Barclays Bank PLC, Research Division - Research Analyst [76]

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And if I can have a follow-up. Aren't there any IP revenues with Auxly because Auxly -- I believe, you gave the IP on blu to Auxly? So aren't there any IP revenues associated with Auxly that accrue to Imperial?

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Matthew R. Phillips, Imperial Brands PLC - Chief Development Officer and Executive Director [77]

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We have granted them a license to use our global vaping technology.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [78]

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Yes. There's nothing substantial.

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Matthew R. Phillips, Imperial Brands PLC - Chief Development Officer and Executive Director [79]

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But no. The revenues are -- royalties are minimal.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [80]

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John? At the front.

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Unidentified Analyst, [81]

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John [Phelp from Ashcroft]. Just a quick one for Oliver. I know this is moving around a lot, but if you had to give us a little bit of help on where the tax rate might get to in the next, say, 5 years, how should we be thinking about that?

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Oliver R. Tant, Imperial Brands PLC - CFO & Executive Director [82]

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Well, I think the answer to that is that the pressure is clearly upwards. So if you actually look at the reason why we've seen the rate move between 19.5% across to 20%, it partially reflects some legislative change occurring in countries. So for example, we are disadvantaged by the transfer pricing regime in Ireland, which is causing a step up for us. And I think we're clearly facing an onslaught as large corporates of these type of localized and indeed even on occasions concerted decisions by taxing authorities across geographies to tax the corporate sector more heavily. Now there are responses in the context of the way in which we organize ourselves and conduct our business that can mitigate those. And looking to the long-term, it's just quite difficult to be specific in terms of a number, but that pressure is definitely upwards. So I think over a sort of 5-year horizon, I would expect sort of percentage points, but probably not beyond that.

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Celine A.H. Pannuti, JP Morgan Chase & Co, Research Division - Head of European Food, Home & Personal Care and Tobacco and Senior Analyst [83]

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Celine from JPMorgan. I've got a few questions on heated tobacco. Could you share what's your share of heated tobacco with Fukuoka? Within heated tobacco, what's your share of pods? And then we have seen 1 competitor expanding in the U.K. and cutting the price of their pack. Have you seen an impact of more U.K. smokers switching to a competitive product in heated tobacco?

And then next question. If you want to build a relevant platform, a big platform in heated tobacco, what's the investment required?

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [84]

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Okay. Do you want to -- let's pick up on U.K. Yes.

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Joerg Biebernick;Division Director, Europe, [85]

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Yes. Sure. So yes, I'm going to think it works. Thank you. Most recently, one of the competitors has changed their pricing strategy in the U.K. And albeit that they are still at a very small level of penetration in trial, we have seen in the last 4 to 5 weeks a doubling of offtake, which is quite noticeable. And actually, we look at that as -- also from a positive point of view because I think I alluded earlier to it, right now, what's really making NGP in general difficult in a market like the U.K. are open systems in vape which are offering an extremely low price per nicotine usage. So seeing that some other players can move the needle is actually encouraging for the broader market.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [86]

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And in terms of Japan and Fukuoka, it's a very small share currently. We're just building out from that at the moment. So it's not something we've highlighted because it's early days.

In terms of the overall HT investment, it's not something that I can put a number on right here, right now. We're doing a piece of work that's looking at the opportunity as we look out over the next 5 years in terms of heated tobacco. And therefore, we'll evaluate what we think is needed behind that. We've already got a chunk of investment behind heated, that's part of the uplift you saw in 2019, which takes us to the capacity that we need for the foreseeable future over the next year or so. But any decision beyond that has not been made at this point in time and will depend on the evaluation of the opportunity with a keen eye to profitability, not some -- not just about generating revenues in that space.

Eddy?

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Edward John Hargreaves, Investec Bank plc, Research Division - Analyst [87]

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Yes. It's Eddy Hargreaves from Investec Wealth. Just moving on to slightly more sensitive ground probably. You announced a new chairperson this morning. It ended up being someone who's essentially been sitting in the chair there or in a chair for some time now. So we can sort of read various things into that as to why that might have taken so long. Is there anything -- bearing in mind you're obviously very difficult to replace, Alison, and I'm sure everyone's sorry to see you go, but can you give any reassurance that the process for finding your replacement will not take as long as it has to find a new chairperson?

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [88]

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I think it's a pretty tricky one for me to comment on, I suppose. It's just not quite my responsibility to find my replacement. But I think Mark can comment briefly, Eddy, if that's okay. I think the context of the chair replacement as well, it has been a -- it is a complex market to try and recruit chairs in the moment given this significant churn around the 9-year cutoff, and that's been influential. Clearly, also, not everybody wants to be a tobacco chair as well, so that's been pertinent there. But Mark?

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Mark D. Williamson, Imperial Brands PLC - Non-Executive Chairman [89]

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I think Alison has covered a good few of the points. Thérèse has led a very thorough process, a real global search for a replacement for me. And we've interviewed -- well, not me personally. I'm obviously not involved in the process directly, but the Nominations Committee interviewed a number of people. We did get down to 1 candidate that we thought was absolutely excellent but there was some contractual difficulties getting that across the line that was proving to be difficult. And then both a combination of shareholders that Thérèse was engaging with and also the Board then turned to Thérèse and said well hang about, looking at all the candidates we've looked at, we think you're probably a better candidate. Do you fancy taking it on? She was slightly hesitant initially, so it wasn't her first choice. But Thérèse is going to make an excellent chairman. I'm absolutely delighted that she's going to follow on from me.

Moving on to CEO search, we think it's going to be different. We think it's going to be slightly easier in terms of time. I think when you're looking at a Chairman role, I think you're looking at people getting towards the end of their career. I think we had a lot of dropout because of tobacco. I think in terms of a CEO, this is a great, exciting company making a fabulous transition into NGP. I think it would be a super challenge for a CEO to take on. So with some way to go until we've got to a landing there, but I think I'm hopeful that it will be a faster process than the chairman search has been. Thanks.

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Alison J. Cooper, Imperial Brands PLC - CEO & Executive Director [90]

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And on that note, I don't think there are any more questions. So thank you, everyone, and have a good rest of the day.