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Edited Transcript of STG.CO earnings conference call or presentation 16-Mar-17 3:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 Scandinavian Tobacco Group A/S Earnings Call

Soborg Mar 17, 2017 (Thomson StreetEvents) -- Edited Transcript of Scandinavian Tobacco Group A/S earnings conference call or presentation Thursday, March 16, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Niels Frederiksen

Scandinavian Tobacco Group A/S - CEO

* Sisse Rasmussen

Scandinavian Tobacco Group A/S - CFO

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Conference Call Participants

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* Nicholas Eckman

Carnegie - Analyst

* Hans Gregersen

Nordea Markets - Analyst

* Andreas Lundberg

ABG Sundal Collier - Analyst

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Presentation

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [1]

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Thank you and good morning to everyone and welcome to our Full-Year Conference Call. My name is Niels Frederiksen; I'm the CEO. And with me today I have our CFO, Sisse Rasmussen and our Head of Investor Relations, Torben Sand.

So please turn to slide Number 2, which is our forward-looking disclaimer. We will not spend too much time on that and move on to page Number 3.

Now, 2016 has been an eventful and important year for Scandinavian Tobacco Group with the public listing in February where we entered a new chapter in the history of our Company and I am pleased to say that 2016 has been a record year for Scandinavian Tobacco Group.

From a financial point of view, we have made a number of important achievements in the year. Our organic net sales increased by 0.4%, basically in line with our revised guidance from November of approximately 0% for hand-made cigars. And the fine-cut tobacco category delivered strong growth, whereas our machine-made cigars and pipe tobacco had a somewhat more difficult year.

All in all, we are pleased to deliver a small positive growth, despite a number of headwinds that we have been challenged by in 2016.

More important, we have delivered strongly on profits and cash flow. Our organic EBITDA growth was 4% after a strong finish to the year and our free cash flow increased by 8% despite a very strong cash flow generation also in 2015.

One of the key drivers for these results are our progress in efficiency and optimization programs and I will return with more details later in the presentation on this matter. But I would like to emphasize that our people have worked hard to reach and in some areas, even exceeded targets we have outlined in order to reduce costs and improve cash flow.

Now, on the back of the results for 2016, the Board will propose for the annual general meeting that an ordinary dividend of DKK5.5 per share will be paid out; an increase of 10% compared to 2015.

Now please turn to slide Number 4. Now, our focus points in 2017 will really revolve around three strategic priorities; leadership enforcement, operating excellence and capital discipline. But especially our machine-made cigars but in principle across all our tobacco categories, we need to make sure that our market share performance is improved in some of those key markets where we have lost ground in 2016.

These are markets such as France, Finland and Belgium and innovations are key to succeed with this and we have now completed most of the TPD work and should see more launches going into 2017. We will continue to look for acquisitions that will further strengthen primarily our cigar business.

We continue to have a high focus of delivering and even exceeding our cost and efficiency improvements and on top of that, we have upgraded our HR resources supporting our line-execution skills and our overall capability assessment and capability-building efforts. They will focus on those different functions [and line].

Finally, we remain very cognizant of being able to continue our positive working capital drive and to safe guard our cash. We are also conscious of the need to keep an efficient capital structure capable of supporting our consolidation ambition.

With these opening remarks, I will now hand over to Sisse, who will walk you through some of the financial developments in more detail. So please turn to slide Number 5 and over to you, Sisse.

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [2]

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As Niels has already mentioned, we are very satisfied with the performance of 2016 where the full-year delivered in accordance with our revised guidance with an organic growth of 0.4% in net sales and 4% in EBITDA. In addition to this, we have seen a very strong cash generation.

We have again in '16 seen fluctuations in net sales development over the quarters due to timing of shipments. As we have said before, it is not unusual for our business as we see fluctuations from quarter-to-quarter with no certain pattern except the first quarter, which normally is the lowest quarter of the year due to seasonality.

The fluctuations are not directly linked to the underlying very stable consumption by our consumers, but due to the timing of shipments driven by fluctuations in the size and number of orders placed by our customers, which can be impacted by excise and price increases, implementation of new regulation, leading to adjustments up or down of stock levels inventory [for us or our distributors].

Then, we also see the capital expenditure before sale of tangible assets that came in slightly below our DKK250 million guidance at DKK235 million, whereas DKK108 million were related to our TBD investments in new machinery. Including sale of assets and dividends from associated companies, cash flow from investing activity was minus-DKK219 million.

Now please turn to slide Number 6. On this table, we have summarized some key financial developments for the Group for the full-year '16, as well as for the fourth quarter. The weak quarterly net sales for '16 increased by 0.2% to 7,646 [sic - 6,746] million and we had a small negative impact form exchange rates whereby organic growth was 0.4%.

In the fourth quarter, organic growth was 1.5%, impacted by good growth in hand-made cigars and fine-cut, as well as we resolved all the backlog issues we had in the third quarter caused by the difficulties with our supply chain or with our supply of new packaging material for the TBD2 products. Adjusted growth margins improved by 0.4% for the full-year and by 1.5% at this point in the fourth quarter, whereby we have seen organic growth in adjusted gross profit ahead of our net base growth.

Operating expenses dropped by 2.3% to DKK1,946 million and adjusted for the non-recurring cost of DKK73 million in 2016 and the DKK94 million in '15 underlying OpEx was reduced by 1.1% as savings more than offset the inflation of the cost base and increase in FDA- related one-cost.

For the fourth quarter, underlying OpEx increased slightly by 1%. Non-recovering items covering one-off costs for the restructuring programs, the TBD and the IPO, was [expanded] DKK562 million for the full-year and DKK557 million for the fourth quarter; this is some DKK25 million higher than previously indicated and is due to the fact that we have accelerated the execution of the organization adjustment for the new operating model, where approximately [70 FPs] out of the total 150 have now left.

Our total nonrecurring cost from the two restructuring programs will still be in line with the numbers we have announced earlier and only the [savings] between '16 and '17 is a bit different. The organic growth and adjusted EBITDA was 4% in '16 and 10.8% in the fourth quarter. Reported net profit for the full-year increased by 2.1% to DKK681 million. Our effective tax rate was 23.8%. Going forward we still expect our tax rate to trend slightly up due to the geographical mix of our earnings.

If you turn to slide Number 7, I will give some more details on our topline and EBITDA development. The next two slides illustrate the annual development income in some of our key financing metric for the past year. In average, the Group organic growth in net sales has been 1.1% since 2013. In both '15 and '16 with our small, but still positive organic growth in net sales, between 0.3% and a 0.4% following the 2.9% in '14.

Two overall dynamics have characterized development in the past two years. Firstly, the strong growth in hand-made cigars fueled especially by demand of share gains in Cigars International. And secondly, the volume decline in our machine-made cigars business driven by the total market development in our core markets.

Despite the modest growth in net sales we have seen solid improvements in the Group's profitability. Adjusted EBITDA margins have for the third year in a row improved and reached 21.4% in '16. The margin improvement has been driven by our efforts to more than offset the negative mix impact from our topline developments through robust price management and impacts from the Cost Optimization and Efficiency program.

Let us turn to slide Number 8 and take a look at the net profits. In 2016 our reported net profit increased 2.1% to 681 million. In total the bottom line has increased by 6.5% since 2014.

However, the numbers have been influenced by non-recurring items in the past two years where we have made the transition to the new TPD regulation, completed the IPO and started to adjust our organization to a new operating model and a new manufacturing footprint.

From a cash point of view, we obviously have had two very good years, showing the results of our strong focus on our cash generation. Cash flow from operating activities have increased by more than DDK300 million since 2014 and the free cash flow of investments by even more.

Notice however that in 2014 we spent 310 million on the acquisitions of Verellen and Torano thereby reducing the baseline.

But we also spend approximately a hundred million a year in '15 and '16 on TPD investments for new machinery on top of our maintenance CAGR.

We are very satisfied with the achievements we have made. Those in '16 and '15 stands out as excellent years from a cash flow point of view, delivering a cash conversion well above the 100%.

One of the key drivers has been the Working Capital Reduction program with the intention to lower our capital side of the inventory by 500 million from '14 to '18.

Another element in '16 is of course the previously announced transfer of connected trade receivables which has had a positive impact on cash flow by a 158 million for the year.

Now please turn to slide Number 9 where we show some more details on our net sales development for '16.

This slide gives a little bit more detail on the development in net sales where we'll talk to the full-year numbers.

As usual you will find the quarterly breakdown in the appendix.

Starting from the right, reported net sales came in at 6,746 million compared to the 6,732 million in 2015. This equals a 0.2% reported growth.

Currency movements have had an impact of minus 18 million and as the reported net sales in '15 was impacted negatively by a non-recurring item of 7 million related to the flavor blend in Canada, illustrated at the left side of the chart, the organic growth in adjusted net sales was 25 million or 0.4%.

In the center of the chart, the contribution to organic sales growth come from our category can be seen.

Basically, there is no change to the trends we have seen in the past year. It remains hand-made cigars and fine-cut tobacco delivering positive contributions.

In total these two categories have delivered 3.2% growth, to our Group total whereas the remaining three categories have dropped this total down by 2.8%.

Niels will come back to some of these dynamics later in the statement review.

Now turn to slide Number 10.

That brings us to the EBITDA bridge versus last year.

Again, starting from the right the reported EBITDA was 1,279 million compared to 1,247 in '15. Both years have been impacted by non-recurring costs.

And I am aware that you can easily lose track on these costs so in order to assist to create an overview, we have included a slide in the appendix showing the various non-recurring costs per quarter and '15, '16 and how they impact cost and OpEx respectively.

In the Annual Report, the Financial Highlights on Page 7 also shows the cost for each relevant circumstance and make the bridge on both reported gross profit and EBITDA into adjusted gross profit and EBITDA.

Nevertheless in 2016, 77 million relates to cost from the 140 restructuring programs; 45 million from the new operating model program; and the remaining 40 million covers the TPD transition and the cost for the IPO in February.

Adjusting for these items organic growth and EBITDA came in at 4% with positive contribution from the gross profit level and OpEx level.

The key, single most, important driver behind this progress is the positive impact from the cost savings which already now kick in in our P&L.

About a third of the total savings from the ongoing program have been realized in '15, '16 but you will have more on this later on.

Now please turn to slide Number 11?

In this chart, we have illustrated the main components in the strong cash generated in '16.

The starting point is the reported EBITDA at 1,279. Adjusting for non-cash provisions in EBITDA and deducting financial net and taxes paid in total 244 million, the cash flow before changes in net foreign capital was 1,035; this is to compare with a 1,001 in the Full-Year 2015 and with a 235 million in the fourth quarter of '16.

The total change in net working capital is 323 million which has a positive impact on our operating cash flow and as you can see on the right side of the slide we grew both operating cash flow and free cash flow versus 2015.

In November, we mentioned the (Inaudible - microphone inaccessible) trade receivables also boosting our cash flow and by the end of '16 this arrangement contributed by 158 million.

The investments net has been 219 million with capital expenditures of 235 compared to our full year guidance of about 250 million.

All in all, we have generated a free cash flow at 1,139 million compared 1,057 million in 2016.

As we have mentioned before our cash flow is also fluctuating over the quarters where the first quarter is a low quarter with limited or no cash flow generation due to lower net sales and inventory, that normally increase in both the first and second quarter due to tobacco deliveries and stock fills ahead of the summer holiday, an increase of [85% in selected markets].

This year will also have to bill some additional stocks of finished goods ahead of the planned factory closures which will go back to normal during the fourth quarter.

But let us take a closer look at the inventory development on slide Number 12? It was as I've said before, a large part of our strong cash flow is driven by our efforts on reducing inventory levels as we continue to challenge ourselves and our ability to run the business at lower inventory levels, keeping a [special needs of our duration targets of] of raw tobacco in line.

The progress we have made in reducing our inventory can be illustrated by looking at inventory ratios.

Our original target was to reduce working capital primarily through inventory by 500 million on a like-for-like basis from '14 through '18.

With the progress, we've made in 2016 we now expect to finalize the program by the end of 2017 despite the expected fluctuations over the year as I mentioned before.

The slide here illustrates the reduction in reported inventories by almost 300 million from 3,099 million at the end of 2014 to 2,824 million at the end of '16.

However, you should keep in mind that reported balances in that period have been heavily impacted by the US dollar rate so on a like-for-like basis we reduced the inventories by 225 million in '15 and by another 251 million in '16; all in all, DDK486 million.

This is well ahead of the revised estimate we mentioned in the third quarter of about two-thirds of the DDK500 million but our efforts in the fourth quarter have had a stronger impact and we've progressed faster than expected.

Measured by inventory ratio of as a percentage of trailing 12-month net sales, we are now at a ratio of 42% compared to a level of 49 to 50% when the program was initiated.

Now please turn to slide Number 13?

And let me turn to the financial position of the Company.

The net interest-bearing debt has decreased by 542 million since Year-End '15 to 2,469. The reduction is driven by the strong cash flow development.

And adjusting for the proposed ordinary dividend of 550 million, the net interest-bearing debt will be slightly above 3 billion.

The leverage ratio defined as the net interest bearing debt over the adjusted 12-month growing EBITDA was 1.7 times by the end of '16 compared to 2.2 times by the end of '15.

Now please turn to slide Number 14.

Based on the solid results, the strong cash flow in the current leverage, the Board proposes an increase in the ordinary dividend per share of 10% to DDK5.5 per share to be taken in connection with the AGM on April 26th.

This equals a pay-out ratio of 81% of net profit.

As I showed in the previous slide, our leverage including this proposed dividend would be 2.1 times compared to our target ratio of 2.5 times.

May I also remind you that our priority for cash allocation is prioritized as follows. First repayment of debt is outside the capital structure; then funding of value-creating business opportunities including M&A; and finally, to return the cash to shareholder.

We have previously communicated that excess cash could be distributed either as a special dividend or through share buy-backs over the year.

For now, we do make the ordinary dividend of DDK550 million in connection with the AGM and with the current leverage that leaves us with some flexibility for the remainder of the year.

However, the Board will continue to evaluate the potential for further distribution of excess cash to shareholders in relation to the third quarter reporting being released on November 8th.

And I will now give the work back to Niels, while you can please turn to slide Number 15?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [3]

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Thank you Sisse.

And I will now spend a little time on our Cost Optimization and Efficiency programs just as I'll give you some more insight to the various categories, regulations and finally our outlook for 2017.

I'm very pleased with the progress we've made in our two programs so far.

By the end of '16 we are slightly ahead of our plans in our effort to reduce the cost base and we are well ahead of plan in reducing our inventory.

As you might recall we had previously announced the acceleration of the 140 program by one year so we are now expected to be completed by the end of '17.

And we have furthermore initiated a new program, the new operating model taking out another 60 to 65 million of cost.

And finally, we have today announced that the Working Capital program or the Inventory Reduction program aiming to reduce inventories by 500 million will be reached already by the end of 2017, one year ahead of the original plan.

We've previously talked to the progress of the plan as run rate by the end of each financial year however in order to evaluate the progress in relation to the impact on our profit and loss; we find it more useful to look at actual impacts on our annual cost. The two programs are intended to reduce cost by about 200 million.

And in 2016 about one-third have materialized as savings in the cost base; remember we also had a small positive contribution in '15. The primary drivers so far have been simplification centered around the SKU rationalization process and the material cost reduction.

Looking into '17, we expect another one-third will impact the P&L leaving the total impact on the '17 cost base slightly above the two-thirds of the combined programs.

The remaining savings will filter through to the 18 accounts, the closure of our factories in Wuustwezel and Nykobing which is taking place during these months will be a key source for the cost savings in '17 and '18. But also the full impact of the new operating model optimizing our sales and support functions and by optimizing our supply chains further will have material impact just as integrated planning and [lean], which are also important elements of or efficiency planning.

We have talked much into the programs and their broad impact for DDK200 million and the importance of taking out costs in order to compensate for the volume decline we are experiencing in some of our categories.

However, we should not forget to talk about the long-term initiatives we also initiate in order to improve our competitiveness and build as strong a platform as possible to meet tomorrow's demands on our organization and we are investing in our future.

We focus more and more on innovation in order to launch new products to our consumers but we have also strengthened several central functions to meet increasing requirements such as compliance with new regulation and HR to make sure we continue to strengthen our organization and our performance culture.

Now please turn to page Number 16. Machine-made cigars. Firstly, machine-made cigars is our largest category delivering 40% of our reported Group profit in 2016.

We've made good progress on some important areas in the past year. We have pruned our product portfolio. We have adjusted our strategic priorities and our strategy and we have had much focus on adapting to the new European Tobacco Products Directive at the same time as we have improved supply chain efficiency.

All this has the potential of creating short-term disturbances, however as we close 2016 and more and more market data have been released, it is clear that we have not done as bad on market share as the initial data suggested.

We have previously looked into market declines around 3% in our key markets but recent year and data suggest that for 2016 this has been somewhere between 3% to 5%.

Due to the fluctuation in stock levels in the trade, which we have talked about at previous calls it is our assessment that we have [markedly lost shares] overall and markets like the UK, Canada and Holland we have gained share whereas we've lost share in France, Belgium and a few of the Nordic markets.

All in all, our volume impact was minus 6% for the year, with a positive price mix of 2.2 and pricing remain obviously, a key priority for us in this category.

So, given the relatively big drop in volumes I am pleased that our cost margin has improved again from 52.2 to 52.6%, the impact from our cost savings showing up in this category.

Now please turn to page Number 17.

Our hand-made cigars have had yet another very good year.

Cigars International our Online and Catalog business continues to take market share. We estimated it to be close to 36% and it is also encouraging that General Cigar have taken a larger share of the market.

General is now approaching 30% of the total market for premium cigar in the US.

TI is obviously concentrating on doing more of the same of what we know works, where General Cigar is focusing really on three key priorities.

One is matching our very strong portfolio of brands against key consumer occasions in the hand-made category so that each brand is preferred in a particular occasion segment.

An example would be Cohiba in kind of a big thing segment and Punch another one of our big mark, that are big brands in the relaxing-at-home segment.

Now secondly, we are focused on improving our position in the brick-and-mortar channel.

And thirdly, on affecting more contract manufacturing customers to leverage our expertise and drive down manufacturing cost overall.

All in all, both businesses are doing well and I will work separately to talk about the IT challenges for CI that we have encountered in 2017.

Please turn to slide Number 18?

Pipe tobacco, 2016 for pipe tobacco was negatively affected by economic unrest in Nigeria and the Middle East.

And the growth in the US of dual usage pipe tobacco has affected price and mix negatively but over the year we do see increasing markets and in most of our regular pipe tobacco markets we continue to grow our share and see healthy pricing.

Please turn to page Number 19?

2016 was an exceptional year for fine-cut and it's important to remember that 2015 closed relatively weak and that 2016 closed relatively strong, not least due to an excise increase in Norway.

However strong pricing combined with the volume growth we've seen especially in Germany delivered a good year despite US volumes continuing to drag down in the opposite direction.

Please turn to page Number 20?

The other category as you will remember consists of our contract manufacturing especially and fire products remain some of the more important ones and we've seen slightly declining sales on the back of some of our contract manufacturing contracts being terminated.

But more importantly we have seen a clear step-forward as we concentrate on improving our margins and we can see a margin improvement from 34.5% to 36.8% for this category.

Now please turn to slide Number 21? Which is about our regulation.

Now surprisingly little development is taking place within the FDA.

We started paying user fees in October and we are preparing for the relatively simple task that will need to take place in '17 which is primarily ingredients reporting and preparation for warning labels.

Big question remains the SE Applications, the "Substantial Equivalence Applications" and here we have limited new information.

Together with some of the leading players in the industry we are spearheading the work to ensure that a testing method for hand-made cigars is being developed. This is basically not existing today and preferably needs to be completed as quickly as possible.

The ban on Cafe Creme in France is the most important development for the Tobacco Products Directive and here we will be challenging the division in the French court system.

But the reality of this ban is that we obviously have a contingency plan and we will most likely have to roll this contingency plan out before we know the results of the French court system.

So please turn to page Number 22?

Our guidance for 2017.

2017 will be another important year for the Group where we will continue to deliver on our saving and optimization programs in order to drive market improvements and a high cash conversion.

In the same time as we're closing two factories in Europe, we increase our activities within product development, within sales excellence and within building a winning organizational culture.

We will also continue our work around the final stages of the TPD implementation as well as progressing further on FDA implementation.

When you look at the market dynamics, we continue to see challenges in the machine-made cigar segment and this is one of our key priorities for 2017.

For the hand-made cigar segment we see good growth opportunities which we will continue to pursue and in order to support our growth, especially in the Online and Catalog business we decided last year to invest in a new future proof IT system including both what we call an "ERP" and a "Warehouse Management System."

The implementation has been prepared at the beginning of 2016 and the system went live in early February 2017.

Unfortunately, we did meet some unexpected challenges in the first month of operation which has caused interruptions in our order handling and shipping leading to an order backlog and lost sales in Q1 which will have a negative impact on our full-year performance.

We expect to have resolved the challenges encountered by the end of Q1 and remain confident that the new IT system will improve the long-term competitiveness of our Online business which remains in a very healthy state.

However even though the negative impact from the IT issues have only been of a temporary nature, it does have consequences for our full-year guidance for 2017.

Based on this we expect to deliver flat, organic growth, in net sales and organic growth in the range of 1 to 3%.

So, this guidance includes the positive contribution from our cost savings programs. We have said that an additional one-third of total savings will hit the P&L in '17.

In the opposite direction, we will invest a little more in our central functions and in innovation, supporting long-term growth.

And included in a guidance is also the FDA user fees which were introduced in October 1, 2016.

And with these words I'll leave the work back to the Operator.

And we are now ready to take questions?

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Nicholas Eckman with Carnegie.

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Nicholas Eckman, Carnegie - Analyst [2]

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The first, if we start with the hand-made cigars, the problems here, the disruptions you've had in Q1. How confident are you now that this issue has been resolved and that volumes can be restored in Q2; do you think that there's any risk that there could be spillover effects going into the second quarter?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [3]

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Well our current assessment is that we will have resolved the problem and be in top of the problem by the end of Q1.

These IT problems are always complicated and once they arrive, one has to be on top of them and we certainly believe we are.

So right now, our assessment is that we are on top of them and will be on top of them by the end of Q1 but as I said before there will be a full-year impact from what we have lost in Q1.

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [4]

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And I think--

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Nicholas Eckman, Carnegie - Analyst [5]

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Okay.

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [6]

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-- to add, some of the spill-over effects that you might see is that there will be of course some additional activities for promotion in order of course to win back the confidence and win back some of the customers we might have lost in the critical days.

But that will then revert some of the topline and that will also maybe have a small impact on the market.

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Nicholas Eckman, Carnegie - Analyst [7]

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And on machine-made cigars, you talked about how you now have a strong pipeline of new products.

Could you tell us about anything about that pipeline and when will these products be rolled out and how significant are these new launches?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [8]

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Well you can say that they have already been started to roll out.

Last week actually we did one, a new launch of a product called "Granger" in Germany and we will continue to rollout Granger in more markets and we also have other things in the pipeline.

We are not quantifying the specific effect of the launches. They are built into our overall plan.

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Nicholas Eckman, Carnegie - Analyst [9]

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Okay and one issue here of course was also that you claimed earlier that you had lost a little bit of momentum in your core markets and in your core brands.

So how do you feel there in terms of getting back on track and getting back to volume growth in machine-made cigars?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [10]

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Well we have certainly provided significantly more attention to some of the markets where we've had performance issues such as France or Finland and Belgium and we continue to give these markets our highest attention.

I don't really want to comment on concrete results before we can show you some but obviously, we are expecting that increased attention and the best efforts of everyone in the Group will have a positive result over time.

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [11]

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And then just to add to that, I think we have not set any time that we expect to see growing volumes on the machine-made cigars.

What we have said so far is that it is our ambition now to reverse the trend in order to deliver the first target, the more or less the flat, net sales.

And a part of that is also to recoup more of the cigarette smokers into the category and that is exactly where Granger is something where we expect a lot as it seems to be a very strong product for that purpose.

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Nicholas Eckman, Carnegie - Analyst [12]

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And also on machine made-cigars here, you mentioned here with traffic trend that you have a contingency plan and that there was a risk here that you would have to use that contingency plan before you know the outcome.

I assume with the contingency plan you are referring to potentially changing the brand name.

Is that what you would do and then can you change the brand name and then basically go back to Cafe Creme or just your thoughts on this would be interesting?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [13]

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Yes.

So, this is a little bit of a bizarre situation where we will most likely be pressured to change the brand name.

I think that if there are good news around this, it is that will have time to make a transition from Cafe Creme to an alternative trademark in a reasonable way.

It's also important to remember that the plain pack in France is not applicable for cigars and hence our trade risk if you want, the look of the package going to be unchanged; it's only the trademark name in itself that will be changed.

And we have a plan in place that we of course have been working on for a while that we will execute.

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [14]

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And it should also--

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Nicholas Eckman, Carnegie - Analyst [15]

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Okay.

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [16]

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-- be taken in mind that the time issue at this point in time is only related to France.

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Nicholas Eckman, Carnegie - Analyst [17]

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And you haven't gotten any indications from any other markets, because this is a part of the EU Tobacco Products Directive so I suppose that other markets could follow as well?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [18]

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There is the risk that other markets will follow but right now we see no movement anywhere else with the exception of France.

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Nicholas Eckman, Carnegie - Analyst [19]

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I'd also be interested to hear a little bit more here on the comments about the dividend and you say that you are basically evaluating options here.

And I'm curious what has caused the Board to delay the decision on a potentially raised pay-out or is this, you mentioned here M&A activities; is this one of the areas that you're looking at and a potentially large acquisition that urges you to be more conservative with your balance sheet?

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [20]

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No, but I think what we have said before is that we consider ourselves to be the consolidator of the industry and that is also where we remain.

And then yes, I mean we can say that we have seen a more active pipeline than we've seen before. It seems like there is more activity in the market. And of course, we want to make sure that we are in a position where we can gain from such opportunities.

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Operator [21]

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[Soolaran Sanzo] with SEB.

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Unidentified Participant [22]

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First, a question regarding the price mix which continues to development actually worsening in hand-made cigars in Q4 and also if you look at '16 it is also, you can say worsening in machine-made cigar.

Maybe you can elaborate a little bit about that? That's my first question.

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [23]

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Yes.

If we look at hand-made cigars first, I think we tried to explain historically that when it comes to CI then CI activities when they drive promotion they can affect the price mix impact negatively.

But I think that the main reason in 2016 is really that we have changed the strategy somewhat for our General Cigar business.

Now this business is always been strong in our Internet and Catalog segment but not really strong enough in the brick-and-mortar.

And we consider the brick-and-mortar channel to be really a key recruitment channel and hence we have decided to basically you know, develop a new strategy for improving our position in the sales channel.

And one of the things we've had to do is actually to raise our margins to the trade on new launches and we've done this because we are actually not competitive on markings compared to some of our competitors.

So naturally this is driving some of the negative price mix in the category.

But apart from that we expect price mix to improve over the year, not least driven by the price increases that is required to offset the user fee.

And it's important to remember that across you know, both our hand-made business we are gaining share.

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Unidentified Participant [24]

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But it's not because you don't see any increase, sort of competition or any lowering of the general price points in the market or some pushback from a customer; it's not like we have a new sort of regime out there where the price is simply just fell below, you think they will sort of come back to historical levels at some point?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [25]

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Yes.

We are not seeing more price pressure in this category.

I think what we have raised also on previous occasions is that right now there are a number of companies that have inventories that will not be compliant with the FDA sometime in '18.

And what we're seeing is that we're trying to sell what we have and competitors are trying to sell what they have and some of that is affecting price mix negatively.

On the other hand, you have the price increases.

So, but if you ask me sort of, "Is there changes in the underlying dynamics reflected in these numbers?" Then the answer is "No."

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Unidentified Participant [26]

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Okay.

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [27]

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On the machine-made cigars, it is correct that '16 has been slightly less positive on price mix and I think here it is mostly a mix question.

There's no real material change in price.

I think that the only market where we have specifically said that we are watching carefully, surprisingly it's France where we need to turn our business around.

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Unidentified Participant [28]

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Okay and then a question on Page 15 in the presentation.

You know talk about that some of these savings you get from your programs will now be reinvested. You haven't really told us about that before; what has changed? Is there anything that's changed here; why are you suddenly talking about that, is, yes?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [29]

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Well, what we wanted to basically flag is that obviously, you can say that if we look over the past couple of years our priority has really been addressing our cost base and our cash generation.

And we feel now that we've made good progress, we've got plans in place and it is important that we now continue to focus on this but also, make investments in the areas where we can see we need to do better.

So, one area which I mentioned was for example, the innovation area and the other area is really around our organization where we want to make sure that we will become even stronger than today.

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Unidentified Participant [30]

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So how much of the 200 million do you actually expect to hit the bottom line so to speak?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [31]

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We are not commenting on that.

I think we are staying with the guidance that our reflection of the overall progress of the business.

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Unidentified Participant [32]

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Okay but this is not impacting your sort of midterm guidance of 3 to 5% adjusted EBITDA growth?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [33]

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It's not reflecting that, no.

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Unidentified Participant [34]

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Okay, finally a question regarding your extraordinary items which goes up quite a lot which you have explained earlier, just wondering, I know you put out your annual report, I couldn't find anywhere where you actually give a detailed breakdown of these extraordinary items which are quite significant.

Maybe could you give us a more detail on what these extraordinary items actually consist of?

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [35]

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Yes. I think, as I said in the financial highlights, we have tried to split out how the non-recurring items for '15 and '16 of the components of that.

So, if you look on, I think it's on page Number 7 in the Annual Report, down in the right corner, then there is a reconciliation from reported EBITDA to the adjusted EBITDA.

And what you will see in '16 is that it is the remaining part of the TBD-related costs. It's 77 million for the 140 programs, the restructuring which includes the factory closures and where we will have some of the final costs kicking in and '17.

And then it's restructuring costs for the case operator model, kicking in with 45 million in '16.

It is slightly more than we had guided the last time because it accelerated a little bit faster.

And then it's an amount, more amount related to the IPO.

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Operator [36]

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(Operator Instructions)

Hans Gregersen from Nordea.

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Hans Gregersen, Nordea Markets - Analyst [37]

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We start with your guidance, can you first of all Sisse, explained to us what FX impact we should assume basin current exchange rates for both sales and EBITDA for this year?

And also, it puzzles me a little bit that you mentioned user fees in the reason for the 1 to 3% EBITDA guidance. You previously argued that it would be recovered by price hikes. That's the first question.

Secondly, Niels in terms of M&A you have previously argued that due to the uncertainty by the regulatory changes both in Europe and the US, M&A was not really feasible as a buyer-seller spread was basically two large given the uncertainty.

Has anything changed there, has any deals been going on and what is sort of 'the talk on the street' about this?

And then finally, if we go to hand-made cigar business, can you be a little bit more specific on what is the benefits of this new IT system, what will it do for you, what were the specific problems?

And finally, you mentioned that there was an order backlog, how big is that and could we foresee that, that has damaged the reputation of your Internet platforms and you will see some market share losses, let's say going into quarter two too, as well?

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [38]

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The first question I will just start with user fee.

User fee, it's not like pay user fee, it's impacting our guidance. It was just like some more additional information that you could be sure that we have taken the FDA user fee into consideration in the guidance we have made.

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Hans Gregersen, Nordea Markets - Analyst [39]

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You will still add it on to the customers?

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [40]

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Yes, that is still the plan. That should be covered by the price increases still in the market, yes.

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Hans Gregersen, Nordea Markets - Analyst [41]

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Sorry, before I go on, while you do the testing, I guess that will carry a one-off cost at some point of time, what markets should we assume that will be in?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [42]

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Yes. Hans, I think that there is no reasonable estimate on that.

As I tried to explain, we're in the bizarre situation that FDA ask for testing but no-testing method exists.

Now what we've done since we have experience from testing, both from our old cigarette days and for more machine-made cigar days is that together with some of the other major players, we are working on developing machines that can physically test hand-made cigars.

This can result in one or two things.

It can either result in actual tests being executed or it could also result in us trying to convince FDA that testing of hand-made cigars is not possible.

So, you can say that we simply do not have more clarity on the testing side.

We still believe that compared to some of the very big numbers that was thrown around early in the process, that when you look at the work we've done prior to 8th of August last year, we will be able to reduce the number of SE Applications quite considerably.

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [43]

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And then I should return to the question on the currencies then with the current rates then we do expect quite limited impact for the rest of the year.

I think it may be the level of 1% or so and primarily driven by some increased rates.

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Hans Gregersen, Nordea Markets - Analyst [44]

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And that will impact both sales and EBITDA?

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [45]

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Yes, yes.

But again, I would say, yes, but really limited.

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Hans Gregersen, Nordea Markets - Analyst [46]

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Yes, so around 1%

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [47]

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-- '16, also very limited, yes.

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Hans Gregersen, Nordea Markets - Analyst [48]

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-- Yes.

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [49]

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So, on M&A activity I think that what we have seen is as Sisse also indicated a kind of a step up in activity.

And you can say that on the European side we have more clarity on TPD.

On the US side, I think we have let's say, I wouldn't call it more clarity on FDA but less concerned on FDA.

And both of these things are let's say, adding to more things moving on the pipeline of potential acquisitions.

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [50]

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So, I think the message would be Hans, that at this point in time, we have a more active pipeline but we also remain patient in order on how we --

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Hans Gregersen, Nordea Markets - Analyst [51]

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So, what you're saying essentially is that sellers are starting to realize what's going on and they're starting to realize the impact and they need to get out the industry?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [52]

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Well need to get out of the industry is not how we see it.

I think that --

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Hans Gregersen, Nordea Markets - Analyst [53]

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No. But the sellers--

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [54]

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-- Yes.

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [55]

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Yes.

But I think that is not the direct link as to where we think the activities at this point in time.

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [56]

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So, back on the IT systems which we fully realize is a very disappointing news to bring to the market.

I think that one has to remember that TI is a fantastic growth story. It's also a growth story built on an old, custom-made, IT platform that we have been looking to replace.

And we've been looking to replace it for a number of reasons.

First of all, we kind of knew that given the size of the business and the continued growth it would not be sustainable to continue to rework everything from the old system.

And secondly you can say as a business like this grows and you do 10,000 packets per day, the stress if you want on the warehouse, the packing on the shipping area, is also increasing.

So, with the change of IT system we are actually tried to replace the ERP system which would be like the backbone but also give us more opportunity to be innovative in our interaction with our customers.

And the Warehouse Management System has been intended to drive efficiency in the business, both from storage, from a packing and from a delivery point of view.

So, what has gone wrong?

The short answer is that a single packet problem we've encountered is maybe having underestimated that when you do 10,000 packets a day and start to see problems in your system then the problem actually accelerates very quickly.

And I could give you one concrete example has been just the time it takes to convert incoming order to packing list, which is of course critical when you 10,000 individual packs.

And there we have faith in the system and basically, I wouldn't say stop selling but we've had to stop certain promotion programs to avoid too much orders coming into the system.

And this is of course why we get quite a material impact on the quarter.

We also still believe that we will have these problems solved.

By the end of Q1 we are now capable of processing a normal data order and we have of course plans in place already to let's say reclaim the customers that we have an annoyed.

And there's no doubt that we have annoyed a number of customers.

When you go to social media, you will also see that it's not the prettiest comments that are coming in.

On the other hand, we also have to emphasize that this is the low season and it's a relatively limited number of our total active customers that actually are exposed to the problem.

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Hans Gregersen, Nordea Markets - Analyst [57]

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Finally, if I may? You mentioned the SE Applications, how many of your products have now been grandfathered and how much do you think you actually have to register?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [58]

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Yes. We are not disclosing any of that. And some of it is not also fully decided yet. I think that what I've explained in the past is that what we tried to do is to make sure that we have maximum flexibility in using grandfathered products across a number of our brands.

But there will be some SE Applications no matter what.

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Operator [59]

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Andreas Lundberg with ABG.

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Andreas Lundberg, ABG Sundal Collier - Analyst [60]

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On the user fees from FDA, how big are they at the moment? That's my first question.

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [61]

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Yes. We have not announced a specific number. But we have in the material indicated that there currently at a level of 1% of our total costs for the Group.

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Andreas Lundberg, ABG Sundal Collier - Analyst [62]

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Okay. And that's split between your US operations--

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [63]

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That's split between the US entities, yes.

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Andreas Lundberg, ABG Sundal Collier - Analyst [64]

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And you expect that figure to be stable by quarter going forward?

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [65]

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That is what we see right now.

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Andreas Lundberg, ABG Sundal Collier - Analyst [66]

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And on the [fee] in Europe or there is a de-stocking effect you have noticed here, [on rates and distributors] in 2016; what's the status on that one and when you think that it will be completed?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [67]

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Yes. This is one of the very difficult topics to assess. I think that what we are saying now more specifically is we can see that the market certainly dropped faster in '16 than we have seen in previous year.

We have sort of decided not to predict the future. And I think that what we will be doing of course is as 2017 starts off we'll have to form a more qualified opinion about this.

It is complicated by the fact that by May here in 2017, there's a new deadline where retailers will have to stop selling non-compliant products.

So, there is still a lot of inventory management attention with our customers and distributors for that matter.

So, we can't say anything meaningful about it right now.

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Andreas Lundberg, ABG Sundal Collier - Analyst [68]

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Yes.

But you expect it still to sort of continuing in your report for 2017?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [69]

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We at least expect the tight stock management to be an issue for our customers also into '17.

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Andreas Lundberg, ABG Sundal Collier - Analyst [70]

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And lastly on, the M&A topic, obviously, cigars are a key priority but when it comes to the overseas you know products and so forth?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [71]

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Yes.

Our product remains cigars. And you can say that we would like those assets in the hand-made cigars and here on the hand-made cigars we are also emphasizing the fact that we are looking for let's say for full value-chain control.

So, acquisitions in principle could be in the full value chain, from growing to retailing.

And in the machine-made cigars it is about the brands and it is about fixing some of the markets where we have relatively low share such as Germany, Spain, Italy--

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Andreas Lundberg, ABG Sundal Collier - Analyst [72]

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Right.

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [73]

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-- and also, machine-made cigars in the US.

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [74]

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And on the machine-made cigars, it's important to notice that we believe that we are certainly the one who can deliver most synergies when there are fees in that segment due to our salesforce that's in many areas and due to the capacity, we have in the factory.

So, our machine-made cigars would obviously almost or always bring cost synergy.

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Andreas Lundberg, ABG Sundal Collier - Analyst [75]

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Yes.

Also, you think it's potentially on the US side given that you have four relatively large players dominating that market and they are only very small players left?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [76]

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On the acquisition side?

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Andreas Lundberg, ABG Sundal Collier - Analyst [77]

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On the acquisition--

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [78]

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Yes.

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Andreas Lundberg, ABG Sundal Collier - Analyst [79]

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-- side, in the US, yes?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [80]

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Again, I think I've said it before, I think that when you look at our brand portfolio in the US, then we have an extremely strong brand portfolio and we will be very selective when it comes to buying additional brands.

So, we will of course look for brands that we think have a kind of a unique positioning and they are not that many of those. It is also other part of the value chain that we continue to look at.

And then of course you could say the US specifically we also have the machine-made cigars which we would like to improve.

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Andreas Lundberg, ABG Sundal Collier - Analyst [81]

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Okay, thanks a lot.

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Operator [82]

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Soolaran Sanzo from SEB.

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Unidentified Participant [83]

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First of all, if you could say regarding what has happened in France regarding Cafe Creme and Paradiso brands, is there at all any risk that this could happen in other countries and maybe give some background to what is actually happened?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [84]

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Yes. The TPD2 legislation include certain let's say rules in terms of references that can be made to taste or to capabilities of the individual smoking and so on.

And the countries are implementing this in a different way.

And what you can say is France have really taken the lead and apart from our trademark, they have also listed a number of other trademarks such as for example, Vogue or Allure and challenging those.

And what we can do is a little bit as I've said, it's in a situation where we can challenge them in the French court system.

We do not right now see any other EU countries driving this agenda.

It doesn't mean it can't happen but right now there's no real movement from other markets and maybe some of them are watching what will happen in France.

And it's just to give you a perspective on timing, what we do now is, we have already challenged these decisions in court and the problem is that a court case will easily take you know, 8 to 12 months or even more months and we can sit a while around and wait for that to happen.

So, this is why we will have to move ahead.

And then we could stand in the bizarre situation that we have chased our trademark name and we win the case eventually and then we have a new situation.

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Unidentified Participant [85]

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And then, finally Sisse regarding the US, I was just thinking about with Trump trying to implement import taxes, how would that impact your hand-made cigars given that you import all your cigars from other countries basically is that going to have an impact at all or would it have an impact I mean?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [86]

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Sisse?

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [87]

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Yes, yes.

It is difficult of course to predict what exactly will happen.

But for sure if there is a broader tax that would impact the imports then we will be hit, but so will the entire industry as all cigars sold in the US are produced outside the US.

So, it will be an industry issue but will see where the --

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Unidentified Participant [88]

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Do you have any [back-of-the-envelope] [based on] how much it would impact your business in US?

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [89]

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No. Not at this point in time.

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Operator [90]

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Hans Gregersen from Nordea.

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Hans Gregersen, Nordea Markets - Analyst [91]

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Yes, just three quick follow-up questions. User fees, just understand you said 1% of cost, was that just for hand-made cigars basis off a Group cost? That's the first question.

Secondly, you have mentioned your stock reduction target of 0.5 billion, you have some 480 if I recall correctly in that vicinity, should I read into that you only need 10, 15 million to go or do you actually see there's more to go than you originally guided? That's the second question.

And then finally, perhaps the more tricky one, in terms of your statements regarding cash returns at quarter three, you debated this at the Board meeting, were there any thoughts about communicating, to what scope and size and format at a later stage and why could you not communicate a potential scope or size for quarter three already at this point of time?

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [92]

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Yes.

First of all, the user fee hit the US businesses but when we now communicate or guide a bit on the label then we talk about 1% of the total Group cost. So, that is just to give you some indication

Then the 500 million inventory target, Hans that's absolutely right. We have progressed pretty fast and also with some timing, I would say here around the year-end.

But what we have said so far is that we accelerate the program so we will deliver it completely at the end of '17, first of the original time, the 18th.

And that is what we announced for now.

I'm not saying that this is the final end destination, not at all but this is a where we stand right now. And then we can see when we are on the other side of the factory closures and so forth.

Then on the cash returns, of course you can see that, just after the dividend or the ordinary dividend, we have a headroom of about 0.5 billion versus our leverage target.

And what we are saying is just that we keep some flexibility for the remainder of the year and then we will see where we are at the third quarter.

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Hans Gregersen, Nordea Markets - Analyst [93]

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But when you mentioned 0.5 billion is that a good number to look at, as an--

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [94]

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No, I'm just--

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Hans Gregersen, Nordea Markets - Analyst [95]

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-- M&A?

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Sisse Rasmussen, Scandinavian Tobacco Group A/S - CFO [96]

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-- mentioning that that that is the headroom after the ordinary dividend payment, yes.

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Operator [97]

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And there are no further questions in the queue at this time.

I would like to hand it back over to the speakers.

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO [98]

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Thank you very much for a good conference call. I wish you all a good day. And see you all sooner or later. Cheers.