Japan Tobacco Inc.

Thank you for joining this call today. I'm Naohiro Minami, Chief Finance Officer of the JT Group.

I will take you through the first quarter earnings results. I will start by covering the impact of COVID-19 on our business and financials.

Please take a look at Slide 3. As you can see, there are no business continuity concerns in any of our businesses as of now.

Each business continues operations by meeting and whenever possible, exceeding the local directives and instructions of the governments of each country. Please refer to the earnings report for more details.

Let me now provide you the status update of each business operation. First of all, in the tobacco business, manufacturing facilities, including those in Japan are operational, while taking stringent personal care and sanitation measures.

Most distribution networks are also operational in these markets with approximately an average of two months' worth of finished goods inventory. There are no significant impacts on the supply of products to our consumers.

On the other hand, in some markets, we have adjusted or temporarily suspended our sales and promotion activities to fully comply with the directives from the local governmental authorities. Although, the distribution or sales channels activities are very different across markets, we did not recognize any significant impact on consumer demand as of the first quarter, other than the inventory buildup in several markets.

Having said this, we did recognize a significant drop in the Duty-Free sales in our first quarter results. In 2019, the Duty-Free sales represented less than 3% of the group's net revenue.

In order to minimize such impacts that have already been recognized and to mitigate those as potential risks, it is necessary for us to closely monitor how the situation evolves. In the pharmaceutical business, while almost all sections of the supply chain are operational, we are experiencing a slight delay in some clinical researches due to the temporary closure of medical facilities.

Because of the nature of pharmaceutical products, there are no significant impact to sales and demand as well. Lastly, in the processed food business, we have not recognized any impact to our supply as all the factories in Japan are operational, taking stringent personal care and sanitation measures.

Although our manufacturing plant in China has temporarily suspended its operation in accordance with government directives, it is now operating normally. In regards to the sales and demand implications, following the local prefectural government's request to avoid nonessential outings, demand for household commodities has increased in frozen and ambient food business.

This, in turn, has resulted in a lower demand for food service products in the frozen and ambient foods and the seasonings businesses as well as the decline in consumer footfall at our bakeries. The impact in the first quarter will be covered later.

In Slide 4, we have provided the precautionary and countermeasures that we have taken across the group. As a global responsible company, the JT group gives utmost priority to the safety of its employees, their families and stakeholders involved in our business activity, and we'll continue this approach as long as it's necessary.

We are ensuring the safety of our employees by, for instance, adopting work from home for all positions that are not critical to business continuity and prohibiting business trips and other non-essential activities. In addition, when a person is confirmed to be infected at any of the business sites, such as the manufacturing or sales site, the employees who are in close contact with the affected person are asked to go home, and the site is disinfected according to the instructions of those authorities before any business operations are resumed.

The business continuity plan has been designed to address contingencies across the group and is already being implemented. In addition, we are extending all necessary support to our third-party supply chain partners by, for instance, relaxing credit terms to limit disruption as much as possible.

From a funding and cash situation perspective, the JT Group has enough resources available to satisfy the requirements from its business activities. While we have ample unused commitment lines, we are increasing cash on hand by implementing measures such as the issuance of commercial paper to ensure a full state of readiness for any possible contingencies.

We will continue to implement all necessary countermeasures to address the volatile COVID-19 situation that is evolving rapidly. From a business and financial perspective, as I mentioned earlier, there are no business continuity concerns in any of our businesses as of the first quarter.

COVID-19 had limited business impact to our financial results in the first quarter. Going forward, while we cannot predict the potential risks or impacts from COVID-19, we cannot ignore the impact of the Duty-Free business, which has been confirmed in the first quarter.

We will keep monitoring closely how the situation from April evolves to analyze the potential impact to our business and financials. The COVID-19 pandemic is impacting the world in an unprecedented scale with significant consequences globally.

We will continue to give utmost priority to the safety of our stakeholders involved in our business activities, including our people and continue to take every possible measure to mitigate business and financial impact to the group. Moving on to Slide 5 for our first quarter financial results.

Adjusted operating profit at constant currency, our main KPI, increased by 14% year-on-year, driven by the growth of the total tobacco to pharmaceuticals and the processed food businesses, this growth was primarily attributed to the international tobacco business, which had a significantly high-growth rate, driven by very favorable pricing gains year-on-year. I will now move on to the reported figures, starting from revenue.

Revenue increased by 2.8% year-on-year, essentially driven by the international tobacco business, exceeding the decline in the Japanese domestic tobacco and pharmaceutical businesses as well as negative currency movements. Adjusted operating profit on a reported basis also increased by 5.8% year-on-year, despite currency headwinds; operating profit, on the other hand, decreased by 29.4% year-on-year, due to the nonrecurring onetime gain of approximately JPY 60 billion in the pharmaceutical business in 2019, despite the growth in the adjusted operating profit.

Profit attributable to the owners of the parent company also decreased by 28.5%, essentially due to the decline in the operating profit and higher financing costs, partly offset by lower income taxes attributed to lower profit base. Moving on to the results by business segment.

Let me start with the Japanese domestic tobacco business on Slide 6. The total tobacco industry volume was resilient, and its volume was almost flat year-on-year.

This was attributed to the favorable price revision impact to the volume. The impact of the tobacco excise tax increase in October 2018 was higher in comparison to that of the consumption tax increase in October 2019.

RMC industry's volume for the first quarter declined by 2.2% year-on-year, and the RMC market share of the total tobacco market expanded in comparison to that of the fourth quarter of 2019, reaching approximately 24%. COVID-19 had limited impact to the industry volume in the first quarter.

Turning to our volume performance. The RMC shipment volumes declined by 4.2%, driven by RMC industry contraction and market share loss in the RMC category where the loss is due to competition in the value segment.

To address this competition that has continued, we launched the slim menthol little cigar SKUs in March and are also launching 3 new SKUs tomorrow on May 1, which offers light tobacco taste. These SKUs are branded by Camel.

Supported by these initiatives, our RMC category share remains resilient compared to the 59.3% share for the fourth quarter 2019. RRP shipment volume increased by 0.3 billion to 0.9 billion units, and the RRP category share reached approximately 10%.

Now let me provide you our financial performance. For the first quarter, there were several negative factors as shown on the slide, such as the RMC volume variance and tax absorption for some brands in October 2019.

In addition, due to the COVID-19 outbreak, sales in the duty-free business declined significantly. RRP-related revenue increased year-on-year.

However, it did not offset the negative factors mentioned earlier. As a result, core revenue decreased by 5.7% year-on-year.

Adjusted operating profit declined by 15.3% year-on-year, essentially due to the revenue decline and increased marketing costs related to RRP and little cigar SKUs. COVID-19 did not impact the bottom line this quarter, as the sales decline in the Duty-Free business was offset by the decrease in the related costs, including marketing and SG&A expenses.

At the bottom right section of this slide, we provide this trend in which we have recently observed, although its duration and extent cannot be predicted. In particular, the sales decline in the Duty-Free business is becoming more prevalent.

We have seen beyond our expectations, a weaker industry volume in the Japanese duty-paid market and increasing RRP category share. This has been true since the local prefectural government's requests to avoid non-essential outings and the Japanese government's declaration of a state of emergency.

In addition, the revision of the Health Promotion Act regulation to restrict indoor smoking has been fully implemented in April, which now has certain impacts on our business. We will closely monitor how, for how long and to what extent of which these factors will affect the tobacco market, mainly the consumer trends in RRP category, especially as the impact will become prevalent from April.

Moreover, we will focus our efforts to address any impacts with an agile mindset, reviewing our initiatives and carrying out the revised plans swiftly. Turning to the international tobacco business on Slide 7.

Robust share performance of our brands, notably GFB, continued for the first quarter. Also, favorable inventory movements were seen with the stock buildup following the COVID-19 outbreak in few markets, notably in Europe, consequently, GFB shipment volume increased by 4.8% to 67.5 billion units.

The total shipment volume was 104.1 billion units, a minimal decline year-on-year as a result of those positive factors, almost offsetting the volume declines due to the industry contraction in several markets. The Duty-Free sales in the international tobacco business declined year-on-year due to the COVID-19 outbreak.

Other than this, no material impact affected the sales volume. The robust core revenue growth was driven by strong pricing gains.

These gains are benefited from price increases that have been made since March 2019, mainly in the Philippines, Russia and the UK as well as favorable comparisons to the previous year, largely attributed to the timing of tax increases in Russia and Turkey. In addition, volume contribution was positive, driven by the solid volume performance in European markets with a higher unit price, where it was also impacted by favorable inventory movements.

These factors resulted in a 14.1% year-on-year core revenue growth at constant currency or a 8.8% growth on a reported yen basis, including currency headwinds. Adjusted operating profit at constant currency grew 29.4% year-on-year or 16.7% on a yen basis, including unfavorable currency movement, essentially driven by significantly strong top line growth for the first quarter.

In the bottom right section, we have provided the trends to date in the international tobacco business. As I mentioned earlier, we have observed more prevailing impact to the Duty-Free business, although we do not see any other material changes on consumer demand at this moment.

However, we cannot ignore the disruption of our supply chain caused by lockdown and travel restrictions. While factors such as a higher unemployment rate due to the slowdown of the global economy may impact consumer behavior, these sequential impacts are difficult to assess or predict.

Therefore, it is currently too early to assess full year implication of these factors as how these factors evolve are still highly uncertain. In addition to the COVID-19 impacts, local currencies in our key markets are depreciating against the U.S.

dollar. We will continue to monitor these situations closely.

Now I would like to briefly talk about the Iran market. As you may be aware, in January, the U.S.

announced an additional set of sanctions coming into effect in April. We have been closely monitoring and thoroughly analyzing implications of sanctions, and we believe we can continue our operations.

However, there are still high levels of uncertainties due to the potential impacts of these sanctions, along with the outbreak of COVID-19. In any case, we will focus our efforts on monitoring the impact to our consumers to the best of our capabilities.

Moving on to Slide 8 for the results of the pharmaceutical and the processed food businesses. In the pharmaceutical business, revenue decreased by ¥2.1 billion year-on-year to ¥20.7 billion, mainly due to lower overseas royalty income.

Meanwhile, adjusted operating profit grew by ¥2.1 billion year-on-year to ¥6.6 billion. This was essentially driven by lower R&D expenses according to the progress of research and development as well as top- and bottom-line growth in our subsidiary Torii pharmaceutical.

In regards to the progress of our clinical development, JT received manufacturing and marketing approval for CORECTIM Ointment, a new drug for atopic dermatitis in January 2020. On April 22, CORECTIM Ointment, was listed on the Japanese National Health Insurance Drug Price List.

Torri plans to launch this drug in Japan, in June 2020. In the processed food business, revenue increased year-on-year by ¥0.8 billion to ¥36.7 billion, and adjusted operating profit also increased year-on-year by ¥0.1 billion to ¥0.4 billion, mainly driven by increased demand for household products in the frozen and ambient food business.

This was partly offset by lower demand in the food service products for frozen and ambient foods as well as the seasonings businesses. In addition, sales in the bakery business also declined.

Moreover, we have observed lower demand in the food service industry since the Japanese government declared a state of emergency in April. Finally, please take a look at Slide 9.

To summarize the first quarter results, despite currency headwinds, consolidated financial performance was solid. This was driven by the strong top- and bottom-line growth in the international tobacco business, which benefited from the very favorable pricing gains year-on-year.

Also, there were no material impacts to the bottom line from COVID-19 this quarter. I would like to mention a word about the full year forecast.

The full year forecast is not revised as we continue to closely monitor how the COVID-19 situation evolves from April in order to determine the business and financial impact going forward. We plan to provide an updated guidance on the forecast during the Q2 financial disclosure or other appropriate opportunity.

As I mentioned earlier, there are no business continuity concerns, following the execution of the business continuity plan. At the same time, however, we must further assess the overall impact to our business and financials as the factors involved in affecting our business are in decline.

Such factors include the implications to the consumer behavior underlying evolving environment as well as the unknown timing of Duty-Free sales recovery. We continue to observe additional currency headwinds under the current circumstances.

The Russian ruble, for instance, has already depreciated approximately 20% against our initial assumptions. Although, it is difficult to foresee how these local currencies move, given that each key local currency remains stable at this current rate from April to December, we estimate that there will be further negative currency impact to adjusted operating profit by $500 million compared to our initial outlook.

Last but not least, I would like to comment on our shareholders return. Our shareholder return policy and DPS guidance for 2020 remain unchanged.

The JT Group is committed to fulfilling our role as a global corporate citizen and contributing to support the resilience of communities where we operate, while we take all possible measures to carry out our responsibilities in minimizing the impact on our business. Thank you for your attention.

I have two questions. First relates to the Duty-Free business, which you have mentioned repeatedly in your presentation.

How severe quantitatively is the current situation. It has been a while since the Duty-Free was taken up as a topic.

But how was the profit margin trending before? My second question is related to COVID-19.

Price increase is expected to happen in Japan as we approach to timing of tobacco excise tax in October 2020. How would COVID-19 impact the thinking process of pricing strategy?

As domestic to domestic and worldwide Duty-Free businesses as mentioned is less than 3% of the group-wide revenue. Cigarette sales volume of Duty-Free in Japan including Chinese business fell year-over-year by 400 million cigs or 40% to 600 million cigs.

This decline is becoming more severe recently. It is difficult to communicate the exact figure, but it can be concluded that Duty-Free business in Japan is trending at a very low level right now.

Now for worldwide Duty-Free fitness for Q1, travel restriction started to impact sales in February, and this became more pronounced in March. The cumulative sales volume declined for Q1 was 20% year-on-year and this decline is accelerating recently.

Speaking of the profit margin, Duty-Free is higher than duty paid markets. Furthermore, higher unit price products are sold at Duty-Free, it can be concluded, therefore, the profit margin for the Duty-Free business is higher in comparison to the group wide tobacco business margin.

On the other hand, as a reaction to the drop in Duty-Free sales, volume increases confirmed and duty-paid markets, such as in UK and Taiwan. In comparison to Duty-Free, consumers are choosing not high priced products but lower price options and relevant tax hike market, suggesting that this may serve as one of the technical factors for promoting downstream.

As for Japanese domestic price and strategy given the impact of COVID-19, there is no change in our basic policies shared back in February. The pricing will be set according to the acceptance of consumers.

As a basic rule, tax hike will be fully passed on to prices the final product and pricing will be decided appropriately, while considering the financial impact resulting from volume decline and downgrading and also changes in consumption patterns and purchasing behavior of consumers. As COVID-19 related initiatives become more full-fledged in April, we would like to make our final decision on pricing based on actual data captured related to changes in consumers consumption behavior.

Thank you very much. Let me confirm some figures.

Could we infer that Duty-Free revenue is around ¥60 billion and OP margin is around 40%? Is my understanding correct?

If you were to combine the fragmented information given so far, your estimate may be correct. However, we are not going to disclose the exact number.

I would like to ask the Minami, what concerns you given the uncertainties surrounding COVID-19 which may stir changes in consumers' consumption behavior? The situation may vary according to different countries, but possible consumer actions are heightened health risk awareness due to COVID-19 leading to decrease the amount of smoking, the acceleration of down trading, accelerated shift to RRP away from RMC due to its healthier image.

What are some of your concerns, keeping in mind the difference amongst respective countries?

This is a very tough question. It addresses a realm that requires utmost attention and well considered countermeasures.

To answer your question, we are concerned about all of the books you have just mentioned. More specifically, we need to identify whether these changes occur only under the state of emergency driven by COVID-19 pandemic, or with these impacts our business for a sustained period of time beyond COVID-19.

Depending on how we discern the situation, our feature measures are bound to change. Regarding the relationship between smoking and health, we have long recognized that it can be a factor in the risk of diseases such as lung cancer.

We also communicate with our consumers that they use tobacco products with this understanding. Despite the lack of scientific grounds and the media coverage, there is a lot of news circulating and we are concerned about this.

Some argue that the use of nicotine is associated with more severe infections while some belief that, it may suppress immune activation. We have no intention to promote these arguments, and believe it is essential to deserve results firmly backed by scientific facts.

With regard to changes in behaviors and market structure, it can be easily assumed that there will be heightened interest or risk reduction. Therefore, in order to make it a more viable option for consumers, we recognize the need to focus more on R&D and commercialization of our key products in the future.

In addition, various insights are available in this environment. This may sound imprudent, but we perceive this as a valuable opportunity to explore the possibilities of digital marketing, examine the future of product marketing and request customer feedback on these.

In both negative and positive ways, we will identify under what timeframe this impact is occurring, whether the impact is permanent or temporary, and we will reflect this accordingly and our measures in a speedy manner.

Looking at the financial results for competitors, the share of our RRP has risen dramatically in Russia and Italy in Q1. Is the current environment helping this move really accelerate the shift from our RMC to our RRP.

To give you the fundamentals, competitors are enjoying an overwhelmingly favorable tax regime for our RRP products in Italy. As a result, competitors have placed refills for RRP products in the low price range which has led to continues acquisition of shares.

In Russia competitors, as well as JT have been actively conducting promotion to deepen the understanding of RRP and positive results are exhibited In light of this, it is difficult to judge how much COVID-19 impacted the performance of each company. In these markets, it is premature to conclude that COVID-19 and RRP are directly linked because of the additional distribution inventory.

There are some signs of such linkage forming in Japan. However, we need to be aware that the revised Health Promotion Act has been enacted from April.

Therefore, it is too early to judge the relationship between COVID-19 and RRP demand. When these trends become long-term beyond April in respective cities and countries, we must analyze the effects for the incorporate them into measures.

Just quickly, Minami, there are various major factors in place, but what are you most concerned about?

In addition to the direct impact of COVID-19, we are concerned about the timing and the time required to subside COVID-19, the state of each country's economy at the end of COVID-19 and subsequent changes in consumption behavior, and whether the impact will be short term or long term. If you can remember the global financial crisis from 12 years ago, cigarettes exhibited strengths as an article of taste and initially had little impact from the title.

However, depending on the economic situation of respective countries, there was a delayed impact on cigarette consumption. Hence we are aware that there may be some direct impact on our business stemming from change and behaviors and perspectives of individuals in society.

More indirectly, the biggest factor to consider is the state of economy of respective countries, especially in emerging countries. And what form will COVID-19 subside?

What would be their economic outlook? This is very important from the perspective of JT Group future growth.

I presume the industry volume trends have changed in March and April, compared to before. Can you provide more flavor on industry volume changes, as far as you know, at this moment.

For Japan, as well as major markets overseas, as it's hard for me to figure this out on my own?

First of all for overseas in countries such as the Philippines were strict movement restrictions are imposed on urban areas. There have been some distribution bottlenecks.

And we have been seeing that year-on-year contraction indices. And scenes where workers will tell restaurants and cafes are closed, and borders are shut down demand has been weak.

But on the other hand in other markets, we have not yet seen any signs of a drop off in inventory, which we're building up until March. But move to COVID-19 related restrictions in each market, distribution based demand supply balance continues to be comfortable to conventional times.

Therefore, COVID-19 duration should determine when a drop off a filter inventory happens. And we are closely monitoring the situation, so that we can understand how our performance is going to be for the full year.

As for Japan, we acknowledge that for now asking citizens to exercise self restraint on February 25 are both the state of emergency declaration in April, we're turning points leading to weaker industry volume. However, unfortunately, we were not able to properly break out the impacts between these events with the impact on the implementation of the revised Health Promotion Act.

We need to continue to monitor demand trends under the current circumstances. At this point in time, it is difficult to provide commentary on what is likely to happen.

Industry borrowing for the domestic tobacco business was originally planned to decrease by around 3.5%. Are you seeing a steeper decrease right now over the short-term?

The January March period has more operating days. So we are broadly in line with expectations.

Even after adjustments, tobacco industry demand was down by about 1%. So we need to look at the impact from fundamentals COVID-19 and the revised Health Promotion Act.

And we are currently taking a closer look at these factors to see whether our outlooks will prove to be true. But it's safe to say that after a certain point, demand has started to weaken.

I have a question about JTI's international tobacco business. In Q1, despite the negative FX impact, there were strong momentum and your performance.

On a constant currency basis, Q1 results already to see that your plan for the full year in reality. Were you originally planning for this quarter to be high?

Or were the results stronger than anticipated? Also you've mentioned $500 million of additional negative impacts, if the current currency rates were to shift and the group performance absorbs the negative impact?

The positive price mix impact for this year was anticipated to be relatively strong in Q1, according to our original plans. Good examples are markets such as Russia and Turkey.

However, as pricing started from April last year, the impact is expected to run its course from the second quarter of this year onwards. Moreover, for high price mix markets like Europe, we saw a buildup of inventory in March due to COVID-19.

And this has boosted profits. As an internal factor, there were some delays in our spending plans.

Therefore, although the January-March quarter alone was at a high level. The carryover price mix impact from last year is expected to be diluted as the current period progresses.

Regarding currency impacts, we were saying that if the current FX rates were to stay where they are until December, we estimate that it will have an additional $500 million negative impact. The answer to your question about if we will be able to offset the negative impact with our performances.

When the impact is this large, it will be challenging to make up for it overnight. Let's be honest, as we face not only currency rate fluctuations, but COVID-19 impact as well, although, we will continue to make efforts to attain the original plan.

We are not at a base to affirm that it is achievable. As for currency movements, for example, depreciation of the Russian ruble accelerated due to COVID-19, but we acknowledge that the directories and coughing this is crude oil production issues.

To this end, we need to quickly monitor market conditions as well as the subsequent economic trends in Russia.

So, on a constant currency basis, is it fair to say that Q1 performance was above your plan?

There were positive factors such as COVID-19 related inventory buildup and negative factors related to the GDP business; however, overall, my sense of fact, we finished the first quarter above plan.

My question is with respect to down trading in Russia and Japan. So Russia, pricing resulted in profit growth, but its comparative did not follow suit and pricing, GFP volume decreased by approximately 16% which is quite prominent.

Can you share with us how to comparative landscape look like under a down trading environment? Next to Japan, prior to the consumption tax like the value segment was less than 10% of the total market.

But in Q1 2020, I acknowledge that it's surpassed 15%. I also have the impression that you have been successful in capturing demand with your value events.

But if it's fair to say that down trading is accelerating, even without the impacts and COVID-19?

For Russia, industry volume for Q1 2020 contrasted by 4.9%. Initial expectations were minus 5% to 7%.

So we are struggling inline. Business volumes, excluding inventory adjustments were down by 10.9%.

The continuation of down trading and growth of RRP and other competitors deciding not to take pricing for some of your SKUs led to shipments decline that was stiffer than industry volume declines. Furthermore, due to unfavorable price differences against competition and competitor RRP growth, Winston’s shipment volume decreased by 15%, also for LD, which capture down trading demand to-date, recorded shipment volume decline of 16.9% due to the unfavorable price difference against competition.

In light of this, we will permit measure steadily that we feel necessary such as re-pricing. The brand's migration process with those [Indiscernible] tobacco brands aiming to better future profitability has been one reason why our share has weakened.

In Russia, we are the leader by volume and that is contributing to price leadership. We will continue to focus on profitability of course, but will also ensure that market share stays above a certain level.

We believe that this will be important for our duty and for long-term strategy. We are aware that competitors' activities and the measures we implement may be volume or share fluctuations.

We hope to think about pricing and other measures based on the robust plan and we are not pessimistic about the current circumstances. As for Japan, in order to secure profit growth over the medium-to long-term market share is an important factor.

For example, for little cigars, tax revision has been decided already and the regime will be the same as conventional ready new cigarettes when they fight. Therefore, from a profitability point of view, although there will be a deterioration of mix, the impact will be limited compared to share being taken away by competition in a one sided way.

We also understand the importance of raising our preference and brand equity in order to take pricing in the future. We will be increasingly focused on raising our presence in sections that are expanding.

Is it fair to say that JT is succeeding in the growing value segment?

So far, products we've launched have been working well. We've heard that the recent Camel Win series has captured inflow from competition.

However, we know that there is still lot to do. As we have run out of time, we will now end JT Group Q1 conference call.

Thank you for listening.