Coca-Cola Bottlers Japan Holdings Inc

TSE:2579

Earnings Call Transcript 2018-Q2

[Raymond Shelton, executive]

Good afternoon, everyone. I am Raymond Shelton, Head of Investor Relations for Coca-Cola Bottles Japan Holdings. For those of you who need a translation, please use the earphones on your table: Japanese, channel 1; English, channel 2.

I'd like to thank you very much for joining us today for our second quarter year-to-date 2018 earnings presentation for analysts and investors. I'm joined by our senior executive officers here at the front of the room. Following prepared remarks by President Tamio Yoshimatsu and CFO Vikas Tiku, we'll be happy to take your questions.

As you know, this presentation is intended for analysts and investors, so we ask members of the media in attendance today to please hold your questions for our media session, which is scheduled separately later today. Simultaneous translation, both Japanese and English, is being provided for today's presentation and during Q&A.

Now before we begin, let me remind you that today's presentation contains forward-looking statements, including statements concerning annual and long-term earnings objectives, and should be considered together with cautionary statements contained in our supporting presentation deck, both are posted to the Investors section of our company website at ccbji.co.jp. Please look on our website for this information in both Japanese and English.

Now I'd like to turn the presentation over to President Yoshimatsu. Yoshimatsu [Foreign Language]

[Tamio Yoshimatsu, executive]

Good afternoon, ladies and gentlemen. This is Yoshimatsu from Coca-Cola Bottlers Japan. Thank you very much for making time for our second quarter YTD 2018 earnings presentation.

Allow me to also take this opportunity to express my heartfelt condolences to those hit in the West Japan torrential rains in July of this year. At CCBJI, none of our employees were lost or injured. However, as we have already announced, the Hongo plant and its adjacent logistics center, located in Mihara City in Hiroshima Prefecture, was submerged in water, and our vehicles and vending machines, as well some of the residences of our employees, also sustained damage. Recovery is currently in progress, the details of which will be mentioned later.

Our understanding is that it will take a while before the lost product supply capacity will be restored. We are in the midst of a peak season in terms of beverage demand, and all the more, we apologize to our customers and consumers for the shortages of products.

I would also like to once again thank our customers for their messages of condolence and for their kind support.

Today, Vikas and I will explain the impact of the torrential rains and our first half performance, upon which we will take questions.

This may be seen as a highly irregular year. Serious natural disasters, such as torrential rain and the Northern Osaka earthquake, a premature end to the rainy season, sudden surges in demand as a result of shifting consumer preference. Much has happened to test our abilities. How has such an extraordinary year influenced us, and what actions have we taken? Let me start from the damages incurred by the torrential rains.

These unprecedented and record-breaking rains caused flooding of rivers and landslides in many locations. Our Hongo plant and adjacent logistics center was submerged in up to 2.5 meters of water.

Currently, we are supplying the affected area with products produced in other areas, while rebuilding the supply structure. However, the influence from the disruption in product supply and logistics is likely to continue, especially with the heightened demand as a result of the heatwave.

We are currently assessing the situation, including the damage to our assets as well as the impact the disruption to transportation has had on our product supply.

For that reason, we are momentarily withdrawing our annual performance outlook to make an announcement once we have had a full grasp of the losses and the influence on the business. The book value of the damaged assets and inventory known to us at this point is JPY 9 billion.

On Slide 6, we have put together a chronological sequence of the disaster and our public announcements. Many of you will have seen our first notice issued July 9, announcing the submersion of the Hongo plant and the adjacent logistics center and accompanying halt to the operations.

As a follow-up, on July 20, we announced the plant shutdown and damages to the inventory, which, combined with the disruption of traffic, caused product supply issues on a wide scale. Further, on August 1, we posted an announcement on our website that a temporary shortage of products was occurring in certain areas. Moving on to the damaged equipment and inventory.

The Hongo plant carried 3 out of a total of 17 production lines we own, one for aseptic PET, one for sparkling PET, and one for SOT and bottle cans. This amounted to approximately 5% of our total production capacity. The damaged logistics center, serving as a central hub for the area, was equipped with an automated storage facility, which on the day of the disaster, held 1.5 million cases prepared to meet the peak summer demand. The submersion halted the operation of the 3 lines and the automated storage. The employee dormitory on the premises was also damaged and is currently out of use. We believe the damaged inventory will need to be written off. The torrential rain hit a widespread area in Western Japan, resulting also in damages to more than 2,000 of our vending machines and coolers. The traffic has also been disrupted, with the roads and railroads having been cut off, leading to a difficulty in sharing logistics measures such as trucks.

On Page 8, we have summarized the current situation as well as some of our countermeasures. The employees are united in their efforts to recover at the earliest possible timing, with the kind operation of our customers as well.

Although the logistics center has been cleaned of debris and operations have started manually, it will still take another 3 months for a complete turnaround. It will still take until the end of the year for a complete turnaround. As for the automated storage, it will most likely take until the year-end to restore its function. The production facilities are being evaluated for reopening. However, it will take a considerable amount of time before operations can be restarted, regardless of whether repair is required or the introduction of new equipment.

Given the role Hongo was playing in our supply network, the production capabilities lost are not insignificant. As for product supply, although we are making steps forward in ensuring production points and procurement points within our supply chain, we have suspended the sales up 7 SKUs, including those only produced in Hongo plant.

The premature end to the rainy season and the subsequent heat has caused a surge in demand. Coupled with the shutdown of Hongo and the adjacent logistics center, it is highly likely their product supply limitation will continue. We would like to ask our customers and consumers for their kind understanding. Given the product supply chain -- given the product supply situation, we have asked our customers to suspend chirashi or flier promotions of our PET products. On the logistics front, there has been a spike in demand for trucks caused by the disruption in the transportation network. We have been unable to secure the necessary vehicles, the fees are rising, and combined with the limits to our production capacity, the influence on our product supply is not small.

As we mentioned at the beginning, we would like to take another opportunity in the future to update you on recovery as well as the outlook on 2018. On Page 9, we have summarized what we have been talking about.

The damage is significant and our annual performance will be influenced. We will continue to strive for steady recovery. The entire group will prioritize the stabilization of our product supply system, so that our abilities to deliver products to our customers and consumers will be restored as soon as possible.

The outlook for 2018 is now under reassessment, and we will update you as soon as we have a better understanding. Our strategies of growth and synergy generation have not changed. We continued to commit to the introduction of attractive innovations in line with new consumer trends and investments to ensure product supply capabilities in the future.

In response to the experience of the extreme heat and the natural disasters, we will commit to building a supply chain network with an ability to respond to various situations in a more agile manner and with a much higher tolerance to risk. Next, we would like to move on to first half performance.

On Page 11, we show the highlights of the first half performance.

The market share of our beverage business has been maintaining its steady trend since the first quarter, with growth in both value share and volume share, with the former outpacing the latter. In the first half, OTC channel volume grew, but vending was weak, and therefore, the pro forma base, which assumes integration since 2017 January, will remain flat year-on-year.

Coffee, which has been one of the challenges, has posted a recovery in the second quarter. Sales revenue grew by 30% year-on-year as the integration took place in the second quarter of the previous year. Pro forma base declined by 2%, pushed down in part by the deterioration in channel mix.

Regarding synergies, JPY 5 billion was generated, which was slightly above plan, contributed mostly by supply chain and procurement.

Operating income was influenced by the goodwill amortization necessitated by the integration and by the deterioration of the channel mix, down by 18% pro forma. Coca-Cola System's first alcoholic beverage, Lemondo, was launched on a pilot basis in Kyushu and is off to a successful start. Next, we would like to look at Page 12.

The integration is progressing steadily, and despite the stark irregularity of the year, the synergy generation of the first half is on track. We have positioned 2018 a year to pivot from building our fundamentals to realizing growth. Activities based on national-scale local presence, innovation, synergies are ongoing.

We have not changed this basic stance. However, given the damage from the torrential rains, we will for now prioritize, first and foremost, our efforts to recovery.

In terms of community-based and scale merit, we have started off this year with a 6-region commercial structure. The optimization of our supply chain network continues. We have also defined our corporate philosophy, THE ROUTE. Innovation-wise, we entered new categories, such as alcoholic beverages, and have introduced products which will meet customer needs.

There was particular growth in PET bottle, tea and coffee products on aseptic lines, necessitating investment into ensuring our supply of these kinds of products.

We have generated JPY 5 billion in net synergies in the first half, and we believe we will be able to achieve at least JPY 8 billion for the year. As for capital investment, there has been some delay in timing, but we are moving forward steadily.

On Page 13, we show our new corporate philosophy, THE ROUTE as well as the accompanying key visuals. Our mission, our corporate identity as well as our culture is defined here.

More than 20,000 employees are engaged in business activities, with our core values of local presence, customer-centric thinking, Hinkaku, or corporate dignity and diversity at heart.

On Page 14, we have the new products in the first half. They have done well, and you can see the package mix is shifting towards the PET bottle format.

New products made up 10% of the total volume. Of the new products, more than 12 million cases were PET bottled products, exceeding our expectations.

On the other hand, our volume in SOT cans, which was our core package conventionally, has declined in volume. And the growth of bottle cans has also settled down, leading to a sudden change in package mix in the market.

Small-sized PET packages, which can be carried around even when not finished, especially aseptic PET products, were especially high in demand, causing tightness in product supply. We are focusing our resources into these growth areas by adjusting the number of SKUs centered around our non-core products.

For the past 5 years, including the years before the integration, we have made investments to enable more in-house production and production capability enhancement in general, with a focus on PET. However, in order to respond to the recent surge of demand, more investment will be needed. With that in mind, we have commissioned 2 PET lines in Kyoto and Kumamoto and planning further enhancement.

Both our customers and consumers have responded well to our so-called lemon sour product or the lemon-flavored alco-pop Lemondo, and the sales are solid. The retail price has been higher than our competitors in some cases. We are now in evaluation towards the next step.

On Page 15, we show our market share and suggested retail price trends -- sorry, retail price trends.

First, from market share. Value share grew by 0.4 percentage points and sales volume by 0.2 percentage points, showing steady improvement. As you can see, the trend continues into the second quarter, with value share continuing to grow at a higher pace than volume share. Despite the harsh environment, we are consistent in our strategy to emphasize profit. Growth in sparkling and NSTs are driving overall share.

Our proactive introduction of new products, such as black tea and coffee, like for example, Georgia Japan Craftsman, and taking a thoroughly area-based strategy in the case of large-scale campaigns, such as Pyongyang Olympics and the World Cup, contributed.

Due to cycling from the improvement in pricing last year, partly due to the launch of FOSHU and FFC products, and also to the strategic adjustment of wholesale prices in certain categories, our retail price of both small-sized PET and large-sized PET declined year-on-year. However, it continues to exceed industry average.

On Page 16, we show the by-channel sales. In the first half, pro forma volume grew in OTC, in supermarkets, drugs and discounters and convenience stores, but declined in vending machines, flat against last year.

Per-case wholesale price declined on the back of improvement last year, but in terms of mid- to long-term profit, the improvement continues in major channels.

Volume grew in sparkling, NSTs and coffee in OTC. In the second quarter, we improved wholesale price per case compared to first quarter by taking a disciplined approach to profitable activities, such as optimizing the wholesale price of Craftsman.

In convenience stores, new product launches under the Coca-Cola and Ayataka trademark as well as THE TANSAN and Georgia Japan Craftsman, were successful, contributing to an increase in sparkling, coffee and NST volume.

First half WSP per case ended up being negative, pushed down by second half product mix, among other factors, but this was the result of FOSHU and FFC cycling and the success of Japan Craftsman, our larger-sized coffee. In vending, where profitability is higher, the continuing channel shift and intensified price competition contributed to a 6% decline year-on-year in volume. This is mainly due to the delay in vending coffee improvement, resulting from the unavailability of Japan Craftsman in vending. I have explained how we are executing various initiatives in vending to promote recovery and growth.

As part of the vending machine strategic project to drive the revitalization and growth of this business in the mid to long term, we are testing 700 machines in one part of Tokyo, utilizing AI and machine learning algorithms, and we have seen volume growth in individual machines. We are also starting to see the fruit of other kind of initiatives, such as optimized pricing per competitive environment, fortified product assortment, improved profitability in competitor-adjacent machines. The next-generation high-performance vendors we mentioned in the first quarter briefing are also being deployed in high-profitability locations. We have one on display next to the reception, so please take a look.

On the digital front, Coke ON Walk, a new feature of our smartphone application Coke ON, which has just been launched in April, already has 1.7 million users and has become an important platform for engagement with our consumers.

Let us move on to by-category situation. Sparkling grew by 5% against the previous year, this is thanks to the success of Coca-Cola PEACH and Coca-Cola Clear, the world's first clear Coke, and other new products such as THE TANSAN, a strong carbonated soda. The Ayataka brand drove the NST category and brought it to 4% growth.

Olympics- and World Cup-related activities and a new FFC product, S-Body, launch were not enough to grow the sports category, which declined by 3%. I LOHAS underwent cycling issues from last year's new product launches, declining by 7%.

Coffee declined mainly as a result of volume decline in coffee in vending. However, Georgia Japan Craftsman, launched in the second quarter, contributed in supermarkets and convenience stores, bringing the negative to 1% against the previous year. The introduction of this product enhanced our share in the PET bottle coffee market, signaling a path toward the recovery of the coffee category.

From here, we would like to ask our CFO, Vikas, to explain the first half performance and synergy generation. Vikas?

[Vikas Tiku, executive]

Thank you, Yoshimatsu-san. Good afternoon, everyone. I'm Vikas Tiku, the Chief Financial Officer for CCBJH.

Yoshimatsu-san has taken you through the overview of the damage and the continuing impact of the flooding in Western Japan as well as our year-to-date operating results and commercial activities. I would like to spend some time discussing our year-to-date financial results, progress on integration and synergy capture as well as some elements to consider for the balance of this year.

Yoshimatsu-san mentioned earlier in his comments that this has been a year of extremes. The record-setting temperatures this summer have been both an opportunity and a huge challenge for the industry. And certainly, with some of the issues we are facing, from rapidly shifting consumer preferences, particularly in coffee; the flooding damage and the logistics disruptions in Western Japan; the demand increase from a historically hot summer; and successful new product launches year-to-date, are all stress testing our current and future design of the supply network in material ways.

Let me take you through the financial results for the year-to-date period. We had steady volume growth, mainly in retail channels, as described earlier. However, volume decline in the higher-revenue vending channel impacted the channel mix, and as a result, pro forma revenue declined 2% year-to-date.

Pro forma operating income declined 18%, partly due to this negative channel mix, increase in DME investments and JPY 1.4 billion of goodwill amortization from the 2017 integration.

Pro forma net income declined 14% year-on-year, reflecting extraordinary profit from selling shares of a subsidiary as well as cycling various extraordinary expenses related to the creation of CCBJI ahead of our first year of operations in April 2017.

On Page 20, you can see the key drivers of our year-to-date pro forma operating income of JPY 15.2 billion.

Starting on the left-hand side of the slide. We experienced continued pressure on our top line performance, and you can see a net JPY 7.2 billion decline in gross profit from volume, pricing and mix. Volume performance versus prior year was even or flat year-to-date, with a 1% decline in the second quarter offsetting a 1% increase in the first quarter.

Double-clicking on this JPY 7.2 billion variance, the majority of the impact was driven by a 6% volume decline in the vending channel, which, as you know, tends to be higher revenue per case. This offset the positive impact of volume growth across all other channels. Of the JPY 7.2 billion, the impact of volume, including channel mix, was JPY 5 billion, and the pricing and product mix impact was about JPY 2.2 billion.

DME, or direct marketing expenses, increased JPY 2.4 billion versus prior year, in line with our expectations for this year. This growth reflects multiple new launches year-to-date, the volume growth in the retail sales channels, and major campaigns, including the support of the Pyongyang Winter Olympic Games and the FIFA World Cup in Russia.

We continue to experience higher raw materials and commodity costs, but at this point in the year, these costs are trending generally in line with our expectations that we communicated at the beginning of the year. We delivered solid net cost of goods savings of 4.4 -- JPY 4.1 billion versus prior year from manufacturing and procurement, including the steady generation of synergies.

Other operating expenses were positive, a net JPY 6 billion, mainly from savings in labor costs, facilities, IT-related expenses, partially offset by increases in logistics and distribution costs.

We are making strategic investments in 2018 related to the integration of our business, including areas as standardizing our HR systems and processes as well as many other transformation projects, which we believe are essential to building a solid foundation for future success. In the year-to-date period, integration-related expenses amounted to JPY 900 million.

Operating income from health & skincare business grew JPY 135 million as we continue to focus on driving operating efficiencies and cost savings.

Finally, goodwill and amortization, including the purchase price allocation related to that integration, was negative JPY 1.4 billion year-to-date, in line with previous communications.

Overall, we continue to make good progress on our synergy commitments and we have delivered JPY 5 billion synergies year-to-date. I would characterize this as slightly ahead of plan and setting a good place for delivering at least JPY 8 billion in net synergies for the full year, even with the added pressure of the flooding and logistics disruptions in Western Japan.

Slide 21 shows a comprehensive view of our second quarter year-to-date reported results. As you see them in our earnings release, or Kessan Tanshin, including the breakdown of reported year-to-date results for our core beverage business and our healthcare & skincare business. As you know, prior-year reported results exclude the first quarter results of Coca-Cola East Japan as we were integrated as of April 1, 2017.

On Page 22, I would like to discuss some key elements of the rest of the year for you to consider.

Clearly, our year-to-date revenue has trended behind plan, with continued channel mix, pressure and competitive operating environment. As Yoshimatsu-san explained earlier, our year-to-date, year-to-go and full year results will be impacted by the damage from flooding in Western Japan and the disruption to our supply network.

Our integration progress continues, and we expect to be fully able to deliver on our JPY 8 billion plan for the year.

We're now evaluating the extent of damage to machinery, equipment and inventory as well as the expected ongoing impact to our operations from this year, and we will update the guidance once we have completed this evaluation. As Yoshimatsu-san explained earlier, the book value of our damaged assets and inventories is approximately JPY 9 billion.

Just to give you a sense of what we are evaluating. We had direct damage to the machinery and equipment in the plant and the logistics center. This includes multiple manufacturing lines and automated warehouse. And we need to make an assessment as to what can be repaired and what needs to be replaced. We also had 1.5 million cases of finished product in the logistics center in the warehouse. And at this time, we anticipate much of it will need to be written off.

The lost inventory and the reduced manufacturing capacity for the balance of this year will have an impact on our performance, including some expected limitations in terms of product supply, at the same time, that the demand is spiking during this record hot summer. And the cost to transport finished products from alternate production sources will increase, due to longer shipping distances and reduced availability of trucks and transport, in general, across the country. We are doing our best to minimize the disruption, but there will be an impact on our business.

We will provide an update to our full year outlook once we have completed this evaluation. And our first priority is focused on responding to consumer demand, while making sure every effort to ensure a speedy recovery of the business. Please allow us a certain period of time to estimate a rational full-year forecast.

Finally, we will pay an interim dividend of JPY 25 per share, as planned, and our expectation for the year-end dividend also remain unchanged.

Let's move to an update on capital expenditures and depreciation costs. The table on the left hand side of Slide 23 shows our year-to-date CapEx and depreciation as well as our plan -- full-year plan for 2018.

Year-to-date CapEx was lower than pro forma 2017, mainly due to timing of investments. We are now currently evaluating the full year 2018 and 2019 CapEx plan to rebuild the Hongo plant and the adjacent logistics center as well as to meet the growth in demand for PET products.

The right-hand side of the slide highlights some of the investments for growth.

As part of the important Shinsei logistics network optimization project that we have talked about before, we consolidated 4 existing sales and distribution sites in Chiba and started operation of newly integrated distribution and sales hub at the Inzai site. Also, construction of a new automated warehouse at our Hakushu plant in the Yamanashi Prefecture is ongoing, with operations expected to start by December 2019. We've also started construction of 2 new PET manufacturing lines at our Kyoto and Kumamoto plants. These are initiatives designed to meet the growth of demand of aseptic PET products, and they will start operations sometime early next year. Our Board of Directors also recently approved investments for 2 additional aseptic production lines to continue to meet this growing market demand.

Year-to-date, depreciation expenses decreased JPY 500 million, primarily reflecting positive cycling of the accounting harmonization changes in the prior year.

With that, let me ask Yoshimatsu-san to come back and wrap up for today. Yoshimatsu-san?

[Tamio Yoshimatsu, executive]

Vikas, thank you.

So I would like to continue my part of the presentation. So I would now like to take you through the second half product launches, marketing calendar and wrap up. So please go to Page 24. We show the second half new products and marketing calendar in part here.

As a result of the damage from the torrential rains, we have had to limit product supply and inconvenience our customers and consumers. However, there are various campaigns and product launches prepared centered around the SSD category to capture the summer demand.

The Coca-Cola summer campaign is underway to stimulate the demand for Coke, Fanta and other sparkling products.

The Coke slim bottle, a popular addition to the portfolio since launch last year, will introduce local design bottles for our 6 regions.

On September 24, the first FOSHU in the green tea category and the fourth FOSHU from the Coke System, Ayataka Tokusencha, will be launched. It is an authentic green tea with the cloudiness, coupled with double FOSHU functionalities of moderated absorption of fat as well as sugar. By communicating both the tastiness of this green tea and the double FOSHU functionality, we will capture new users and aim for improved profitability through increase in sales volume and improvement in mix. We have prepared samples of Ayataka Tokusencha, in addition to the colored bottles from the ongoing Coca-Cola summer campaign, so please take them back with you.

On Page 25, we show the current situation against the 2018 objectives. In the first half, revenue growth was short of plan, but value share growth, synergies and various return initiatives to our shareholders were on plan.

In terms of the outlook for 2018 as a whole, we need to have an understanding of the direct and indirect influence of the torrential rains on sales revenue, volume growth and operating income, in addition to the first half results, so please expect to hear from us again on annual performance.

On Page 26, the wrap up for today. First of all, for integration, we are on track, and the synergy generation as well. Initiatives to optimize organizational structure continue. On August 1, Narihiko Uemura, who has supervised the Nissin Food Holdings group HR function, has joined us as part of the enhancement of the HR function, which will play an important role in our mid- to long-term growth.

As for the 2018 outlook, we are currently evaluating the impact of various factors, including recovery from the flood damage, activities toward new growth and our response to the increased demand due to extreme heat. So we are going to try to achieve steady recovery. Although, yes, this damage will have a one-time impact on our performance, our basic strategies of synergy building and growth will not change.

This is all for myself. Thank you.

[Raymond Shelton, executive]

Thank you, Yoshimatsu-san. I think we're ready for Q&A. If I could remind you, this Q&A session is intended for analysts and investors, so we ask members of the media in attendance to please hold your questions for our media session scheduled separately today.

If possible, please provide your name and company when asking a question, and please try and ask one question at a time as we are translating your questions into English. We're all ready for questions now. [Foreign Language]

[Raymond Shelton, executive]

Yes, here right up in the front. Thank you.

[Haruka Miyake, analyst]

This is Miyake from the Morgan Stanley. I would like to express my condolences for the damage and wishing for your quick recovery. For the first half actuals and also for the outlook for the second half, I have a couple of questions. First of all, based on the first half actuals, the vending machine sales volume was not favorable. That's that data that you've shared with us. And of that, especially the coffee was very weak. So again, the reason why the coffee was not doing well, we understand that the Craftsman was not fully deployed. Is that the only reason or do you not need any other initiatives? I would like to understand better around the Georgia brand. How should we understand the Georgia brand? That's the first question.

[Raymond Shelton, executive]

So a question on the first half results, specifically, in the vending channel, which showed weakness. We talked about the coffee performance in vending channel and pointed out that Georgia Japan Craftsman is not yet in vending. Could you give a little bit more information around the expected progress in coffee in vending?

[Haruka Miyake, analyst]

So shall we go one by one? You mentioned about the mid- and long term. Okay. Then let me go through all of my questions. So secondly, related to the vending channel. Even excluding the coffee, the vending channel, the other product's average volume is coming down. And I think that's, on average, 4% to 5% decline. Please correct me if I'm wrong. But anyhow, the total vending channel's volume decline, let's say the market average is 3% to 4% decline, then you have a steeper decline, compared to the market average. So how should we understand that? That's the point that I would like to know. From the past, you've been saying that you have been withdrawing the unprofitable vending machines, and we understand that strategy. But how much is that impacted? And also, how should we understand the fact that of the soft revenue performance of the other SKUs in the coffee? As for the mid- and long-term, of course, there is the heavy rain impact, so I can understand that there will be a short-term impact. However, let's say, 2 years from now, 2020, I understand that you already have a SPP towards 2020. And towards that, how should we understand that? Will there be any impact? I understand that the market environment is changing, and if that's the case, then I would assume that the 2020 outlook is going to change as well. So what are your ideas around the 2020 and what should we expect from you?

[Raymond Shelton, executive]

So just to summarize quickly, make sure we got it. So the first one, we summarized which is around vending and coffee, specifically. Miyake-san's follow-up question was to ask about other categories and how is our vending business comparing against the industry. Also, a question on withdrawal of unprofitable machines in the prior year. And then, finally, mid- to long-term strategy, a question of understanding that the flooding will likely have an impact on the shorter term, but how to think about the mid- to long-term plan? Miyake-san, did I get them all?

[Tamio Yoshimatsu, executive]

So first of all, the vending channel. The current -- let me just highlight what is happening in the current vending channel right now. So I think you already know about this. So the overall category shift from the can products to the PET bottles, and especially from the SOT bottle cans to the PET bottle, this is the major trend that we're seeing among the consumers. And now, based on that, when we start the analysis of our numbers, first of all, the SOT can and the bottle can, how much does it account for within our vending? It accounts for actually 80%. And the vending sales, which has 60% of the negative vending volume sales, 60% is coffee, which means in order to restructure the vending immediately, we need to tackle the coffee. So what's the difference with the competitors? So we believe that there is a couple of percent difference with the competitors. This is a difference of whether the coffee is launched or enough coffee is filled or not. So based on that, within Tokyo, based on 700 vending machines, based on the advanced net long-term plan, we have conducted a pilot test, and we are going to be utilizing the most advanced AI and also the new algorithms to identify what is the optimum pricing and also what is the optimum assortment. That's what we're trying to identify. And as for those 700 vending machines, actually, Japan Craftsman is filled in those 700 vending machines. So compare that to the controlled machines, both in indoor and outdoor, we are seeing 4% higher effect. So a lot of the locations are having better performance than the previous years. So therefore, obviously, the vending machine struggle that we are facing is due to the coffee. And therefore, for us, the best way -- the shortest way is to recover the coffee category.

And the point that I explained last time is that, based on the short-term solutions, we need to make sure we cover the current performance. And in order to do that, we have 2 initiatives. In order to fight and compete -- to be able to compete with the competitors, 170 milliliters will be sold at JPY 100 or in small PETs will be available. And in addition to that, we will make sure that the assortment is going to be attractive for our consumers. So those are the short-term actions that we have been taking. And of course, depending on the areas, we are taking different initiatives, which I will not be touching upon on this right now. And with that, we are seeing a difference in the share -- movement in the shares, meaning, from last year to this year, the area where we were struggling, which is the share, probably, against the competitors, there was 2% to 3% share difference. That's what we're seeing from the data. However, based on the short-term actions taken in June, just with that, actually, we are seeing a positive. Within the vending machine sales, there is a category which has turned into the positive. I'm talking about SSD, which is 0.85% positive; and also NST, 0.2 point positive growth; and also the sports, it's plus/minus 0. However, as I have been talking about earlier, when you look at the coffee category, it's 8.9% negative versus last year. And the water has some issues as well, however, when you look at this comprehensively, among the 6 areas, 3 areas, the share is actually growing compared to last year. And at the same time, even for the 6 areas total, there used to be a couple of percentage differences. However, after June, we are down to 0.1 point negative -- or difference. So based on that, if we're able to take thorough actions with coffee, we are sure that the vending channel -- vending business, that we can restructure and recover. However, in order to expand this model that we are testing right now, we need to make sure we have solid evidence. We need to make sure that we can do a cost-effective investment. So once we have all of those informations ready, we would like to come back to you. In terms of the mid- and long-term perspective, I would like to ask Vikas to fill in.

[Haruka Miyake, analyst]

Sorry, there's an area which I was not clear. So for 700 vending machines, you've already have the Craftsman available. And in those machines, compared to the machines without Craftsman, you have 4 points higher sales in terms of the coffee. Is that what you said?

[Tamio Yoshimatsu, executive]

No, not just the coffee, but I'm talking about the volume per machine in that specific vending machine. The coffee revenue or coffee sales is actually more higher than that.

[Vikas Tiku, executive]

Can I -- I'll add a couple of points to the current situation, then go into mid- to long-term plan. Miyake-san, you talked about the impact of us withdrawing the unprofitable machines from the market. Clearly, in our 2017 results, we were executing that strategy. And as we are cycling that, we have fewer machines for most of this year until we get past that in the market. We estimate that somewhere around 2% of our volume results are coming from the fact that we have fewer machines in the market today than we did at this time last year, for example. We do believe that we have reached what we think is the appropriate footprint from a machine standpoint, so we're not continuing to withdraw machines anymore, but just the cycling of that will continue to have an impact. Second, while Japan Craftsman is a clearly big initiative and it's on-trend with the consumer preferences we talked about, we still have a very large loyal consumer base in canned coffee, and we can't ignore that base either. So you will see us having initiatives in vending and other channels to support that business in a big way for the balance of this year, so I don't want to ignore that part of the business. It's not just about Japan Craftsman. Finally, about the mid to -- mid-term outlook. Clearly, the changing preferences that we've talked about today, the impact on our manufacturing with what's happening with just from a product package diversification standpoint as well as to rebuild Hongo, will clearly have an impact on our mid-term plan as well, not just for 2018, but also to the mid-term plan. Our expectation is that we first come out with a 2018 outlook that is clear for people to follow. And then as we go through the business planning cycle for 2019, we will endeavor to update our mid-term outlook at that point in time as well. But I would clearly expect that to have some impact as well related to everything that we're talking about today.

[Raymond Shelton, executive]

I think we're ready for our next question. Yes? Very easy to pass.

[Naomi Takagi, analyst]

My name is Takagi from SMBC Nikko. I would like to ask about the supply chain first. The aseptic line products have seen a surge in demand, and you were saying, maybe, I believe, that you were unable to meet that surge in demand. And I think that I would feel that this is an industry-wide issue if this is happening in other companies as well, but it seems that it is especially applicable to Coca-Cola. So is it because of the integration? Is it because of some kind of structural issues? Will you be able to correct -- course-correct this in the future?

[Tamio Yoshimatsu, executive]

It has nothing to do with the integration. Let me try to explain the backdrop. So 160 million cases was the original plan, and we had around 177 million cases in terms of structural capability. So we believe that there was no issue if things were according to our plan. What happened was as follows: So there were 12 million cases in terms of the new product total, and most of them were in PET. So this was, first of all, beyond our expectations. So that was the first issue. Japan Craftsman, of course, was one of those products that created that big bulk. But basically, as I explained when I was talking about Georgia, there was a larger movement on the consumer side from cans to PET, as I said, beyond our expectation. So on one hand, it was the result of the success of our new products, but also, this kind of a large trend, major shift. We had a premature end to the rainy season, compared to the average year as well as extreme heat following that. So we have tried to adjust the numbers of our SKUs and make it more efficient -- making production more efficient, and that's how we tried to counter the situation. And we have been able to increase the amount of production -- we tried to increase production, and we were successful. However, unfortunately, we came against a wall in terms of the storage as well as logistics/transportation. And we have in the end, ended up inconveniencing our customers. Upon this, we also had the damage from the torrential rains. So we believe that there, we were lacking in our -- in the depth in our analytics and analysis. But in the future, we have a much better understanding of the needed capacity. And in fact, the 4 lines, 2 and 2, have already been approved in the recent BOD meetings.

[Naomi Takagi, analyst]

My second question is towards the second half. So for volume and price mix, it feels like the current is turning towards a negative situation for you. We understand the vending part -- I understand the vending part now. But I believe that the mix is also not pointing towards a positive situation in the second half. So including price, how are you going to bring the product mix current back to positive and then to an advantage towards you?

[Tamio Yoshimatsu, executive]

So for pricing, setting aside the mix as a result of -- the pricing as a result of the mix, we can see that for the second quarter, we see a positive trend. So we will be -- we believe that we will be able to achieve a positive, but the biggest -- as we said, the biggest influence is the cycling from the previous year or -- so we were better in absolute average price as well as the mix last year, and there has been some backlash cycling against this year. However, when we looked at this by SKU, we believe that, on average, we are above the industry, so we still can continue to say that we lead the industry.

[Naomi Takagi, analyst]

So you were saying that there's a cycling or a backlash against the previous year in terms of mix. But I believe that you would have known that, you were aware of that, and that you were going to improve even further in terms of your product assortment for 2018. Perhaps that leads me to the conclusion that you were weak in your forecast and in your analysis.

[Tamio Yoshimatsu, executive]

Well, when we take Coca-Cola PEACH and Coca-Cola Clear that came out in spring, I think that we have had high unit-priced products. However -- so in that sense, I think we were in line with that -- with our strategy. However, I think Ayataka gives you a very good example. In order for us to protect the core, the subcategory product, Chaba no Amami, was lowered in price slightly. As a result of this, the core products were actually protected in terms of price. So when competition keeps launching attacks, within what we have, within a limited number of cards, what are the strategy that does not influence negatively our core, the mainstay of our portfolio is what we have been trying to do.

[Satoshi Fujiwara, analyst]

This is Fujiwara from the Nomura Securities. I would like to confirm some points on the supply chain. So the internal production rate has been increased. And when the demand heightens, usually, you can outsource it to the packers. Usually, the beverage manufacturers have that option. But instead, if you increase your own lines, then when the summer is not blessed with a good weather, then you have high fixed costs. You're sitting on a fixed cost. So the relationship with the packers outside and also the basic SCM management going forward, based on the experience this year, how are you going to think about it is the point that I would like to ask. And the second point is the first half new launches, I think it sold very well and I think the hit rate of the products are improving as well. So when you look at the overall Japan, this is improving. What is the trigger or what is the context of this improvement in terms of the R&D?

[Tamio Yoshimatsu, executive]

On the first point, yes, we had a lot of learnings. The issue of the flexibility versus the efficiency, there is a strong correlation, so we cannot focus too much on the cost reduction. If we focus too much on that, that will -- we will end up being short of the flexibility. So as we look at the overall production plan, how are we going to secure the outsourcing percentage is something that we are going to foresee and for next year, some of the areas we're starting to negotiate for next year's packer capacity. And the second point, on the new products, for the CCBJI to become a bigger company, the relationship is becoming more simple. What I mean is that we are in charge of 90% of the overall sales, so the in-store information and the customer information, by providing that in a speedy manner, the dialogue with the CCJC is completely different from what we saw in the past. What they produced, they show it to us, and whether we can show it or not, that was the conventional way. However, from the start of the development, there is one CIF. There is a scheme within our company, and we are involved from the beginning where we do the concept building, and we look at the appropriateness towards the business and we also consider the profitability issue for the bottlers' side as well, and that's how we're moving forward. So what we decided, as the bottler, we are able to immediately execute. So the strength of both CCJC and the bottler side is working better.

[Unknown Analyst]

So this is [ Tanoda ] from JPMorgan. So I have a couple of questions as well. The first one is over the influence of torrential rains. So you were mentioning the suspension of chirashi/flyer promotions. I'm sure that this will cut down on DME or expenses. But at the same time, I understand that the penalties could potentially be quite large as a result of this kind of suspension. So for the logistics costs and promotions costs in that sense, should we be prepared in the second half for quite an amplification -- or increase? The second point is around FOSHU. In the first half, your FOSHU products as well as your functional products, what is the percentage of the positive impact from these products on the total? And I understand that there will be another FOSHU product coming out. On the other hand, in the -- when we look at the industry-wide impact of FOSHU -- from FOSHU, it's actually, we believe, settling down. So I'm sure that you were trying to raise your share, but how are you going to achieve that? By stimulating and enlarging the pie or are you just trying to take more share from others?

[Tamio Yoshimatsu, executive]

So let me talk about the influence of chirashi or flyers. It is difficult to try to calculate how much this will be. Of course, there will be impact on volume as well as share. On the other hand, our promotions are divided into a number of patterns. One is deep desk special discount, then there's deep discounts, there's Teiban discounts, there's weekly discounts. What we are doing this time is just the special discounts with flyers. So it is -- we have been suspending just where we would have a large profit outflow. On the other hand, we would have to really see how the customers will respond for us to be able to calculate the damage accurately. Moving on to FOSHU. So I believe that the cola FOSHUs will be a good example for you. So we were quite delayed in being able to introduce our FOSHU product in the cola segment in Japan. However, I think that we were able to expand the pie itself for cola product FOSHUs and FOSHUs in general. So we believe that we also need to take into account what the vehicles and channels are. So in-store, what we are opening up is perhaps more skewed towards conventional users. However, we also have other kind of vehicles and channels, such as vending machines. And we only have 2% in FOSHU in volume, but we have 4% in -- it gives us 4% in profitability, in profit. So I believe that it continues to be a matter of urgency for this industry to continue for these products to take root.

[Unknown Analyst]

For this new Tokusencha product, once it is expanded in terms of distribution, how is it going to improve the 2% and 4%, respectively?

[Tamio Yoshimatsu, executive]

Well, we need them to grow at the same pace, so it has to double the revenue impact and double the volume impact as well.

[Unknown Analyst]

No, I was wondering how much you forecast it to grow. So it's 2% now, how far is it going?

[Tamio Yoshimatsu, executive]

Well, from a competitive point of view, it will be very difficult for me to give you a clear answer. If you could please look at the precedents.

[Unknown Analyst]

Well, but isn't it this the key item to offset -- key weapon for you to offset the negatives in vending machines? Is that correct?

[Tamio Yoshimatsu, executive]

Yes, that's one thing. And also, within the SOT cans, we also have a cluster of products that will boost that side of the business as well.

[Hiroshi Saji, analyst]

So this is Saji from Mizuho Securities, and I have 2 questions. The coffee availability or filling rate in the vending machine, certainly, there's been an advancement, and it seems like they've been able to stop the decline in the volume. So the Craftsman coffee of your company, the availability or the filling rate in the vending machine, when are you targeting to have it in the vending machines? And also, after that, how should we expect that? Meaning, the channel mix, are you going -- you will be able to stop the negative decline? However, the product mix itself, the negative trend is going to continue for a while, I assume. After you fill it into the vending machines, how should we regard the mix? I still think that there is still a challenge, so if you can sort that out and explain to that us -- that to us. And second point is on the Lemondo, what have you learned? What are the findings? Can you share some of the findings? And also, when is the next step? And I believe if the results were good, then you are going to expand your sales in the next step. So what are the findings based on the test market? What are the challenges and what are the positive findings? If you can share some of that with us.

[Tamio Yoshimatsu, executive]

First of all, about the coffee. Based on the supply-demand situation, we are creating some confusion and inconvenience to our customer consumers. So under the situation, I would like to refrain from mentioning the clear time line. We have, as much as bottle cans, so SOT can -- compared to selling the SOT can at JPY 100, the profitability will improve. Therefore, within the current test, it has been validated, and the NSR contribution, and on top of that, the contribution on the profit -- we will have a better contribution by switching over from SOT can to the PET bottle. So please regard it as the same as the CVS. CVS, the revenue per case has come down. However, the volume has covered for that in terms of the profitability. What are the findings for the Lemondo? The marketing in the soft drink beverage and also the know-how, we are seeing a lot of commonalities. So the conventional learnings or the learnings from the past or the findings can be leveraged. Other than that, there is nothing that I can share with you right now based on our findings. So we were confident when we challenged, but looking at the first week to fourth week sales, we believe that -- and also, the fact that our sales marketing is effective with the consumers, we believe that our marketing is effective. We have been able to build confidence on that, I believe, which is a great outcome.

[Hiroshi Saji, analyst]

In the future, this alcohol beverage, of your overall business, how are you going to position it?

[Tamio Yoshimatsu, executive]

So we have started out under the Beverage for Life concept. However, how are we going to position that within our business and what is the scale, we still don't have full results from the tests, so I'm not in the position to be able to answer that question right now.

[Raymond Shelton, executive]

Thank you very much. I think we have hit our time. I'd like to thank you once again for your interests in our business. We look forward to having more opportunities to interact with you. Please reach out to us and to our team in the Investor Relations department with questions or feedback, and we'd be happy to continue the conversation. Thank you very much, and thank you for coming during Obon.