Aeon Co Ltd

TSE:8267

Earnings Call Transcript 2021-Q2

[Unknown Executive]

Thank you very much for participating in today's briefing on Aeon's financial results. I will open the briefing with a few remarks, after which, Kahori Miyake, the Executive Officer in charge of Investor Relations, will report on the financial results.

First of all, I will briefly review the first half and discuss the outlook for the second half. During the first quarter, Aeon faced an emergency situation, unlike anything we've experienced before, because of the COVID-19 outbreak, and we strove to ensure a stable supply of food stuffs and other daily necessities to fulfill our role as a form of infrastructure essential to people's lives.

In the second quarter, during and after June, when the government lifted its request for voluntary restraint in activities, we resumed full-scale business activities only after first instituting our protocol for infectious disease control as a means of preventing infection.

A rebound in demand and so-called revenge consumption occurred after the lifting of the voluntary restraint request, and the government provided cash handouts in various tax benefits. Business performance during that period recovered considerably faster than expected, and we achieved revenue and profit increases exceeding the prior year level in June and July.

From the second half of July into August, Japan was hit by a second wave of infection that was larger than the first wave. I believe the number of cases was higher during the second wave.

Looking at the results on an operating profit basis, whereas we reported an operating loss of JPY 12.5 billion for the first quarter, we achieved substantial improvement in the second quarter, recording operating profit of JPY 46.4 billion despite the second wave of infection. Factors contributing to the improvement included a shift by the government from focusing on epidemic control to a policy of balancing epidemic control and the economy from the first wave and into the second, and the ingraining of good infection prevention habits among customers.

As for Aeon, because we have a multi-format retail business, I think we were able to achieve more stable results than if we operated as single format business. Although the results suffered for a time because of temporary closures in the Shopping Center Development Business, the Supermarket Business made up for the shortfall. These 2 businesses are in a mutually complementary relationship.

Turning now to the most recent situation in China, where COVID-19 began to spread from Wuhan about 2 months before it arrived in Japan, October 1 marked the start of the National Day holiday week. Both sales and customer traffic during the 5-day period from October 1 through 5 were higher than last year, with sales increasing by 9% year-on-year.

In particular, in Wuhan, where the outbreak began, our business returned to the pre-COVID growth rate, with sales increasing 16% year-on-year. Although, this may be limited to the National Day holiday period, we believe that at the very least, it shows that customer resistance to visiting shopping malls has diminished substantially.

Another factor may be that the inability to travel abroad has spurred domestic demand. We consider this a positive phenomenon that may portend a similar trend at shopping malls in Japan. I think that we must regard the second half as a time when damage to the economy from COVID-19 will emerge in the form of an economic downturn.

Deterioration in consumer spending and purchasing power due to a worsening employment situation are particular causes for concern. From the perspective of our business, I think the greater customer price sensitivity and budget consciousness will come into play here and there. Accordingly, realizing that we must be price competitive in sales floor development and product provision, we decided to respond to an increase in the liquor tax this October by maintaining the price of Barreal, a third category beer that is a mainstay product in the Top Valu product line. We intended this as a message to communicate Aeon's commitment to supporting people's daily lives.

People are increasingly concerned about possible parallel outbreaks of influenza and COVID-19 ahead. I think that health consciousness and the desire to boost our immune systems will become further ingrained in our minds. We believe that the market in the health and wellness business sector will expand, and I think that we need to tightly focus on the Drugstore business.

The go to campaign is currently being implemented in various forms, and movement of people has increased. Customer traffic in malls this weekend returned to last year's level.

Although it feels like people's awareness of the need to prevent infection has diminished a little, it is just the opposite at Aeon. We intend to review the protocol for infectious disease control we instituted in June in light of the current situation and do business on the basis of clearly defined communicable disease control guidelines. Facilities that reflect a firm focus on safety earn the trust of customers, and I think this will become an important store selection criterion for customers.

I will now briefly discuss my perception of the business environment. Even if the direct impact of COVID-19 diminishes, I consider it likely, that some customer behaviors, attitudes and values brought about by the COVID-19 crisis will continue and become ingrained in people. And I believe the negative macroeconomic impact will continue as well.

Digitization of Japanese society had been identified as a key task since before COVID, and the government has come up with a policy for a transition to Society 5.0. I think this initiative is now likely to progress at an accelerated pace, and I also think climate change will become a more firmly established trend. The trend toward increased health consciousness will be accelerated because of COVID-19. I believe that companies will have to increase the speed of change, something that lifestyle habits will change due to COVID-19.

What I think most probably will happen is that things heretofore consider likely to change will change rapidly. And I believe that the biggest expectation placed on companies will be the expectation that they increase the speed of their own transformation.

With the government preparing to establish a digital agency, digital technologies will become commonplace in the social rules and life tools of the future. This means that rules premise and digital technologies will become a prerequisite for corporate activities.

Besides that, amid the previously mentioned firm establishment of climate change as a trend, I believe that ESG-related initiatives will become an inevitable element of corporate evaluation and that we will have to strive for environmental consideration in every aspect of our corporate activities.

I want to ensure that this perception of the business environment and sense of crisis are shared throughout the Aeon Group and that we do business with the mindset that, on the contrary, changes like those I've described give rise to business opportunities.

I hope to continue to communicate with our stakeholders in various ways in order to provide an understanding of our thinking and initiatives.

I will now hand this over to Kahori Miyake, who will explain the financial results.

[Kaori Miyake, executive]

Good afternoon. I'm Kahori Miyake, the Executive Officer in charge of IR. I will now provide an overview of the consolidated operating results.

First of all, let's look at the cumulative first half results. Operating revenue was JPY 4,270.5 billion, and operating profit was JPY 33.9 billion. Although both revenue and profit declined year-on-year, we achieved profitability on the operating profit and ordinary profit lines. Operating profit is at the upper end of the full year profit forecast range we presented at the beginning of the year.

Looking now at the second quarter results. Operating revenue increased 0.9% year-on-year in the second quarter, following a decline in the first quarter. We were able to narrow losses at each profit stage from a substantial loss of more than JPY 40.0 billion in the first quarter to a loss of about JPY 10.0 billion in the second quarter. I will explain the reasons for this in the discussion of results by segment.

This slide shows operating revenue by segment. Operating revenue from the Supermarket Business and Health and Wellness Business in the second quarter increased substantially year-on-year due to higher at-home consumption demand resulting from people refraining from outings and continue demand for products to prevent the spread of infection. The General Merchandise Store Business secured second quarter sales at roughly the prior year level. Takemi Ide, President of Aeon Retail, will report on the situation of the General Merchandise Store Business later.

Although the Shopping Center Development Business, Services and Specialty Store Business and Financial Services Business were affected by temporary closures and reduced business hours following the state of emergency declaration, revenue recovered substantially once business operations were restored.

In the International Business, the COVID-19 crisis affected the second quarter sales of companies in the ASEAN region, for which the period from April to June, when the second wave of infection spread corresponds to the second quarter due to the accounting period difference.

This slide shows operating profit by segment. The Supermarket Business and Health and Wellness Business achieved substantial profit increases again in the second quarter connected with the increase in sales. Second quarter profit from the General Merchandise Store Business also recovered to nearly the prior year level. Similarly, the Shopping Center Development Business, Services and Specialty Store Business and Financial Services Business showed a second quarter profit recovery trend coinciding with sales recovery.

Profit decline in the Services and Specialty Store business improved in real terms after excluding the impact of a JPY 14.5 billion loss in connection with improper accounting at a subsidiary recorded as a lump sum in the first quarter of last year.

In the International Business, the profit decrease is mainly attributable to companies in the ASEAN region whose figures reflect the impact of the first wave of infection.

Next, I will discuss the situation by segment in greater detail. As shown in the graph, the Supermarket Business also achieved year-on-year sales increases up from 5% to 10% from June onward, attributable to increased opportunities for having meals-at-home because of the tendency to refrain from outings and spend more time at home, although not to the degree experienced in the first quarter when the first wave of infections struck.

In particular, My Basket stores and other small discount stores and supermarkets in the Tokyo metropolitan area, which are meeting demand from people who want to make quick shopping trips to get what they need at stores located close to home, are showing even higher sales growth.

Also in August, ordinary everyday food products sold better than food products for special occasions as people were refrained from travel and hometown visits during the Obon festival period.

Because there was little movement of people to regional areas for hometown visits or travel, sales at stores in the Tokyo metropolitan area were very strong during the Obon holiday season.

Next, let's look at the situation in the Shopping Center Development Business. The graph on the screen shows monthly specialty store sales by country. Sales bottomed out in February for China, which was hard hit by the first wave of infections, and in April for Japan and ASEAN countries.

But with shopping centers reopening for business, sales are now recovering. The spread of infections did have an impact on the Beijing area in June, on Japan in July and August and on Vietnam in August. But since then, sales have returned to a recovery track.

In China, which was the first country to stage a recovery, sales in August and September rebounded to prior year levels. This result is a sure indication that the Aeon Mall business model is capable of earning the trust and recognition of customers, and we'll be able to continue offering value in the future, even if society has no option but to coexist with COVID-19 because we have put in place, thoroughgoing infection countermeasures.

Needless to say, there remains the possibility that the Shopping Center Development Business will be affected by the pandemic going forward, but we will make every effort to turn earnings around, by creating new events and sales opportunities even with COVID-19 still present in society.

For example, we intend to implement in Japan the same kind of initiatives carried out in China where infections have now eased, such as online sales with live video streaming by tenant, employees and social media influencers.

Next, let's take a look at the Financial Services Business. The profit decline in the Financial Services Business has shrunk considerably, with profit moving back into positive territory in the second quarter from a loss in the first quarter. The improvement largely owes to a substantial decline in bad debt expenses compared to the first quarter.

The graph on the screen shows a comparison of bad debt expenses in the first 2 quarters at group company, Aeon Financial Service. On the left of the screen, you can see that bad debt expenses decreased by JPY 12.8 billion from JPY 32.3 billion in the first quarter to JPY 19.5 billion in the second quarter.

Particularly in overseas markets, we announced repayment moratoriums in line with the policies of local central banks and built up our allowances for doubtful accounts, mainly in the first quarter. However, bad debt expenses declined sharply in the second quarter after a steady progress was made on collecting receivables when COVID-19-related restrictions were later eased.

In Japan, as a result of a carefully examining future risk, bad debt expenses rose by JPY 2.8 billion in the second quarter from JPY 8.1 billion in the first quarter. But thanks to the decline in expenses overseas, the overall figure has dropped quite considerably.

As we've been able to address future risks that at this point in time, we anticipate could potentially occur in Japan and overseas, we will continue to make steady progress on collecting receivables and endeavor to turn earnings around even further.

Next, the situation in the Services and Specialty Store Business. The apparel specialty store, COX, immediately responded to customer changes and started taking orders for face masks online from early on, which garnered very strong support from customers. Not only did this make up for declining sales at brick-and-mortar stores, it also greatly boosted COX's e-commerce sales. As a result, both revenue and profit made in about phase from first quarter results to move higher in the second quarter.

Sporting goods specialty store operator, Mega Sports, also bolstered its lineup of popular outdoor equipment on the back of the government's message to avoid the 3 Cs, of closed spaces, crowded places and close contact settings. As a result, second quarter results were up on prior year levels.

In contrast, the amusement business operator, Aeon Fantasy, and cinema business operator, Aeon Entertainment, are still recovering. Nevertheless, they are working to boost sales despite the continued presence of the novel coronavirus. For example, Aeon cinemas are offering whole day tickets to let moviegoers watch as many titles as they like in a single day.

Monthly revenue for Aeon cinema shows that their recovery is progressing month by month. Sales in July were only 30% of last year's level but rose to 42% in August and then 63% in September. We expect to see more of a recovery up ahead once popular movie titles that have been postponed start hitting the screens and as the drive-in theater format is expanded and improved.

Here, you can see quarterly operating profit by geographical area. Looking at Japan first, we booked an operating loss of JPY 5.0 billion in the first quarter. But as I explained earlier, operating profit rebounded to JPY 37.4 billion in the second quarter on brisk sales at supermarkets and drug stores as well as the recovery in earnings in the General Merchandise Store Business and Shopping Center Development Business.

In ASEAN countries, operating profit increased year-on-year in the second quarter to JPY 7.6 billion, thanks to a decrease in bad debt expenses in the Financial Services business. In China as well, operating profit was in the red in the first quarter but moved back into the black in the second quarter driven by the resumption of operations and recovering sales in the Shopping Center Development Business. The circumstances surrounding the pandemic differ from country to country, which means we must remain watchful, but we are implementing watertight infection countermeasures and working on achieving a greater earnings turnaround in all regions, where we have a business presence.

The most important issue in the first half was responding to the COVID-19 pandemic. But at the same time, we have continued to make steady progress with reforms. I have included this page for reference. It shows the main items we have reached a decision on or acted upon, since the start of the fiscal year.

Convenience store business operator, Ministop, announced the other day that it aims to develop a new business model and will gradually switch to Ministop partnership agreements for the purpose of sharing business profits with participating store owners.

To conclude my presentation, I will discuss our earnings forecasts for fiscal 2020. At this time, we have made no changes to our earnings forecasts announced at the beginning of the term. The number of new COVID-19 infections in Japan continues to decline after the second wave in July and August. But with the winter flu season approaching, there is no predicting what might happen up ahead. And in other parts of the world, there was no indication that growth in the number of new cases is slowing.

As we have discussed today, our earnings are on a recovery track. But at this juncture, we are leaving our initial forecasts unchanged, given that full year earnings can fluctuate substantially, depending on the fourth quarter, which is when we usually generate the highest profit levels for the entire year.

We will continue to prioritize the safety and security of our customers and employees and work on sustaining and improving earnings by rolling out new initiatives designed to meet the changing needs of customers. The Aeon Group will continue to put into practice its "Customer-First" philosophy as a corporate group with an everlasting innovative spirit.

This concludes my presentation. Next, Takemi Ide, President and Representative Director of Aeon Retail, will report on Aeon Retail's first half results and progress on reforms.

[Takemi Ide, executive]

Hello, everyone. I'm Takemi Ide. I would now like to review the first half at Aeon Retail and talk about the progress made with general merchandise store reforms.

Firstly, though, I'd like to explain what Aeon Retail aims to achieve by the year 2025. Last year, we formulated our medium-term strategy, a plan for growing the company by developing comprehensive strength, or in other words, new value that combines our strength in brick-and-mortar stores with digital technologies. And digital transformation will be the key to this plan.

There are 3 approaches we are taking with these initiatives. The first is creating earnings opportunities. We will look to tap new growth opportunities in the online supermarket and e-commerce domains.

The second approach is improving productivity. We will utilize digitization to conserve labor, power and space, and at the same time, seek to boost customer and employee satisfaction.

The third approach is enhancing organizational agility. In this age of future uncertainty, it is vital that we make business decisions with a sense of urgency. I believe it is important that we engage in a process of observation, analysis, judgment and action at our stores, our contact points with customers. To that end, we must also push ahead with digitally-driven management reforms.

Accordingly, fiscal 2020 and 2021 will be a period in which we ramp up our revival plan by squarely solving fundamental issues and building a foundation for a new growth.

For our earnings structure in particular, we have decided to first take steps to tackle and solve issues relating to sales per square meter, gross profit margin ratio and cost structure.

First, I'd like to review Aeon Retail's operations in the first half. Revenue in the first half dropped 3.1% from the previous fiscal year. In the first quarter, which coincided with the first wave of COVID-19 infections, revenue declined 5.6% year-on-year due to people refraining from outings and the suspension of operations of specialty store zones. But as we found ways to respond to the so-called, new normal, revenue improved from June onwards and came in at minus 0.7% year-on-year in the second quarter, nearly on par with the same period last year.

We were also permitted to keep our stores open even during the declared state of emergency, because our business operations are considered a lifeline for customers. As a result, we achieved our initial first half revenue target for food products.

The gross profit margin ratio deteriorated 1.2% year-on-year in the first half. It declined 2.7% year-on-year in the first quarter, particularly because of a slump in sales of clothing and household and recreational merchandise as a result of the restrictions placed on shopping in nonessential, nonurgent outings. However, the gross profit margin ratio improved to 0.1% year-on-year in the second quarter due to improved sales and inventory optimization from the first quarter. I believe we have a foundation in place from which we can work to improve the gross profit margin ratio.

As for expenses, we achieved a 4.6% year-on-year reduction because our revival plan progressed as planned from the start of the year. As a result of these factors, operating profit in the first half declined year-on-year. But in the second quarter, it recovered to be only JPY 3.1 billion short of last year's figure.

One factor behind the recovery, I believe, was the entire Aeon Group taking swift action to create an environment in which customers can shop with peace of mind. We did this by establishing the Aeon COVID-19 Protocol for Infectious Disease Control and implementing concrete measures to prevent the spread of infection.

We set up transparent acrylic boards as a measure against infection via respiratory droplets and placed markers on the floor near checkouts and on escalators, to ensure the customers practice social distancing. We also implemented similar measures in employee break rooms and other backroom facilities. We additionally distributed flyers to give our customers a better understanding of the initiatives being implemented. We believe the benefits of these measures led to a recovery in customer traffic and sales from the second quarter. And recent figures for October indicated that we are certainly on course for a recovery.

In the second half, we will maintain the initiatives implemented in the first half and step up our response to the new normal so that we can continue to be a lifeline for our customers and communities.

I will now discuss a number of specific initiatives we implemented in the first half. Demand in the online Supermarket Business surged because of COVID-19. To accelerate growth of the business and make it more convenient for users, in June, we established the online Supermarket division, which reports directly to me. We are working swiftly to increase the number of stores and pickup points.

The number of stores offering online supermarket services is currently at 185 and scheduled to reach 197 by December. We are also rapidly increasing the number of pickup points. Use of the pick-up service has grown, because it shortened shopping time. Means, no waiting at check-outs and limits instances of close contact. The service is currently available at 178 stores.

On September 10, 2020, we formally launched a drive-through pickup service at the Higashi-Kurume store, with a dedicated lane and intercom facility. We also expanded the online Supermarket product range with particular focus on fresh produce for which demand is growing among customers. Products like assortments of fish, fresh off the fishing boats and preordered fruit and vegetables from Toyosu market have proven popular. As a result of such initiatives, online supermarket sales were up 20% year-on-year, with sales of fresh produce actually growing as much as 50% year-on-year.

Online shopping is also growing. Elementary school backpacks have proven popular with customers, including the 24-color range of TOPVALU school backpacks launched in 2001, and the [indiscernible] school backpack range that went on sale in 2012. This year, we expanded the number of products sold online because many customers were unable to go shopping with their children due to people refraining from outings to prevent the spread of COVID-19.

In the first half of the current fiscal year, elementary school backpack sales were up 8% year-on-year, with online sales up 74% year-on-year, thanks partly to additional TV commercials.

We have also strengthened product offerings to meet demand for the gift items. In the current fiscal year, online sales of Mother's Day gifts overtook retail store sales, and overall sales of Mother's Day gifts exceeded sales in the previous fiscal year.

Next, I would like to talk about Regi go, which we launched last year. Regi go is a customer self-scanning and self-checkout service using special checkout kiosks and dedicated smartphones that we provide to customers to scan product barcodes. We are accelerating the expansion of Regi go because it shortens waiting times at checkouts and reduces instances of close contact. The Regi go service is currently available at 14 stores. At AEON STYLE, Ariake Garden, which opened in spring this year, 30% of customers are using Regi go.

There has been a marked increase in the number of family groups using Regi go with a service proving popular with children. We have succeeded in reducing the number of checkout operators with a 30% reduction in working hours at checkout at 1 store, helping to enhance productivity.

Customers can shop without worrying about waiting in line at the checkout and are less likely to forget to buy something on their shopping list because they can easily check everything they have scanned on their smartphones. Customers who use Regi go buy up to 20% more items than those who don't. We will continue to refine the features of Regi go, while rolling it out at all stores to makes shopping more enjoyable and convenient for our customers.

New demand for masks emerged amid the COVID-19 pandemic. To complement the nonwoven cloth masks sold in the Health and Beauty care category for preventing colds and seasonal pollen allergies, we developed a diverse range of masks as fashion items, such as the TOPVALU Peace Fit Gokusara Mask and lace mask.

Handicrafts specialty store, Pandora House, also sold handmade masks. Having prepared masks in a variety of different categories, we set up mask sales corners at 340 stores. Mask sales in the first half grew to JPY 10 billion overall. We are planning to launch masks suitable for the fall/winter season in the second half. So keep watching this space.

We've also developed products that meet stay-at-home demand. On your screen, you can see examples of newly developed HOME COORDY products. The 2-color pot allows users to cook 2 kinds of soup at home in a single pot and the Tall Kotatsu heated table with a USB port, which is convenient for those working from home. The Tall Kotatsu, in particular caused a buzz online and trended on Twitter. Products such as these that have been developed to meet stay-at-home demand are selling well and have been extremely well received.

We have also expanded sales floor space for health and wellness products. Sports-related demand, in particular, has increased among our customers due to the desire to boost immunity and stay healthy amid the COVID-19 pandemic. We're helping customers improve their health through 3 activities: walking, running and general fitness enhancement by accelerating the expansion of Sporsium, specialty sales corners, selling not only sportswear, but also providing general wellness information and products such as yoga mats, shoes and so on. Sporsium sales corners have already been opened at all stores, and sales were up 54% year-on-year in August.

In addition to expanding the sales floor space, we are also developing individual products in pursuit of enhanced functional performance. TOPVALU'S BODY SWITCH is performance innerwear that can be used for everyday activities or sports. Developed to provide excellent ease of movement, user-friendliness and a flattering silhouette, it is highly absorbent and dries quickly, while also offering excellent heat retention performance.

TOPVALU SELECT Celliant range of clothing helps the wear to recover from fatigue.

Registered as a general medical device, Class 1, it is the first private brand product range made from Celliant, a fabric that incorporates 13 minerals, including titanium and aluminum. Wearing Celliant innerwear at night and during the day over long periods of time helps with fatigue recovery and improves blood circulation. Sales of Celliant were up 130% year-on-year in August. We will continue our work on developing high-performance products like this. We are also taking action in response to growing public interest in sustainability.

SELF+SERVICE is an apparel brand developed around the concept of ethical consumption. Its objective is to enable consumers to contribute to environmental conservation and communities in their daily life through the development of products based on natural materials like organic cotton. The brand is currently sold at 270 stores.

Yves Rocher is a French botanical beauty care brand with 6,700 stores in 90 countries. In August 2019, Aeon Group became the exclusive distributor of Yves Rocher products in Japan. The products are high quality and made from select natural ingredients, yet, reasonably priced for everyday use. They are currently on sale at 193 stores, and we plan to sell them at more stores going forward. We also plan to expand the product range this autumn.

We were also one of the first retailers to move to reduce the use of disposable plastic shopping bags. On July 1, 2020, free plastic bags were banned by law, but Aeon Retail stopped providing free shopping bags at all retail stores from April 1, 2020, and promoted the use of reusable bags made from recycled plastic. With the cooperation of many customers, the percentage of customers who declined plastic shopping bags at checkout reached 88.8% in August 2020. We intend to continue responding rapidly to customer lifestyle changes in the new normal.

That's all from me on the situation on Aeon Retail in the first half and some of the initiatives we have been implementing.

I will now discuss the progress we have made with our revival plan. As I mentioned earlier, we consider fiscal 2020 to be a year for squarely solving fundamental issues and building a foundation for new growth. I will discuss the main initiatives we're implementing in relation to this.

We are trying to solve 2 issues: the first relates to gross profit margin ratios, primarily in the apparel and household and recreational lines. And the second relates to cost structure.

First, to solve the gross profit margin ratio issue, we optimize purchasing [ and ] store inventory for the apparel and household and recreational lines. Optimizing purchasing entailed steady, patient efforts to reduce SKUs and improve the sales ratio of each and every product item. Optimizing store inventory meant upfront disposal of slow-moving stock that accumulated due to the COVID-19 crisis. As a result of these efforts, Aeon Retail's overall inventory, which had increased temporarily due in part to the impact of COVID-19, began a sustained decline. And by the end of August 2020, it was down 21.8% from the beginning of the fiscal year. Inventory turnover improved by 10.2 days, thereby, already exceeding our initial target for fiscal 2022.

Gross profit margin ratios also began to improve from July in proportion with the reduction of inventory and faster turnover. These achievements have had a number of positive knock-on effects, such as increased work efficiency, enhanced product freshness and reduced storage costs.

With regard to food products, sales and gross profits have been growing amid the COVID-19 pandemic, which we think is due to our response to newly emerging demand centered on TOPVALU. As consumers stayed home to help prevent the spread of COVID-19, we absorbed demand for eating out by offering gourmet foods like Atlantic salmon and Tasmanian beef as well as expanding the range of easy-to-prepare time-saving frozen meals like Gyoza dumplings and fried rice. As a result, TOPVALU share of sales was 20% of all food products, up from the first half of the previous fiscal year.

We intend to continue developing TOPVALU products with the functions and purposes that customers require in order to further increase the brand's share of sales and pursue gross profit margin ratio enhancement and greater differentiation.

We also implemented 3 initiatives to tackle cost structure issues: first, we revised our organizational structure; second, we promoted digital transformation; and third, we work toward reducing operational costs.

We revised our organizational structure by redeploying key employees from headquarters to stores, to strengthen on-site power. We also reduced costs at headquarters by 21% year-on-year by streamlining meetings, seminars and recruitment activities, and shifting these online and conducting reviews of necessary expenses.

With regard to digital transformation, we used RPA and AI to replace some manual tasks and installed semi-automatic self-checkout registers and unmanned checkouts to cut expenses. With regard to operational costs, we cut working hours by standardizing work tasks and also reduced sales promotion costs.

Another major contributing factor behind reduction of operational costs was secondary effects of the inventory reduction that I mentioned earlier, such as reduced work time and lower equipment, rental and product storage costs. As a result of these initiatives, we lowered store costs by 5% year-on-year. We will continue to advance these initiatives in the second half and firmly establish them as standard operating procedures.

Finally, I would like to discuss a growth model that we are currently piloting with a verification test that started this month at AEON STYLE Ariake Garden. We have positioned Ariake as a pilot store, that combines the existing AEON STYLE model with digital technologies. We have launched a new combination model that merges analog and digital approaches, such as promoting cashless, contactless shopping with the Regi go service, displaying product descriptions and menu suggestions with digital signage, using digital sales promotion based on shelf ad video displays and preventing the 3 Cs, closed spaces, crowded places and close contact settings, with a system that monitors the number of customers in the store, using cameras and AI.

We will be working to identify customer lifestyle changes that have been highlighted by COVID-19 crisis, and harness our product development and sales floor development capabilities together with digital transformation to hone our competitive advantage of comprehensive strength, to further accelerate growth.

This concludes my presentation on Aeon Retail. Thank you.

[Unknown Analyst]

You mentioned that the speed of reforms is important. Looking at the second quarter results, I'm amazed at how quickly you were able to implement reforms given your company's scale and the extent of the reforms.

From a management viewpoint, what do you need to do to further increase management speed? And what areas do you need to focus on with this?

The results suggested the reforms implemented in the second quarter may enable you to continue generating favorable results without worrying too much about fluctuations in business conditions or a renewed outbreak of the coronavirus. Please share with us your thoughts on the current status of the speed of reforms and future challenges you face.

[Unknown Executive]

It's been a half year since the start of the novel coronavirus pandemic, and we have seen many changes occurred at rather incredible pace. At first, store managers were at a loss as to how to respond, but I believe the extent to which store managers are allowed to make their own decisions is a crucial factor in the speed of our response.

For example, we were able to create mask sales areas with an ample supply of masks in about half a month because purchasing managers and sales floor managers acted quickly with a shared understanding of the situation. Customers responded favorably. And as President Ide reported earlier, we were able to generate JPY 10 billion in mask sales.

When store managers see customers respond positively to their decisions and actions, they begin to sense the joy of working. I think it is extremely important to provide our store managers with opportunities to have successful experiences like this. We are seeing this beginning to flourish at Aeon Retail. I think the fact that actions are now being initiated at the store level is an important factor. However, it is also important for top management to prepare for the worst and provide proper guidance.

Of course, there are a lot of things that store managers can accomplish and things they cannot, but they should take action while clearly stating that, this is the best response for this situation, and be ready to analyze the results later, if things do not go as planned.

I think that the lesson our employees learn from this pandemic is that they must first take action and respond in an agile manner. The same can also be said for infection countermeasures. When we decided to install protective panels at cash registers, the first thought was, how long will these be needed? However, at a certain point, we decided that, that is something we will continue with. And we invested hundreds of millions of yen in installing acrylic panels, which has created checkout spaces that customers feel are hygienic.

The decision was made by President Ide as the Head of Management at Aeon Retail. He gave sound instructions to staff, and that let each store implement measures in a flexible manner. I think creating this type of corporate culture is extremely important, and I think we are seeing the emergence of a more agile Aeon Retail as a result.

[Unknown Analyst]

So can we expect further increases in speed with digital transformation?

[Unknown Executive]

Absolutely. I believe digital technologies will have the biggest impact on the speed of change.

The new Yasutsugu administration has clearly indicated, it intends to push forward with digitalization, including the creation of a new digital agency. Those who don't catch this wave will not be able to compete.

In the case of the omnichannel model experiment that we're conducting at AEON STYLE Ariake Garden, which was mentioned earlier, we place orders for the necessary equipment and systems immediately after the decision to conduct the experiment was made. As for digitalization as well, we are going to move forward in an agile manner by trying various things out at first and then working on fine tuning.

[Unknown Analyst]

I guess the impression that the recovery in earnings is very clear at the operating profit and ordinary profit stages, but I wonder what caused the apparent sharp rise in the cost of sales. Also, although second quarter profits are up sharply through the ordinary profit level, you were not able to return to the black at the net profit level but instead posted a small loss. I imagine that impairment losses and the coronavirus-related extraordinary loss were significant, but can you explain the reason for the slight loss at the bottom line?

[Unknown Executive]

As President Ide mentioned earlier, we are focusing on increasing sales and generating gross profit. So the point is, how we view inventory after linking it to sales and purchasing. Considering Aeon Retail only, loss and valuation of products reduced gross profit by JPY 10 billion. Of this amount, JPY 7 billion was written off in May. This inventory was then sold off completely during the June sale, enabling the inventory to be converted to cash. That cash was then used to purchase new merchandise. We work to steadily manage sales and gross profits, while considering the amount of cash generated by this inventory turnover and the inventory turnover period.

In short, our actions were based on consideration of the balance between sales, purchasing and inventories. As a result, we successfully reduced our inventories. We also reduced backroom inventories and inventories at distribution warehouses. This led to a virtuous circle that enabled us to devote more staff time to preparing sales floors.

In the second quarter, inventory disposal amounted to JPY 3 billion, which is being linked to sales in October. So the answer to your question is that our response reduced gross profit by JPY 10 billion in the first half.

Essentially, the first half saw a significantly managed cash flow and gross profit by using the difference in cash generated by inventory turnover sales and cash needed for new purchases. This challenge is also being taken up by other group companies as well as specialty stores. We will use the same approach in the second half, thus continuing this practice for the full year.

As for net profit, I think you will remember that in the first quarter, we posted about a [ JPY 30 billion ] extraordinary loss related to expenses generated during the period, when businesses were being requested to suspend operations or shorten business hours. About JPY 3 billion was pushed into the second quarter, because an audit could not be completed in time. As for store impairment losses, future annual cash flows are hard to assess, until the fourth quarter.

If you look at our portfolio of companies, you will notice that our group companies can be divided into 3 different groups, those benefiting from tailwinds, those encountering headwinds and those that have paused to revise their business models. Accordingly, in the third and fourth quarters, we will steadily respond to each of those groups, while examining their respective circumstances.

As a result, our decision to close some stores as planned, will generate an extraordinary loss.

[Unknown Analyst]

So would it be correct to say, that if those extraordinary losses had not slipped into the next quarter, net profit would be close to being in the black?

[Unknown Executive]

That is correct.

[Unknown Analyst]

My question is about the composition of group operating profit. Until recently, operating profit was driven by the Shopping Center Development and Financial Services Businesses, but this has changed greatly due to the impact of the novel coronavirus pandemic. Do you expect this situation to continue for the medium to long term? How long do you think it will be until the contributions from the Shopping Center Development and Financial Services Businesses return to their pre-pandemic levels?

Also, while I think it may not be easy for you to say, given the wide range of businesses the Aeon Group is engaged in, when do you expect digitalization to contribute to operating profit?

[Unknown Executive]

Last year, earnings were supported by the Shopping Center Development, Financial Services and Drugstore Businesses, which compensated for the damage to retail earnings. As I mentioned earlier, this year, a complementary relationship has developed, but the Shopping Center Development Business's profit decline was clearly due to temporary store closures. Meanwhile, the Financial Services Business' earnings decline was clearly due to the need for provisions for bad debt.

As I said, when discussing China, our business model is not broken. Based on consideration of circumstances in China and the current number of Aeon Mall customers, we expect a gradual recovery.

The segment that currently requires the most careful handling is the Supermarket Business. After seeing its profitability decline in recent years, the Supermarket Business suddenly became a top earner in the first half of this year. The question now, however, is how long the business can hold on to its top earner position? Since its earnings were buoyed by special demand, some fallback is to be expected.

Another important question is, if they can retain newly won customers and get customers whose purchases increase during the pandemic to continue shopping at similar levels. I think that if we can limit the decline, it will be an added plus when earnings of their Shopping Center Development and Financial Services Businesses rebound, and we will be in good shape. I regard this as a major point going forward.

As for our Drugstores, my sense is that they should continue to do well, benefiting from the tailwind provided by the heightened awareness of hygiene that has become more firmly-entrenched among consumers. If we make the right moves, I feel that our business portfolio could become even better balanced than before.

However, the outlook remains unpredictable. And as I mentioned at the start of this presentation, business sentiment in the second half looks quite negative. I expect price competition will intensify, lowering our profitability as the intense competition is reflected in our product prices. While there is some uncertainty, I'm not pessimistic about the outlook for our Shopping Center Development and Financial Services Businesses.

Regarding digitalization, President Ide mentioned earlier that online supermarket sales increased 20% year-on-year during the novel coronavirus crisis, but there were periods in which even greater leaps were seen. Several stores are now achieving profitability through their online supermarket services. In 1 month, our online supermarket business generated a total profit of JPY 400 million. We now know that we can exceed the breakeven point, if we can increase customer numbers to a certain level. We believe this can be a viable business, if we can expand customer purchase sizes, including through the use of various channels and pickup methods.

[Unknown Analyst]

Is it difficult to accelerate your project with Ocado?

[Unknown Executive]

Our project with Ocado has a set schedule, and it will take some time to construct the buildings and get all the equipment installed. As much as we'd like to shorten the preparation period as much as possible, shortening the construction period is difficult. However, with the demand for online supermarkets rising considerably, Aeon Retail has responded by establishing a separate organization that has increased its agility remarkably, and its efforts to meet the rising demand are centered on this new organization. I believe this new organization will enable Aeon Retail to increase its capacity for meeting this demand.

[Unknown Analyst]

You have not revised your full year earnings forecast. Can you tell us what aspects of the operating environment in the second half and beyond might have the biggest impact on earnings?

[Unknown Executive]

The impact from a third wave of infection. The government has considerably relaxed its infection prevention measures as it seeks to buoy the economy through such measures as the go-to campaign, while also preventing the spread of the coronavirus.

Europe and other areas have suffered considerably from second and third waves of this pandemic. I hope that Japan does not find itself in the same predicament. We are already seeing an increase in domestic travel, but I think things can go well, if everybody wears masks and observes the rules and etiquette, they can prevent the spread of this virus. It will not do, however, if people let their guard down. And the situation begins to resemble today's Europe. I see that as a potential risk.

I think the biggest risk for us is the risk of such a situation arising during our peak sales season. However, during my visits to stores, I've gained the impression that customers are really being quite cautious.

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