Edited Transcript of 023530.KS earnings conference call or presentation 9-May-19 8:00am GMT

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Kyong Seo Park, [5]

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(foreign language)

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Ji Hwan Seol, [6]

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[Interpreted] On Page 4, you can find the summary of consolidated financial results. In the first quarter of 2019, Lotte shopping’s consolidated revenue was approximately KRW 4.4 trillion, indicating 2.6% year-over-year increase. Operating profit was KRW 205 billion, indicating 7% increase year-over-year decline. Net profit totaled KRW 109 billion. Just as a reminder, the consolidated financials include 46 affiliate companies.

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Kyong Seo Park, [7]

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(foreign language)

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Ji Hwan Seol, [8]

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[Interpreted] Page 5 is the brief financial summaries of major business divisions. I’ll now move on explaining divisional operational summaries starting from Department Store on Page 6.

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Kyong Seo Park, [9]

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(foreign language)

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Ji Hwan Seol, [10]

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[Interpreted] On Page 6 is the Department Store operation summary. Domestic SSSG rate was up by 0.6% Y-o-Y in the first quarter of this year. Sales revenue have increased in home appliances and electronics, global fashion and men’s sportswear. However, food, womenswear and accessories categories have shown weak sales trend. For your reference, there was a one-time revenue of KRW 45.1 billion in the first quarter of last year regarding Pyeongchang Olympics good sales. Despite the efficient cost management efforts, first quarter operating profit for Domestic Department Store was KRW 154.7 billion indicating 3.5% decline Y-o-Y, mainly due to one-time profit coming in — came in from the first quarter of 2018 regarding Pyeongchang Olympic group sales. As 40 overseas Department Store operation, sales revenue has decreased due to store closures in China. However, and more importantly, its operating loss has turned into profit generation through SG&A reduction along with the restructuring progress in China.

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Kyong Seo Park, [11]

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(foreign language)

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Ji Hwan Seol, [12]

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[Interpreted] On Page 7 is the Hypermarket division. Domestic Hypermarket SSSG rate was declined by 3.6% Y-o-Y in the first quarter of 2019, mainly due to undergoing merchandising restructuring work. However, operating profit has increased through SG&A reduction of KRW 4 billion year-over-year. Just as a note there was a new accounting standard application which affected KRW 6.3 billion year-over-year decrease in the SG&A. As for the overseas operation, SSSG rate was up by 4.3% Y-o-Y in the first quarter of 2019. Operating profit of Indonesia division was increased by 53% year-over-year through a solid SSSG trend and new store openings. Operating profit has increased in Vietnam by 93% year-over-year, driven by a strong 9.8% SSSG rate. Overseas operation is becoming more prominent as the new growth engine for Lotte Hypermarkets division. For your reference, we have provided details of overseas Hypermarket strategies on Page 17 and 18 of today’s presentation material.

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Kyong Seo Park, [13]

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(foreign language)

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Ji Hwan Seol, [14]

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[Interpreted] Page 8 is the Himart, our electronic specialty retail division. 2019 first quarter revenue was KRW 1 trillion, indicating 8.9% Y-o-Y increase. Sales revenue has increased in air pollution related home appliances category, such as air purifier, laundry dry machines, air conditioners and et cetera. Online shopping sales has also shown significant sales growth in the first quarter. Himart’s first quarter operating profit was KRW 24.3 billion, indicating 41.3% decrease year-over-year, mainly due to decline in gross profit margin, which was affected by increased online sales portions and aggressive promotion events. Decreased operating profit was also affected by increase in labor cost and SG&A. Himart plans to improve its profitability by developing more [PB] products and expanding premium product offerings as well as home appliances for maintenance service expansion.

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Kyong Seo Park, [15]

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(foreign language)

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Ji Hwan Seol, [16]

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[Interpreted] Page 9 is the Supermarket division. Same-store sales growth rate was increased by 1.9% year-over-year in the first quarter of 2019. Sales revenue has increased by 4.5% Y-o-Y from fresh food categories. In particular fresh meat and convenience food have shown significant sales growth. Supermarket’s first quarter operating loss was stretched Y-o-Y due to store closure impacts and undergoing store renovation work. In the second half of 2019, we plan to improve our profitability through a sales recovery and cost optimization efforts.

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Kyong Seo Park, [17]

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(foreign language)

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Ji Hwan Seol, [18]

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[Interpreted] Financials related to other business units are listed on Page 10 for your reference. In the first quarter, Lotte Home Shopping recorded KRW 231.8 billion of revenue, indicating 0.5% Y-o-Y increase. And its operating profit was KRW 33.2 billion, which was up by 4.6% year-over-year. Despite the solid gross sales trend, the net revenue has only increased slightly, mainly due to increased sales mix portion of lower margin products. Lotte Cultureworks, our cinema division, the revenue was KRW 201 billion, indicating a 15% Y-o-Y increase. And its operating profit was KRW 8.3 billion, which was increased by 26% Y-o-Y. Domestic operation revenue was up by 13% Y-o-Y, and its operating profit has also increased by 37% Y-o-Y, mainly driven by increased box office sales as well as moderate success from invested films. Revenue from Overseas’ cinema operation has increased year-over-year in the first quarter but its operating loss has been increased due to increased SG&A, regarding new theaters openings in Vietnam.

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Kyong Seo Park, [19]

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(foreign language)

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Ji Hwan Seol, [20]

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[Interpreted] Nonoperating financial summary is provided on Page 11. In the first quarter of 2019, increased interest expense of KRW 52.9 billion year-on-year was reflected due to new lease accounting standard adoption.

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Kyong Seo Park, [21]

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(foreign language)

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Ji Hwan Seol, [22]

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[Interpreted] Equity method financial summary is provided on Page 12. Equity method gains from FRL Korea, which is UNIQLO, which was KRW 4.9 billion in the first quarter of this year. ZARA Retail Korea equity method loss was KRW 0.7 billion. I’ll now finish today’s presentation here. Before we begin the Q&A session, Mr. (inaudible), head of corporate strategy for E-commerce division will briefly explain Lotte Shopping’s e-commerce strategy. Please refer to Page 20 for the e-commerce strategy explanation. And after the e-commerce strategy explanations, we will begin the Q&A session. Thank you.

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Unidentified Company Representative, [23]

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(foreign language)

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Unidentified Company Representative, [24]

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[Interpreted] This is (inaudible) in charge of planning department of Lotte e-commerce. I will now explain Lotte’s e-commerce strategy.

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Unidentified Company Representative, [25]

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(foreign language)

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Unidentified Company Representative, [26]

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[Interpreted] Lotte will integrate 38 million of the customers and 100,000 directly-sourced products to make consolidated updates in the e-commerce platform.

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Unidentified Company Representative, [27]

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(foreign language)

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Unidentified Company Representative, [28]

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[Interpreted] Lotte will open this platform to small online sellers who will add more products, which will attract more traffic, which will then attract more [online] sellers. Creating this virtual cycle is the key to Lotte e-commerce strategy.

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Unidentified Company Representative, [29]

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(foreign language)

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Unidentified Company Representative, [30]

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[Interpreted] To do so, Lotte established Lotte E-commerce as a division of Lotte Shopping last June and Lotte E-commerce integrated all Lotte Group E-commerce IT engineers and added hundreds of new IT engineers. Lotte E-commerce built the first phase of 1 Lotte e-commerce system and launched new L-Lotte service successfully last December.

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Unidentified Company Representative, [31]

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(foreign language)

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Unidentified Company Representative, [32]

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[Interpreted] And Lotte launched the Lotte ON service on March 28, linking 7 Lotte e-commerce services together.

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Unidentified Company Representative, [33]

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(foreign language)

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Unidentified Company Representative, [34]

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[Interpreted] Since the opening, monthly active users in April was 3.85 million, up 60% Y-o-Y. Gross merchandise volume was KRW 467.5 billion, up 23.7% Y-o-Y. And membership grew by 415,000 or by 12.4% from March.

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Unidentified Company Representative, [35]

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(foreign language)

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Unidentified Company Representative, [36]

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[Interpreted] Lotte ON service enables the customers to use all 7 Lotte e-commerce services: L-Lotte, Lotte Mart, Lotte Fresh, LOHB’s, lotte.com, [Lotte] Shopping and Lotte Himart after logging into one of the 7 apps. The UI is simple and standardized for ease-of-use and familiarity. It also has some integrated search and recommendations feature, allowing access to products of all — allowing access to products in all 7 services without having to visit all of them.

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Unidentified Company Representative, [37]

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(foreign language)

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Unidentified Company Representative, [38]

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[Interpreted] Thanks to Lotte ON service, Lotte retail companies can now easily offer cross-links, co-marketing or omni marketing. And more integrated views of customers are being accumulated.

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Unidentified Company Representative, [39]

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(foreign language)

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Unidentified Company Representative, [40]

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[Interpreted] In March 2020, Lotte plans to launch the integrated Lotte app by consolidating the remaining 6 Lotte e-commerce services. The integrated Lotte app will combine not only logins but also product information, search, recommendation, order payments and customer support.

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Unidentified Company Representative, [41]

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(foreign language)

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Unidentified Company Representative, [42]

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[Interpreted] And personalized integrated search and recommendation will be the leading strength of this integrated app.

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Unidentified Company Representative, [43]

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(foreign language)

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Unidentified Company Representative, [44]

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[Interpreted] Lotte will integrate e-commerce terms and conditions as well as purchasing and behavior data. We’ll also try to lock-in our customers by launching Lotte prime membership, which offers not only online benefits such as free delivery but also offline benefits such as free parking and free movie tickets.

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Unidentified Company Representative, [45]

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(foreign language)

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Unidentified Company Representative, [46]

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[Interpreted] Lotte will keep differentiating itself by adding services such as repair, installation and after-sales service. Lotte will also add an open marketplace to allow small online sellers to freely sell their products on the Lotte e-commerce platform. And we also experimenting with a [share] e-commerce where individuals can exchange used products.

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Unidentified Company Representative, [47]

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(foreign language)

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Unidentified Company Representative, [48]

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[Interpreted] To prepare for the emerging Voice Commerce, the AI shopping adviser currently being experimented by L-Lotte will be upgraded and added to the integrated Lotte app and new smart devices.

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Unidentified Company Representative, [49]

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(foreign language)

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Unidentified Company Representative, [50]

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[Interpreted] For this purpose, Lotte Shopping will invest KRW 800 billion until 2023, KRW 200 billion for the integrated Lotte app, KRW 80 billion for AI and KRW 520 billion for logistics. This concludes my presentation.

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Ji Hwan Seol, [51]

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(foreign language) Now if you will begin the Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question will be given by Ji Hye Yang from Meritz Securities.

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Ji Hye Yang, Meritz Securities Co., Ltd., Research Division – Analyst [2]

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(foreign language)

[Interpreted] So my first question is pertaining to the new lease accounting under the IFRS 16. So after this, what has been the impact on the operating profit of the overall group? So for example, the SG&A and the interest expense and income. So what has been the impact on the operating profit? And the second question is — so you have just given a detailed explanation about your e-commerce strategy. So I wonder then, now for your e-commerce this year. So what is going to be the gross merchandise value for Lotte Shopping e-commerce? So can you give us the guidance for this year?

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Unidentified Company Representative, [3]

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(foreign language)

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Ji Hye Yang, Meritz Securities Co., Ltd., Research Division – Analyst [4]

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(foreign language)

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Unidentified Company Representative, [5]

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[Interpreted] Now first about the lease accounting. So on a consolidated basis in the first quarter, operating profit went up by KRW 20 billion, And for the — (foreign language) So for the interest expense, this will also increased by KRW 53 billion. So overall, for the [ordinary] income this had an impact of minus KRW 33 billion. (foreign language) And for the e-commerce, sorry. So for e-commerce the guidance of the gross merchandise value for this year is KRW 3.8 trillion.

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Unidentified Company Representative, [6]

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(foreign language)

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Operator [7]

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Currently there are no participants with questions. (Operator Instructions) The following question is by [Kee Young Han] from IBK Investment & Securities.

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Unidentified Analyst, [8]

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(foreign language)

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Unidentified Company Representative, [9]

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(foreign language)

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Unidentified Analyst, [10]

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(foreign language)

[Interpreted] So my question is pertaining to Page 10, #5 other business units. So under that [is where we get] the operating profit and [under] others it says minus KRW 21 billion. Can you explain what this is?

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Kyong Seo Park, [11]

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(foreign language)

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Unidentified Company Representative, [12]

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[Interpreted] Now let me explain the others — under the other business units. So here we have had the loss from LOHB’s in the amount of KRW 7.4 billion, from e-commerce KRW 13.7 billion and from [GFR] KRW 65.8 billion.

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Unidentified Company Representative, [13]

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(foreign language)

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Operator [14]

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The following question is from Hyeeun Kim with Morgan Stanley.

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Kelly H. Kim, Morgan Stanley, Research Division – MD [15]

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(foreign language)

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Unidentified Company Representative, [16]

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[Interpreted] I have 2 questions. First is about your Overseas department business. I see that some of them have turned to operating profit and especially China it seems that there has been profit because of the reversal of the provisions. So then given that the restructuring will continue throughout the year and you believe that the profitability in the Chinese Department Stores for this year. So what is your expectation or guidance for the profitability of the Chinese Department Stores? And the second question is about the lease accounting under the IFRS. So we have seen the impact in the first quarter of this year. So do you believe that in — throughout the rest of this year so going into the second, third and fourth quarters, this impact will remain? In other words, along the amount of about KRW 33 billion? Or do you expect to see changes here?

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Unidentified Company Representative, [17]

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(foreign language)

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Unidentified Company Representative, [18]

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[Interpreted] Now first about the Department Stores in China. So among the 5 Department Stores, 3 — for 3 we have completed the restructuring. So for the 3 Department Stores, the reversal provision is in the amount of KRW 13 billion.

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Ji Hwan Seol, [19]

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No. It was KRW 10.3 billion.

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Unidentified Company Representative, [20]

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[Interpreted] It was KRW 10.3 billion so the reversal to the provision is KRW 10.3 billion for the 3 Department Stores in China. And then 2 Department Stores are still in operation, 1 in Shenyang, the other in Chengdu. So 1 in Chengdu is expected to return to profit this year where as the one in Shenyang is expected to continue to see a negative growth.

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Kyong Seo Park, [21]

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(foreign language)

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Unidentified Company Representative, [22]

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[Interpreted] And regarding the second question about the lease accounting and it’s impact. Now for the Lotte Shopping on a consolidated basis. So unless there is a large-scale new leasing to occur in the second and third and the fourth quarters of this year, we can expect the impact of the new accountings to be roughly similar to this quarters.

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Unidentified Company Representative, [23]

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(foreign language)

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Unidentified Company Representative, [24]

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[Interpreted] And let me explain a bit more about the lease accounting. So for this, the depreciation and amortization and also the interest expense. So they should be treated as identical or they should be treated as equivalent. But then [other] is a more discount at this point. So at this point, there has been more impact on the expenses. But down the road we believe that this is going to be reversed, so between the depreciation and amortization and interest expenses, they will be roughly similar.

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Operator [25]

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The following question is from HeeJin Park from Shinhan investment.

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HeeJin Park, Shinhan Investment Corp., Research Division – Analyst [26]

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(foreign language)

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Unidentified Company Representative, [27]

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[Interpreted] Now I also have several questions. First is about the Domestic Hypermarkets. So for the lease accounting, because of that, perhaps there — it appears that the profitability has improved. So what do you see as the trend in profitability of this year? So do you believe that your profit will continue to improve? Or will there be overall improvement in the profit and loss of the Domestic Hypermarkets? And then the second question. So for the Domestic Hypermarkets, you have also opened a new store in [Gongyeong]. So what is your plan for additional openings? And then the third question is about [Yongsan Seoul] Train Station store as well as for the Seoul Train Station. So what is your plan for the train station stores?

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Ji Hwan Seol, [28]

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Let me make a slight amendment on the second question. The second question was regarding the [Ritz] transaction. And the question was asking whether will there be additional stores added in the Ritz ?

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Kyong Seo Park, [29]

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(foreign language)

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Unidentified Company Representative, [30]

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[Interpreted] Now regarding your first question on the Hypermarket. So in the first quarter — so we believe that for the remaining of this year, the impact from the lease — new lease accounting would be similar. But even putting that aside, we believe that for the year — throughout the year this year, the operating profit is going to turn to profit.

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Unidentified Company Representative, [31]

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(foreign language)

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Unidentified Company Representative, [32]

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[Interpreted] Now regarding your second question about the Lotte [Ritz] lease transaction. So by having the value [incline] contribution from the [Gongyeong] store. So this is the first step — it would be the first step in our new endeavor. And this is the preparation for us to have additional selloffs of the Department Stores and Hypermarkets. And at this point, it is difficult for us to provide additional disclosure. But then we will be reviewing the Hypermarkets and the Department Stores for selloffs in the future.

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Unidentified Company Representative, [33]

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(foreign language)

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Unidentified Company Representative, [34]

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[Interpreted] About the [Yongsan Seoul] Train Station, so they have begun the public bidding. So we are currently producing the proposal for this and as for our department store. So our strategy is to keep predicting our sales.

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Unidentified Company Representative, [35]

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(foreign language)

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Unidentified Company Representative, [36]

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[Interpreted] And as for the Hypermarket in the Seoul Train Station, our strategy here is to continue to protect our existing sales. So we have come up with the [plan] to do so. And so we would try to make sure that the sales in the Hypermarket in the Seoul Train Station will continue.

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Operator [37]

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Currently there are no participants with questions. (Operator Instructions)

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Unidentified Company Representative, [38]

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(foreign language)

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Operator [39]

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The following question by Ji-young Lee from NH Investment & Securities.

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Ji-young Lee, NH Investment & Securities Co., Ltd., Research Division – Analyst [40]

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(foreign language)

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Unidentified Company Representative, [41]

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[Interpreted] My question is about the Domestic Department Stores. So I understand that the restructuring on some stores is still ongoing. So I wonder whether you have plans for key restructuring down the road, so from the second quarter and on?

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Unidentified Company Representative, [42]

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(foreign language)

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Unidentified Company Representative, [43]

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[Interpreted] Now for Department Stores, so for the small- to medium-sized Department Stores in noncapital regions and also for the underperforming stores, we would continue to restructure them. So either sell them off or restructure them, whether they are leased stores or directly operated stores. But then it is too early for us to tell which stores would be subject to such restructuring.

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Ji Hwan Seol, [44]

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(foreign language) We will now finish today’s earning announcement and the further questions will be will be answered by our IR team through individual meetings. Thank you.

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]