Bridge Report:（2722）I.K Fiscal Year May 2019

Chairman & CEO Hiroshi Iida	I.K Co., Ltd. (2722)

Company Information

Stock Information

*The share price is the closing price on July 17. Shares Outstanding, ROE, DPS, EPS, BPS are taken from the financial settlement report for FY 5/19.

Earnings Trend

*Unit: million yen. Stock split in a ratio 1:2 was conducted on 1st December, 2017 and 1st April, 2018. EPS and DPS were retroactively adjusted.

The financial statement for fiscal year ended May 2019 and many more about K.I Co., Ltd. will be described.

Table of Contents

Key Points
1. Company Overview
2. Fiscal Year ended May 2019 Earnings Results
3. Fiscal Year ending May 2020 Earnings Forecasts
4. Conclusions
<Reference: Regarding Corporate Governance>

Key Points

• The sales for the fiscal year ended May 2019 were 17,614 million yen, down 3.9% year on year. The demand from foreign visitors was sluggish. Gross profit margin and amount rose; however, the sales efficiency of “Butterfly Abs,” which is the main product in television shopping, declined. Selling, general and administrative expenses could not be absorbed, resulting in a fall in operating income by 51.9% year on year to 431 million yen. The forecasts for the business results were revised downwardly twice in October 2018 and April 2019. Sales and profit decreased for the first time in 5 years.

   

• The sales for the fiscal year ending May 2020 are estimated to decline by 3.9% year on year to 16,946 million yen and operating income is projected to rise by 33.6% year on year to 577 million yen. The amount of dividend that the company will pay is expected to remain unchanged at 12.00 yen/share. The estimated payout ratio is 22.3%. In order to be the world’s one and only “marketing manufacturer,” the company plans to analyze the market data while proceeding with BtoC and BtoBtoC businesses; then, it will utilize the data for product development and sell the products again through the diverse sales channels of BtoC and BtoBtoC with promotions. Moreover, it will put the effort into enriching the training system of its employees and using RPA and AI to improve productivity by streamlining internal operations.

   

• Unfortunately, the forecast was revised downwardly again, and sales and profit declined for the first time in 5 years. The decline in demand from foreign visitors was the main causing factor to decline sales, which is unlikely to make a major recovery during this term. Therefore, the key factor for recovery from this term onwards will depend on the performance of the new business model of “multi-channel retailing that starts from TV shopping,” which was almost established during the previous term. The company thinks that it has developed a lineup of products that are good enough to be incorporated into their portfolio for the TV shopping slot. We would like to monitor the sales performance of their products, especially their hit product, “Butterfly Abs DT.”

   

• On the other hands, as for the company’s makeup cosmetics brand “LB,” whose sales in the Chinese market is going to be a major pillar for their growth strategy, the company expects to obtain the permission from NMPA (formerly CFDA) for adding 20 SKU, which will augment the existing SKU to 50 SKU; thus a strong base for operation will be ready. The company reported more activities in Taiwan, Hong Kong, and South Korea, and we are looking for any concrete progress.

   

1. Company Overview

I.K Co., Ltd. is a “marketing manufacturer,” which conducts integrated business activities including product planning, manufacturing, selling and distribution through its original promotion strategy. It conducts 3 businesses: the manufacturer-vendor business, which sells products such as sundries, food product and cosmetics through diverse sales channels including co-op, mail-order firms, physical stores and television shopping, the SKINFOOD business, which sells cosmetics, and the IT Solutions business, which develops contact centers, etc.
The company strives to establish a group management to make all stakeholders its fans by promoting “the increase of fans” as its corporate philosophy.

1-1 Corporate History

After spending his high school and college days in a “freewheeling” school environment, Mr. Hiroshi Iida (present chairman and CEO), who had a strong entrepreneurial spirit from the beginning, worked for a nonlife insurance company and went on to establish I.K Ltd. in May 1982. While working on the sales of various products, he opened an account of Aichi CO-OP Union in April 1983 on getting favors from people in charge of sales, and started trading with occupational co-ops.

As the sales of flyers about a rechargeable cleaner, the first product, became a major hit, the horizontal expansion to other co-ops progressed, the number of items handled also increased and the business expanded rapidly. It got listed on the JASDAQ market in December 2001.
Due to the increase in recognition and reliability after the listing, the company began supplying products to the mail-order systems of department stores and retailers in a full-fledged manner, steadily expanding sales outlets, and achieved sales increases for 25 consecutive terms until the fiscal year ended May 2007.

However, as the Lehman’s bankruptcy put the growth at halt, the company shifted to a “marketing manufacturer” that conducts integrated business activities including product planning, manufacturing, sales and distribution of products on its own using a unique promotion strategy and established “B to C channels” in addition to “B to B to C” to offer its products directly to customers, which allowed it to return to the growth track once again.
The company is actively putting efforts in M&A such as making Prime Direct Inc., a major company for television shopping, into a wholly owned subsidiary in September 2014.

1-2 Management Philosophy

1-3 Business Description

I.K Co., Ltd. has had three business segments until the end of FY 5/19: the manufacturer-vendor business, which sells sundries, food, cosmetics products, etc., the SKINFOOD Business, which sells cosmetics products and the IT Solutions Business, which develops contact centers, etc.
Furthermore, from the fiscal year ending May 2020, the company will enhance the operation speed and focus investments on promising businesses, all of which are necessary steps for growth. In addition, it will try to let investors gain a better understanding about its business. That is why the company will change the business segment to “BtoBtoC Business,” “BtoC Business,” and “Other.”

* About the new segments
The old segment was reconstructed to a new segment as below

* The IT Solutions Business is categorized as Other because it is less significant.

(1) Manufacturer-vendor Business
The company has two business formats, i.e., the “manufacturer-vendor business format,” which provides cosmetics, apparels, shoes/bags, beauty and health related products, etc., planned and developed by the company as a manufacturer to a variety of sales outlets such as co-ops, mail-order companies, and stores, and the “manufacturer retail business format,” which provides products to consumers directly using the company’s website or the slots of television shopping of its subsidiaries.
The company also offers products in overseas variety stores, drug stores, TV shopping, and their website mainly in Asia.

(Major Sales Routes)

(Main Products)

<<cosmetics>>

<LB>	<B!FREE+>
<intima>	<SKINFOOD>

<< Sundries>>

<Butterflyabs DT>	<LOCOX>
<STEP 8>	<Speed heat vest>

<<Food Products>>

<Aged black garlic>	<tear grass extract>
<Lowcalo Life>	<Prussia 8>

(Source: the company）

(2) SKINFOOD Business
The wholly owned consolidated subsidiary Food Cosme Co., Ltd. is opening stores of Korean cosmetics brand’s food cosmetics "SKINFOOD" mainly in station buildings in major cities of Japan.
The number of stores as of the end of May 2019 is 23, which includes 21 directly managed stores and 2 FC stores.

(3) IT Solutions Business
The wholly owned consolidated subsidiary Alfa Com Co., Ltd. sells systems related to the development of contact centers, such as the voice call recording system “Voistore,” the business version of LINE called “LINE WORKS,” the chat system “M-Talk,” etc.

1-4 Characteristics and strengths: Business model as a marketing manufacturer

The primary point characterizing the company is a business model as a "marketing manufacturer" which conducts integrated business activities including planning, manufacturing, sales, and distribution of products on its own with a unique promotion strategy.
The company’s business model is composed of the following 3 functions.

(1) Powerful product development, discovery, and procurement
The company is developing, discovering and procuring attractive products by taking advantage of information gained from a wide range of sales channels and experiences cultivated over 30 years. The "Development Approval Conference" is held once a month, and three teams of cosmetics, sundries and food with 7 to 8 members in each team, propose new products to officers and people in charge of sales.
In their company where challenges are valued, each team proposes an average of 10 or more items each month based on freewheeling ideas, but not everything is approved.

The company has set "10 rules for development," which stipulates "emphasis on originality" and "thorough differentiation" regarding product development, and the proposed product is strictly criticized based on them, and homework is given out sometimes. However, these processes train the staff members in charge of development and are leading to further enhancement of product development capabilities.

(2) High marketing ability
“High marketing ability” is playing a major role in developing a hit product.
Test marketing is conducted using various sales channels to check whether candidate products actually sell well. By making innovations in various aspects such as package, timing, target and price and conducting new promotions, the company has been creating many hit products.

(3) Various sales channels
Rather than just proposing products to the various sales outlets mentioned above, they propose the best ways of selling and showcasing in other sales channels together with successful stories of those channels.
They blend ideas unique to I.K co., Ltd. with the needs and feedbacks of customers and brush them up daily.
It is a major feature of the company that it provides all solutions, which fit the sales channels, to customers including product selection, catalog and medium creation, quality control, order reception, logistics and customer service.

While many other companies in the same industry specialize in planning and marketing of products, have only stores as their sales channels, and outsource manufacturing and distribution work to other companies, the company can execute a unique promotion strategy that they cannot imitate as the company can respond flexibly with the system and know-how.

1-5 ROE Analysis

All 3 factors declined. Particularly, due to the decline in the net income margin, ROE was set back all the way to single digits.
The net income margin during this term is expected to increase from the previous term of 2.37%. ROE is expected to rise thanks to the expected steady achievement of forecasted results.

2. Fiscal Year ended May 2019 Earnings Results

(1) Consolidated Business Results

*Unit: million yen
*Net income is profit attributable to owners of parent. Revised forecasts were announced in April 2019.

Sales decreased because the demand from foreign visitors was sluggish. Profits declined as sales efficiency fell and selling, general and administrative expenses increased.
Sales were 17,614 million yen, up 3.9% year on year. The demand from foreign visitors was sluggish. Gross profit margin rose together with gross profit; however, the sales efficiency of “Butterfly Abs,” which is the main product in television shopping, declined.
Selling, general and administrative expenses could not be absorbed, resulting in a fall in operating income by 51.9% year on year to 431 million yen. The forecasts for the business results were revised downwardly twice in October 2018 and April 2019. Sales and profit decreased for the first time in 5 years.

(Variation in Selling, General and Administrative Expenses)

*Unit: million yen

The increase in the broadcast slots for home shopping, test-marketing of new products, etc. led to a rise in the ratio of advertising expenses to sales.
The packing and shipping fees have also increased.

◎Quarterly Earnings

*Unit: million yen
As for quarterly results, sales and profit dropped year-on-year in the second and third quarters.

(2) Trend of each segment

*Unit: million yen. Composition ratio of operating income is operating income margin.

① Manufacturer-Vendor Business
Sales and profit decreased.
Although sales in the co-op route and store wholesale route increased, the profit from the overseas route decreased due to the decline in the demand from foreign visitors and the registration delay in NMPA (National Medical Products Administration, formerly CFDA), etc.,.
Furthermore, advertising expenses increased by 23% year-on-year due to the increased use of television media. On the other hand, due to the increase in their exposure for future test marketing, the sales efficiency of home shopping (MR = Media Ration) dropped from 190% to 171%, which led to a decrease in profit as sufficient revenue could not be secured.

(Details of retailing routes)

＊Unit: million yen。

② SKINFOOD Business
Sales and profit decreased.
In October 2018, SKINFOOD Co., Ltd. (in South Korea), which is the franchiser of the SKINFOOD business, filed for rehabilitation proceedings (equivalent to Japan’s civil rehabilitation proceedings) in a court in Seoul, which led to a slight decrease in sales.
Moreover, the sales of the representative operation of stores for foreign tourists dropped substantially due to the slowdown in demand from foreign tourists in Japan. This resulted in a decline in profit.
The number of stores at the end of May 2019 was 23 including 21 directly managed stores (20 in the same period of the previous year) and 2 franchise stores (3 in the same period of the previous year).

③ IT Solutions Business
Sales and profit increased.
The sales of the mainstay product, M-Talk (chat system), remained favorable.

(3) Financial condition and cash flow

◎ Main BS

*Unit: million yen

Due to the increase in inventory assets, current assets increased 417 million yen from the end of the previous term while noncurrent assets increased 112 million yen. Total assets increased 529 million yen to 6,818 million yen. Total liabilities increased 364 million yen to 4,129 million yen due to the increase in loans payable, etc. Net assets increased 164 million yen to 2,688 million yen due to the increase in retained earnings and such.
Equity ratio decreased 0.7% from the end of the previous term to 39.4%.

◎ Cash Flow

＊Unit: million yen

The decrease in profit and trade payables caused operating CF and free CF to turn negative.
Financing CF turned positive due to the augmentation of short and long-term borrowings.The cash position declined.

3. Fiscal Year ending May 2020 Earnings Forecasts

(1) Full-year earnings forecast

*Unit: million yen. The estimated values are those announced by the Company.

Sales dropped and profit increased
The sales for the fiscal year ending May 2020 are estimated to decline by 3.9% year on year to 16,946 million yen and operating income is projected to rise by 33.6% year on year to 577 million yen. The amount of dividend that the company will pay is expected to remain unchanged at 12.00 yen/share. The estimated payout ratio is 22.3%.

(2) Strategies for each segment in the second half of the term

As a company-wide initiative, in order to be the world’s one and only “marketing manufacturer,” the company plans to analyze the market data while proceeding with BtoC and BtoBtoC businesses. Then, it will utilize this data for product development and sell the products again through the diverse sales channels of BtoC and BtoBtoC with promotions. Moreover, it will put the effort into enriching the training system of its employees and using RPA and AI to improve productivity by streamlining internal operations.

（Source: the company）

(3) Segment trends

As mentioned in Section 1-3 “Business description,” the company will enhance the operation speed and focus investments on promising businesses, all of which are necessary steps for growth. In addition, it will try to allow investors get a better understanding about its businesses. That is why the company has decided to change the business segment to “BtoBtoC Business,” “BtoC Business” and “Other.”

（Source: the company）

In addition, on September 1, 2019, the company plans to conduct an absorption-type merger with Graceas Co., Ltd., which conducts online sales of dietary supplements. Moreover, the Hong Kong I.K Trading Company Limited and LB (Shanghai) Cosmetics Co., Ltd. will be subject to consolidation in the fiscal year ending May 2020.

（4） Sales forecast for each segment.

*Unit: million yen

① BtoC Business
◎ TV & EC routes
The company aims to repeatedly do test marketing for new products, and establish a system that steadily releases hit products from the next term onwards.
The company has been able to constantly keep about 5 items of hit products while attempting to optimize the television shopping slot. Now that the product lineup is more comprehensive, it can compose an optimal portfolio for the television shopping slot.

(Sundries)
- Expand sales of “Butterfly Abs DT,” which is the renewed version of “Butterflies Abs”
- Increase the broadcast slot for the new products, “Step8” and “Air Yawn”
- Launch sales of “Speed Heat vest” in October

(Food products)
- Start the television broadcasting for “Kuro-Ninniku (Black Garlic)”

◎ Store route
Expand the retail store sales of SKINFOOD cosmetics.
- Work towards improving the returning customers' ratio through sample exchange tickets, popularity on LINE, and Introduction cards for friends.
- Make efforts to make the stores leave a strong impression by utilizing Instagram official accounts and improving customer service.
- Aim for re-branding by appealing for reassurance and safety of the slogan “SKINFOOD = Cosmetics made from food.”

② BtoBtoC Business
◎ Fostering growing businesses
* Cosmetics products including LB
- Expand the number of stores handling the products of “LB” from 2,000 to 2,300.
- Expand the product lineup by releasing 3 new colors for “3 in 1 Eyebrow,” and launching the new products, “High matte Rouge” and “Powder Eyeshadow,” etc.
- Strengthen sales promotion through SNS (YouTube, Instagram)

* Expand cosmetics sales overseas
- Strengthen overseas sales through the consolation of 2 overseas subsidiary companies.
- Expand sales channels in China by registering in the NMPA license (hygiene registration)

◎ Synergy with the BtoC Business
- Aim to expand sales of products developed by the company and to improve the gross profit margin through strengthening multichannel retailing with home shopping as the starting point.

4. Conclusions

Unfortunately, the forecast was revised downwardly again, and sales and profit declined for the first time in 5 years. The decline in demand from foreign visitors was the main causing factor to decline sales, which is unlikely to make a major recovery during this term. Therefore, the key factor for recovery from this term onwards will depend on the performance of the new business model of “multi-channel retailing that starts from TV shopping,” which was almost established during the previous term. The company thinks that it has developed a lineup of products that are good enough to be incorporated into their portfolio for the TV shopping slot. We would like to monitor the sales performance of their products, especially their hit product, “Butterfly Abs DT.”
On the other hands, as for the company’s makeup cosmetics brand “LB,” whose sales in the Chinese market is going to be a major pillar for their growth strategy, the company expects to obtain the permission from NMPA (formerly CFDA) for adding 20 SKU, which will augment the existing SKU to 50 SKU; thus a strong base for operation will be ready. The company reported more activities in Taiwan, Hong Kong, and South Korea, and we are looking for any concrete progress.

<Reference: Regarding Corporate Governance>

◎ Organization type, and the composition of directors and auditors

◎ Corporate Governance Report
Last updated: December 14, 2018

<Basic Policy>
While corporate governance is expected to function effectively, the company strives to become a reliable firm by improving its management foundation, maintaining high ethics and increasing the transparency of the management further in order to fulfil the social mission and responsibility as a listed company.
Also, the company considers the establishment of a management structure that can respond to the changes in the business environment fast and accurately as one of the important business challenges, and it is making efforts in information sharing from many sides by holding a regular meeting of Board of Directors (once/month), an extraordinary meeting of Board of Directors (as per the need), an in-house officers meeting (once/week) with regular directors (including directors serving as audit and supervisory committee members) and executive officers, and a top meeting (once/week) composed of people from team mangers post or above.

<Reasons for Non-compliance with the Principles of the Corporate Governance Code (Excerpts)>

<Disclosure Based on the Principles of the Corporate Governance Code (Excerpts)>

For back numbers of Bridge Reports on I.K Co., Ltd. (2722) and Bridge Salon (IR seminar), please go to our website at the following URL. www.bridge-salon.jp/