NEC Networks & System Integration Corp

TSE:1973

Earnings Call Transcript 2019-Q2

[Takashi Niino, executive]

I am Niino, President of NEC. Thank you very much for gathering today. I will explain the summary of FY ending March 2019 Q2 financial results that have been announced today.

Page 2 shows the topics I will cover today. Firstly, I'll cover the results of the first half, then move on to our full year forecast and end by reporting the progress of midterm Management Plan 2020 announced this past January. Please note that there is no change for the full year forecast.

Firstly, a summary of the financial results. Page 4 is the summary of the first half financial results. Firstly, revenue. Public and Enterprise businesses increased, resulting in 3.8% growth year-on-year. Next, operating profit. Global business and others improved, recording an increase of JPY 6.6 billion year-on-year. Although operating profit improved, net profit was down by JPY 9.7 billion due to the absence of gain on sales of affiliates' stocks recorded in FY '18.

Page 5 shows the first half results on the right. Revenue was JPY 1,336.4 billion; operating profit, JPY 13.8 billion; income before income taxes, JPY 21.8 billion; and net profit, JPY 9.2 billion. Free cash flow was an outflow of JPY 17.1 billion, a decrease of JPY 92.5 billion year-over-year. I will highlight the details later. Actuals for the first half posted an improvement of JPY 35 billion in revenue and JPY 4 billion in operating profit against our budget.

Page 6 is the first half results by segment. Operating profit of Global Business and Others improved year-on-year. Against our budget, revenue of Enterprise and Network Services businesses outperformed while global business underachieved. Enterprise Business overachieved in operating profit.

Now let me walk you through each segment in detail. Page 7 is Public business. In public infrastructure area, aerospace and defense businesses were up, contributing to recording JPY 419.7 billion in revenue, up 3.8% year-on-year. In the absence of one-off profit of the public infrastructure area recorded in FY '18, operating profit was down by JPY 2.3 billion, resulting in JPY 12.3 billion.

Page 8 is the Enterprise Business. All segments, including retail and services, financial institutions and manufacturing industries, trended upward, resulting in a revenue increase of 10.3% year-on-year, recording JPY 211.7 billion. In retail and services, convenience stores were a major driver while insurance and security houses were the main contributors of the financial segment.

Since company-wide IoT platform moved on to the commercialization phase, inter-business development cost allocation to the Enterprise business amounted to JPY 2 billion. However, a hike in revenue absorbed this cost, enabling the Enterprise Business operating profit to be flat year-on-year, recording JPY 15.7 billion.

Page 9, Network Service business. IT services declined while network infrastructure increased, resulting in the revenue increase of 1.6% year-on-year, posting JPY 176 billion. While network infrastructures profitability improved, one-off loss of JPY 3 billion was recorded for one particular IT service project, pushing operating profit by JPY 2.1 billion year-on-year, resulting in JPY 3.4 billion.

Page 10, System Platform business. Due to an increase of business PC, revenue was up by 0.5% year-on-year, resulting in JPY 242.6 billion. Investment costs for launching new products pushed down the operating profit by JPY 1.3 billion year-on-year, ending at JPY 4 billion.

Page 11, Global Business. Submarine cable system and display solutions declined while safety solutions enjoyed a big boost, thus increasing revenue by 0.6% year-on-year, landing at JPY 213.3 billion. Safety and wireless solutions' profitability improved, contributing to an enhancement of operating profit by JPY 6 billion year-on-year, resulting in an operating loss of JPY 5 billion.

Page 12 depicts the Global Business in more details. The bar graph on the left represents the revenue breakdown. On the right is a list of first half highlights. Safety Solutions' newly consolidated Northgate Public Services and acquired new customers' projects and realized organic growth. This led to a remarkable increase of revenue by 175% year-over-year. Service provider solutions' revenue was down year-on-year but with the major new orders received, we are observing a steady improvement.

Revenue of the wireless solutions was flat year-on-year. Submarine cable systems revenue was down, in particular in Q1 due to the phasing out of existing projects but new orders trended favorably, and we expect the full year revenue to recover and land on par with FY 2018.

Page 13, net profit change. Operating profit improved by JPY 6.6 billion. However, in the absence of gain on sales of stocks of NEC Tokin and Renesas Electronics Corporation, which were recorded in FY '18, financial income was down by JPY 15.6 billion. All in all, therefore, net profit was pushed down by JPY 9.7 billion year-on-year, recording JPY 9.2 billion.

Page 14 is Free Cash Flow. Let me explain why the first half free cash flow dipped year-on-year. Firstly, cash flow from investing activities are lower right-hand. In the absence of gains on sales of Renesas stocks and repayments of loans from NEC Tokin recorded in FY '18, which amounted to about JPY 50 billion, cash flow was down by JPY 56.7 billion.

Next, cash flows from operating activities. Negative repercussion from the advanced payment of JPY 10 billion made in the end of FY '18 and an increase of receivables due to a boost in sales caused the cash flow to decrease by JPY 35.8 billion. As a result of all these factors, free cash flow was down by JPY 92.5 billion year-on-year. But as you can tell, there is no negative business impact.

Let me now move on to full year forecast. Page 16, please. The full year forecast is unchanged from the announcement made on April 27. Operating profit is projected to go down by JPY 50 billion. This is due to onetime business transformation cost as well as the growth investment as announced in the full year briefing. So far, performances are in line with the plan that we have internally. For the second half, we have both upside potentials as well as downside potentials. However, overall, we believe that we can achieve the full year guidance.

Page 17, please. This is about the business environment. This chart shows the IT service order trend in Japan. During the first half, we had favorable areas such as financial, public and manufacturing. As a result, on a year-on-year basis, we had a 7% growth for the first half of fiscal year. Based on the strong trend at the moment because of these areas where we had strength, we expect to improve the full year performance.

Page 18 shows the full year operating profit forecast for the global business. The bar chart on the left-hand side shows the global business operating profit, actual for the first half and forecast for the second half and full year. For the first half, overall, the profit went up by JPY 6 billion year-on-year, driven by the safety business turning to a positive territory on the back of higher sales and wireless solution improvement of profitability. During the second half, we expect to increase the operating profit by JPY 22 billion year-on-year.

The safety business has been showing a firm trend. The wireless solution business is also expected to improve due to the absence of the JPY 3 billion lossmaking project, which we had in the second half of last year as well as the JPY 3 billion business transformation cost we had last year as well as the expected benefit of JPY 1.5 billion from business transformation. On the other hand, service provider solution, energy and the display businesses have some downside risks, which require continuous attention.

Lastly, let me move on to the progress on the medium-term management plan. Page 20 shows the 3 policies under medium-term management plan and the summary of progress over in the first half. The first point is about profit structure reform. In order to reduce SG&A, we have introduced an early retirement program starting this week. And so far, we have progressed as expected.

And also for the business structure for the wireless solutions business improvement, we are taking measures for profit improvement. And for the energy business, we agreed on the new buyer in August of NEC Energy Devices and are promoting a profit structure reform of NEC Energy Solutions at the moment.

The second area is the growth realization. NEC's Safer Cities, which is defined as the new growth engine, is showing solid expansion due to the consolidation of NPS and organic growth.

The third area is execution capabilities reform. The project RISE has been put into place in order to maximize the potentials of employees. And as part of the project, we have formulated the code of values which show the expected behaviors as members of the NEC Group. There are several initiatives that I would like to explain to you in detail.

First, on Page 21, this is the progress and status of NEC's Safer Cities. The safety business which was positioned as the growth engine of the global business under 2020 of the TMP has 2 parts, organic and inorganic. For the organic, we acquired a project from the U.S. government agency and a strong outlook is there on airport airline projects in APAC, Europe, EMEA, Middle East and other areas. For inorganic, we have a positive outcome from NPS synergy, and we have acquisition of the investment activities as well. So far, the safety business has been showing steady progress on both sales and profit fronts. We will continue to promote these activities for the organic growth as well as M&A activities.

Page 22 shows the initiatives for the wireless solutions business or Pasolink. The most important objective of the first half was to achieve positive profit for that business. And we were able to achieve that by promoting selective order-taking for higher profitability and the forecast product lineup. And as a result, for the second half -- for the first half, we were able to achieve improvement in profitability.

In the second half, we will accelerate initiatives to improve profitability on the medium-term basis, and we have started a discussion and actions to secure profitability for the medium term, which is to be finalized within this fiscal year.

On the next page, I'd like to touch upon the 5G partnership aiming at global market. As announced on October 24 press release, we have concluded a partnership with Samsung Electronics to strengthen the next-generation business portfolio, including 5G. We will take full advantage of each other's strength to jointly develop products based on 5G standards and to jointly explore global market and take a leading position on the full 5G on a global basis and accelerate software and services business.

Page 24 shows Project RISE. In order to change the NEC culture fundamentally, we have started the Project RISE. This project has 6 drivers to accomplish these aims. We are focused on 3 drivers this year, namely code of values. We have formulated and we're disseminating this and establishment of personnel appraisal system to promote growth and application of the system to the management personnel and implementation of initiatives to realize 50% reduction in business processes and operations to streamline operations.

As explained during the first half, we have seen signs of improvement in several different areas. During the second half, we will continue with transformation and initiatives to achieve full year and medium-term targets.

With this, I would like to conclude my remarks and presentation on financial results as well as medium-term Management Plan 2020. Thank you for your kind attention.