NEC Networks & System Integration Corp

TSE:1973

Earnings Call Transcript 2022-Q2

[Yushi Ushijima, executive]

Let me take you through the financial results for the first half for the year ending March 2022. This is the agenda for today. I will start with the earnings summary for the first half.

This is the summary. For the first half of the year, top line decreased due to reactionary fall of big projects from the previous year. Profits, however, achieved a record high for the first half as we did last year. Orders increased steadily in strategic areas such as DX, work-style innovation and Telecom Carrier business. However, GIGA school projects that concentrated in the first half last year saw a reactionary fall. Orders were JPY 165.9 billion, down 7% year-over-year. Same applies for sales good results in the strategic areas, but in addition to the reactionary fall of large projects, such as GIGA school and mega-solar semiconductor shortage led to slow sales. Sales JPY 141 billion, down 7% year-over-year. Reactionary fall of big projects was anticipated. And the key is how much we can grow beside that. Excluding special factors, orders were up 11%, sales, up 3% and backlog was up 15%. In profits, GIGA school and mega-solar projects with lower profitability compared to ordinary projects decreased while value-added projects, such as DX and telecom business grew, leading to improved sales mix.

Efficiency improvements were maintained at a high level. Altogether, operating income was JPY 7.6 billion, up JPY 900 million year-over-year, and operating income margin was 5.4%, up 0.9 points. As a result, net income for the quarter was JPY 4.7 billion, up JPY 700 million, demonstrating sustainable profit growth. This, however, is behind our July 29 forecast, mainly due to semiconductor shortage issue that became apparent from the second quarter, impacting slow sales.

Orders received, net sales and operating income change year-over-year. Impact of reactionary drop of GIGA school had JPY 27 billion impact on orders received and unconsolidated affiliate impact was minus of JPY 1.5 billion. As originally planned, drop in orders received has been covered not entirely, but to a certain extent with growth in DX and telecom business. GIGA school orders for the full year last year was a little less than JPY 30 billion, mostly recognized in the first half. Therefore, impact in the second half will be smaller. Net sales drop in GIGA school, JPY 6 billion; mega-solar, minus JPY 6.5 billion and unconsolidated affiliate, minus JPY 1.5 billion.

A total of JPY 14 billion in downside factors was partly compensated by growth in DX and telecom business. Sales recovery is slower than orders due to orders shifting to service provision model and semiconductor shortage pushing back sales, which is temporary. Operating income, impact of increase in sales for DX and telecom of JPY 700 million and higher value-added services and improved profitability of JPY 1.8 billion was enough to compensate for the drop from GIGA school and increase in SG&A. Operating income was JPY 7.6 billion, up JPY 900 million year-over-year. Operating margin was 5.4%, up 0.9 points.

Orders received net sales by business model. We are shifting our business model from the conventional product system integrated model to solution service business model, utilizing DX capabilities. In the first half, business model transformation made progress as seen in significant growth in orders received and sales for service business. Sales will be temporarily pushed back, but growth in sales business will mitigate volatility while creating recurring business with customers. It will contribute to stable business and profit growth for the company. We will continue to focus our effort in this area.

Breakdown by segment. First, orders received. Digital solutions, impacted by reactionary drop in GIGA school, minus JPY 14 billion and unconsolidation of a subsidiary minus JPY 1.5 billion. The segment ended with JPY 62.2 billion, down 13% year-over-year. In the meantime, DX and workstyle innovation-related business continued to perform well, particularly in the first half, business is growing for government and municipalities as well as business, 12% growth year-over-year, excluding special factors in the previous year. Network Infrastructure, JPY 49.6 billion, up 4% year-over-year. Telecom carrier business grew such as for Rakuten and KDDI. This, I think, is proof we are being recognized as strategic partners from telecom carriers. We will strengthen this relationship and expand the business. I will note that last year's figures included large projects for submarine seismometers of JPY 3 billion. So technically, orders received is progressing well.

Engineering & Support Services was down 5% year-over-year to JPY 51.9 billion due to GIGA school impact of JPY 13 billion. Transport and traffic-related business that suffered last year increased with rise in construction business in Japan. Excluding the GIGA school impact, this segment was up 25%. Net sales by segment. Digital Solutions, impact of GIGA school minus JPY 1 billion and unconsolidation of a subsidiary, minus JPY 1.5 billion, was coupled with extended lead time from orders received to sales due to shift to service provision model, JPY 52.4 billion in net sales for the segment, down 8% year-over-year.

Network Infrastructures. Business for telecom carriers drove growth in addition to social and public infrastructure-related business, JPY 42.8 billion, up 12% year-over-year. Engineering & Support Services. Impact of GIGA school minus JPY 5 billion; and mega-solar projects, minus JPY 6.5 billion was combined with slow sales due to semiconductor shortage. JPY 42.3 billion, down 18% year-over-year.

Next is operating income by segment. Total was JPY 7.6 billion, up JPY 900 million year-over-year, reaching a new record high for the first half. Digital Solutions, JPY 5.6 billion, up JPY 300 million year-over-year. Margin was up 1.3 points. With progress in business model change from SI to solution service business utilizing DX, we were able to improve our sales mix. Network infrastructure, JPY 2.8 billion up JPY 600 million. Margin improved by 0.7 points. In addition to sales increase, and improved fixed cost efficiency, we were able to bring in design operations previously handled by customers and become strategic partners for new customers. Growth in value-added business contributed to profitability improvements. Engineering & Support Services, JPY 3.4 billion, flat year-over-year, owing to GIGA school and so sales due to semiconductor shortage. Since sales mix and profitability improved, margin was up 1.4 points.

Forecast for the full year. No change to the original forecast for the full year. We will aim for sustainable growth through improvement in sales mix to achieve record high profit. Impact of semiconductor shortage is expected to remain a concern in the second half, but we plan to offset by growing strong business with telecom carriers. While there is still unpredictability in the external environment, we will continue to invest in new business development by allocating resources to kick start our new midterm plan starting next year and to establish a foundation for growth over the mid and long term.

Full year forecast for the company will not change, but forecast by segment will be revised in light of progress in the first half. Network Infrastructure with its strong performance revised up for orders received, net sales and operating income. Digital Solutions revised up for orders received, but net sales and profit revised down against the backdrop of extended lead time from shifting to service business as well as impact of semiconductor shortage. Engineering & Support Service also was revised taken into account the impact of semiconductor shortage.

Dividend. As usual, our policy is to increase corporate value through investment in growth and sustainably increase shareholder return on a stable dividend basis. Dividend will take DOE into account. Since profit level increased last fiscal year, DOE has been raised from 3.8% to 4.5%. Based on this thinking, JPY 19 per share will be paid in the interim as planned and JPY 38 for the year-end. This will be 15 consecutive years of increase in dividend. Next is update of strategic areas. The company is aiming to become a leading player in combining digital and 5G where digital technology is utilized on a 5G or 6G infrastructure. That is why both digital and 5G are focus areas under the current midterm plan.

This slide shows progress in digital area. The speed of digitization such as moving to cloud-based environment has accelerated more than we expected due to COVID. With this as a tailwind, DX-related orders such as multi-cloud service doubled year-over-year to JPY 13 billion in the first half alone, driving many parts of our business and continuing to remain strong. Lately, we are seeing a pickup in demand for teleworking and cloud services from the public sector in addition to private sector demand.

We have been expanding our DX and workstyle innovation business with the public sector by leveraging our ability to build work-from-home environment based on our track record. As a result, we received orders from Saitama Prefecture and Toyama Prefecture as well as National Tax Agency in the first half. We are able to win new customers in the workstyle innovation business. We will share this across other businesses to expand sales into other prefectural governments and to establish a solution model to smaller governments in cities, towns and villages to promote DX and workstyle reform across the country. We are also approaching local government network to address network resilience demands, LGWAN-ASP services. Further market growth is aimed by capturing such demands.

This is an example of Saitama Prefecture. They have adopted an advanced workstyle, and we are engaged in multi-cloud service used for teleworking and paperless work. As you see on the slide, cutting-edge cloud environment is combined with web communication tools and paperless support software, file management system and authentication service. In other words, services the company has put into practice over the years. We believe that our track record in implementing DX across the company and our proposal based on our own experience in achieving efficiency was highly evaluated in the bid process. We plan to sell this model to other local governments as well as local municipalities that connect to prefectural governments to grow our DX and workstyle innovation business with municipalities.

The company has been putting workstyle innovation into practice since 2007, teleworking since 2015 and distributed working NDX since 2019. We have been a step ahead of other companies in introducing new workstyles. Today, in post-COVID or new normal, we will not lose in our efforts, and we'll continue to pursue new and innovative work styles, one of which is hybrid work. With COVID, we no longer go to the office every day and enjoy the benefit of reduced commuting and balancing work with child care and nursing care. In the meantime, we are also aware of communication challenges where virtual and physical presence at work is mixed.

As an initiative to get the best of the 2 worlds, we are adopting hybrid work by combining physical and virtual. The idea is not just connecting office workers and teleworkers, 360 degrees image of the office is used to create an environment where people working in the office and from home are in the same space or use robots to show up in an office in a different country. This is our challenge to create new value propositions for workstyle. Proof of concept has started at our Nihonbashi innovation base. Please drop by if you have a chance.

Through these initiatives, we plan to create a working environment where people working in the office from home and globally are able to engage as a team efficiently and with high motivation. We will increase our offering to enable such hybrid work style. At the same time, we, as a top runner in workstyle innovation will continue to challenge change how people work and contribute to the society.

Next is an update on progress in the other growth pillar, 5G. The current midterm plan is positioned as preparation phase towards full-scale investment in 5G. We are on track. In the telecom business, key is building closer ties as strategic partners with carriers, one of which is to build trust with new customers by leveraging existing assets. Our business with Rakuten Mobile that started from end of fiscal year 2020 has grown steadily. New business was awarded in this first half. We are able to forge a robust relationship based on our track record. With KDDI, a joint venture company, KNSI, has been set up. KNSI's business that started with construction of base stations where our share has grown, has now expanded into more value-added areas such as network setup.

Such business with higher value increase in the first half of the year contributing to profitability. This investment into 5G has barely started on a full scale. We will step up our efforts to further grow the business. In the meantime, local 5G POCs are accelerating towards implementation. We are focusing on our strengths, workstyle innovation and community building in collaboration with municipal governments. In order to address societal challenges, we think it is crucial to gain know-how across a broader array of themes.

In the POC projects, for MIC or Ministry of Internal Affairs and Communication, 3 out of 26 that are adopted are projects in which we are responsible for local 5G infrastructure. We are seeing steady increase as in this case. Another example from Tokushima Prefecture, which I referred to last time, it is making progress as a first initiative by a municipal government in local 5G network on sub-6 band. This initiative is referred to in our integrated report in an interview with the person responsible for the project in Tokushima, I hope you can find time to take a look.

In terms of strengthening business foundations in 5G, our basic technical center in Kawasaki acquired a license as a local 5G lab. The 5G lab in this center will be used to accelerate the speed of verification of 5G device connectivity and application demonstration. Regarding talent development for 5G, we have a goal to train 400 people by the end of this fiscal year. We are on track as we were able to train more than 300 engineers, including partners in the first half. These are the 3 projects adopted by MIC for local 5G in the first half.

As you can see, there is an acceleration across diverse themes. The first POC project is achieving productivity improvement in the primary industry. This project is about verifying remote operation of vehicles in forestry as well as safety management using high-resolution visuals and AI. The second project in the middle is related to tourism and disaster prevention. POC will be conducted in Mt. Fuji as well. The project addresses challenges associated with the vulnerability of telecommunication system as a lifeline for administrators, climbers and victims using local 5G.

Third project is using local 5G in public events that had been restricted during the height of the COVID pandemic. As we transition to post-pandemic, POC will be conducted at a large international conference complex in Yokohama City to test safe and secure events with remote monitoring. We will utilize wireless technology developed over the years in building network for telecom carriers to come up with use cases and test communication capability, quality and conditions to spread the use of local 5G, among others. We will continue to co-create with diverse partners, including local governments, CATV operators, universities and laboratories to address societal challenges through our services to contribute in building a safe, secure and convenient community as well as a sustainable society.

Lastly, this fiscal year is the final year in the current midterm plan. As I explained in the earnings section, we are facing some environmental changes, such as semiconductor supply shortage, but we are on track towards growth. We will continue to seek innovation without fear of change or failure and take actions that will lead to our next midterm plan. Your continued support and understanding are very much appreciated. Thank you for your kind attention.

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