NEC Networks & System Integration Corp

TSE:1973

Earnings Call Transcript 2023-Q2

[Yushi Ushijima, executive]

As introduced, this is Ushijima, President and CEO of the company. Thank you for joining us today for the financial results briefing for the second quarter. Today, I will start with a summary of the first half results and full year forecast for the year ending March 2023 followed by update of the midterm plan.

First, results for the first half. This is the earnings summary. I will start with orders. First quarter was challenging in both orders and sales, but we recovered a little in the second quarter, resulting in JPY 172.4 billion, up 4% year-over-year. Orders were up 11% in the second quarter. This is mainly due to an increase in orders from enterprises from the private sector. Demand grew across various business driven by DX business.

Net sales, JPY 142.7 billion, up 1% year-over-year. Here again, we are seeing a recovery in the second quarter. Service-related sales increased. However, longer TAT, prolonged duration of the projects due to a variety of factors, resulted in a decrease in SI/construction work.

Turning to profits. Procurement costs increased due to rapid yen depreciation JPY 1.4 billion. Adding to that was loss at an overseas subsidiary, JPY 1.1 billion. SG&A for future growth increased as part of pursuing our midterm plan. This consists primarily of personnel costs, among others, related to strengthening sales and new business development. As a result, operating income was JPY 4.6 billion, down JPY 3 billion year-over-year. If we take out these special factors, GP margin was slightly up from the same time last year.

Cash flow, minus JPY 5.5 billion year-over-year, this is because we had a large payment related to GIGA School last fiscal year. At the bottom of the slide, orders backlog, JPY 196.4 billion, up 20% or a little more than JPY 30 billion year-over-year. This is the first half summary.

Next is orders received and net sales by business model. At the top of the slide in blue, SI/construction. Orders are increasing, as mentioned earlier. Sales in the meantime is down 2% due to shift in sales. As for service, orders were down 4%. This is a reactionary drop from last year when we had large projects in the public sector with municipal governments. In substance, we are seeing a rising trend. Net sales, also growing along with that trend, up 6% year-over-year for service.

Turning to operating income analysis, please look at the waterfall chart. Sales and profit increased from last year, JPY 0.5 billion and JPY 0.6 billion, respectively, a total of JPY 1.1 billion. In the meantime, SG&A increased for investment in growth, minus JPY 1.6 billion; in operation, negative of JPY 1.5 billion (sic) [ JPY 0.5 billion ] year-over-year. Foreign exchange impact, JPY 1.4 billion, coupled with loss in overseas subsidiary. This was a loss incurred in a Thai subsidiary related to a telecom infrastructure project, JPY 2.5 billion. All netted out, JPY 4.6 billion, this is where we are. But again, as I briefly mentioned earlier, if we take out onetime impacts or special impacts, operating income was up slightly year-over-year. Please understand that our track record shows a steady improving trend.

Orders received by segment. Let me remind you that growth for Q2 are in brackets, which illustrates how Q2 contributed. Starting with DX Solutions, JPY 61.6 billion, plus 1% in the first half but up 12% in the second quarter. This is a reactionary fall from last year, where we had large orders from the public sector. In the first half, product business with financial companies picked up and made up for that drop. Orders from manufacturing companies and other municipalities increased in DX. We are seeing steady flow of inquiries as well. Network Solutions, JPY 44 billion, down 7% for the first half but up 13% for the second quarter. Local 5G and marine business showed steady growth. Environmental & Social Solutions, up 3% for the first half and up 10% for the second quarter. Product-related service business is growing, while construction business decreased slightly. There are some fluctuations by project quarter-over-quarter, but we have a solid pipeline of prospective projects.

Turning to net sales by segment. All segments were impacted by the semiconductor market and foreign exchange: DX Solutions, JPY 51.9 billion, up 1%; Network Solutions, JPY 36.3 billion, up 2%; Environmental & Social Solutions, JPY 50.9 billion, up 3%. It was a mix of marginal increase and marginal decrease. As mentioned, we are subject to various external factors. Despite of that, service business in DX Solutions achieved 10% growth.

Next is operating income by segment for the first half. DX Solutions, JPY 5.3 billion, down JPY 0.3 billion year-over-year, this is due to ForEx impact and cost up for investment in growth. Conventional business, which consists mainly of PBX, is being replaced by DX. In this transition, profitability is partially down. Network Solutions income is down year-over-year due to increased cost for future growth. Gross profit improved slightly in spite of ForEx impact. Environmental & Social Solutions, due to ForEx and loss in an overseas subsidiary, down JPY 1.4 billion year-over-year. Others and elimination, minus JPY 0.7 billion, this is due to cost for headquarter relocation and review and development of the ERP system.

The table shows gross margin by segment. Network Solutions, as I explained earlier, was up moderately.

Next is our guidance for the year ending March 2023. For the reasons explained earlier, such as ForEx and loss in an overseas subsidiary, we will revise our income forecast. No change in our guidance for orders and net sales, but for ordinary income, we will revise down from JPY 26 billion in the original forecast to JPY 22 billion. This should be the bottom.

We will take various measures to aim for improvement. Various initiatives are accelerated to aim for the goal you see on the slide. We have a solid pipeline of prospective projects, as I mentioned earlier. Order backlogs are also increasing. We will work on these opportunities. In the meantime, we have not been successful in passing on the impact of yen depreciation in the first half. Not all contracts have reached renewal timing yet. Therefore, it might take time to pass through in full, but we will accelerate price pass-through in the second half of the year. Transition to higher value-added service and more efficient operation with DX, as we called for in the midterm plan, will be implemented to transform our business to a more resilient and profitable one. And lastly but not least, reduction of nonurgent costs, we will work on this to actively secure profit.

Full year forecasts by segment. Small adjustments for orders received and net sales in ESS, but overall, no change from our previous forecast. In the meantime, operating income will be revised down due to impact expected in DX Solutions and ESS.

Dividend. As explained earlier, there are various factors, but all in all, we are on track regarding our growth strategy. Therefore, there will be no change in the dividend plan. Interim dividend will be JPY 23, as originally planned. Year-end dividend of JPY 46 means increase in dividend for 16 years in a row.

Let me now take you through the update of our midterm management plan. This is a recap of the midterm plan. Towards 2030, which is a little further in the future, we intend to do business towards a sustainable symphonic society, in which we aim to realize a sustainable society with prosperity that resonates for all by combining DX and next-generation network technologies. Our approach is represented by this circular-spiral diagram.

We start from self-implementation or co-creation to enhance new service values. Know-how and new technologies acquired through this process will be utilized to shift towards consultation-style business. And by leveraging new technologies and solutions within the company, we intend to further enhance the quality and added value, consistent service to our customers that is unique to us, from design, proposal, implementation, operation and maintenance, offering site-specific consultation by making the most of our unique characteristics. This is the spiral model or a recurring model based on consultation, and this is what we aim to create in the midterm plan.

Basic strategy comes in threefold: original, creating value that is original to the company and accelerating value creation; enhancing our comprehensive capabilities to solve social challenges; expanding our business by applying the technologies we have developed in various fields. Through digital transformation of not only the services we offer but also ourselves as a company, we will improve the quality of our services, eventually feeding back to self-implementation. These are the key points of the basic strategy.

I also want to say a few words on our progress. Regarding accelerating original value creation, we are steadily increasing our unique offering model that leverage our strengths and know-how. Two things, I have case 1 and 2 on the slide. On the left, this is the case of building a network environment for a new plant of a manufacturing company. In the manufacturing industry, partly because of the pandemic, production sites are being consolidated and optimized. Customers are looking for OT or operational technology expertise, combined with information network such as the ERP system, being able to use IT and OT in a secure environment or taking into account the diversified use cases in the field. Such offerings have become prevalent these days. We are acquiring a large number of customers and prospective customers through this model while utilizing our knowledge and experience in this type of work style.

To the right, this is a model case for a prefectural government. Introducing work-style innovation, as stipulated in MIC's guideline beta model. Various technological applications are being developed. Our approach to customers with a variety of demonstration models centered on DX and work-style reforms is now attracting a lot of interest from local governments. Demand is growing.

We are seeing particularly strong growth in the public domain, accelerated public DX business. We are among the first to create solutions such as DX coordination services for the public and LGWAN-ASP, which are exactly the kind of solutions applied to the examples mentioned earlier. Since July, we have been using our Nihonbashi office and the Shin-Kawasaki Technology Center as a public DX showcase to present ideas to public sector customers based on our accumulated know-how in DX, work styles and social environment business. As of September, 20 customer organizations visited, as shown on the slide, and we are receiving visitors from various municipalities on a daily basis. We intend to offer solutions that are useful to society based on these activities and pick up speed. I'm happy to report that we are seeing progress in our efforts.

Lastly, a few words on next-generation network. The company has been focusing on local 5G in particular to have a distinct feature in this area. In February, we announced our local 5G strategy. In April, we invested in a start-up initiated by the University of Tokyo called FLARE SYSTEMS. Our employees are cooperating, and we are exploring new areas of local 5G. In 5G device, we invested in a Korean telecom manufacturer, HFR. They are a little ahead of others in this field. And from July, we started training highly skilled engineers to be future ready for the new network technologies. Preparations for the coming era of local 5G and/or ultra-high-speed wireless networks are steadily underway.

As for local 5G itself, we believe that we have been able to considerably reduce the cost of equipment or product, but we still need to reduce the cost on the receiving end. It might take another year to get there. Local 5G is already being used in areas such as video AI and monitoring and control of important facilities such as power plants. I believe that we have been able to make good progress for the future in the past 6 months.

And with this, I'd like to conclude my brief presentation. Thank you for your kind attention.

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