Komatsu Ltd

TSE:6301

Earnings Call Transcript 2019-Q2

[Unknown Attendee]

Ladies and gentlemen, thank you very much for coming despite your busy schedule. We would like to start the meeting for the business results for 3 and 6 months ended September 30, 2018.

First of all, there is one thing that we would like to announce. In terms of the business results meeting, conventionally, after the meeting, we have been uploading these audio on our website. But from this time, including the presentation from our side, in terms of the question and answers, we will upload it on our website. In terms of the presentations, the announcement contains forward-looking statements, which reflects the management's current views with respect to certain future events. These should be considered as risks and uncertainties. Actual results may differ materially from these projected, so please be alerted about this.

So let's check the material. So we have the presentation title, Business Results for Three and Six Months ended September 30, 2018. If you do not have this presentation, please notify the staff nearby you. I think everybody has the material.

I would like to introduce our presenters. In the middle, we have President and CEO, Mr. Tetsuji Ohashi. On the right, we have Executive Officer and CFO, Mr. Takeshi Horikoshi; on the left, Executive Officer and General Manager of Business Coordination Department, Takuya Imayoshi. I am the moderator for today, Takahashi from the IR group.

So turning to today's agenda. First, let's hear from Mr. Horikoshi, who will give you a presentation about the second quarter and the first half results. Next, Mr. Imayoshi will give you the presentation about the outlook for the fiscal year 2018. After these presentations, we will go into a Q&A session. It will take 90 minutes, and we would like to end by 5:30 p.m. So a request from our side is that please refrain from photographing or videotaping or recording this presentation. Thank you.

Mr. Horikoshi, CFO, will talk about the business results for 3 and 6 months September 30, 2018. Mr. Horikoshi, please?

[Takeshi Horikoshi, executive]

Hello, I am Horikoshi, the CFO. Before we go into the explanation about the business results for the second quarter and the first half, please turn to Page 3. So I have explained this in the first quarter already, because we have decided to adopt a new pension accounting of the U.S. GAAP. There has been a reclassification on the PL statement.

Since the fiscal year ending in March 31, 2019, we have adopted a new pension accounting standard meaning that the net periodic postretirement benefit costs, separated from other personal expenses, are presented in nonoperating income and expenses, whereas they were conventionally presented in segment profits. Accordingly, the corresponding amounts for fiscal year 2017 are retrospectively reclassified as shown in the table below. More specifically, the operating income portion is a negative JPY 3 billion. In terms of other income is a positive.

Then please go to Page 4. This is the highlights of the business results for the second 3-month period for fiscal year 2018. In terms of the exchange rate, JPY 111.2 to the $1; JPY 121.6 to EUR 1; and JPY 16.4 to CNY 1. Year-over-year, the yen has depreciated against the dollar. Against the euro and renminbi, it has appreciated.

In terms of the net sales, because the volume has increased and there has been a difference in selling prices, year-over-year, we have seen an increase of sales of 12.4% to JPY 671.9 billion. In terms of the consolidated sales, this has been a record-high level for a second quarter. For the operating income, we are seeing a volume increase, a difference in selling prices and the decline of one-off expenses for KMC. There was a 75.3% of increase reaching JPY 104.2 billion. Operating profit ratio has improved by 5.5 points to 15.5%. Both operating profit and operating profit ratio has been a record-high level as a quarter.

And on this PL income statement, in terms of the other gains and expenses, year-over-year, it's minus JPY 41.2 billion. There is a great difference against the previous year. This is because in the previous year, there were gains from the sales of investment securities basically called shareholding shares and we had a gain of JPY 39.5 billion. And the net income on the very bottom line has declined by 4.5%, reaching JPY 62.4 billion. The reason why we saw a decline of the net income is mainly twofold: one is, as I have explained in the previous year, we have a sales gain of JPY 39.5 billion coming from the sales of the investment securities. Another is that, starting from the second half of this year, for some of our overseas subsidiaries for the noncontrolling equity portion for the minority shareholder equity, we changed how this will recognize this. So retrospectively, we booked a one-off loss of the JPY 5.4 billion. This is because, conventionally, we had been calculating the equity of the minority shareholders based on their equity ratio. But we changed it so that this will reflect the profit-sharing agreement in the shareholders' contract. So we have reclassified this accordingly.

Going to Page 5. I would like to explain about the segment sales and profits. So sales of construction, mining and utility equipment year-over-year, it has increased by 10.4% to JPY 606.3 billion. Segment profit was increasing by 73.6% to JPY 95.6 billion. This is because the volume has increased and there was a difference in the selling prices. We have been able to see an increase of net sales. In terms of our profit, this is due to the volume increase and the difference of selling prices and the decline of one-off expenses from KMC.

Retail finance sales increased by 10.9% from the corresponding period a year ago to JPY 15.1 billion. Segment profit advanced by 58.3% to JPY 4 billion. Mainly due to an increase in assets in North America, both net sales and profit grew. Sales in industrial machinery and others segment advanced by 37.7% from the same period last year to JPY 55.7 billion. Segment profit improved by 84.7% to JPY 4.4 billion. Both sales and segment profit improved mainly supported by increased sales of machine tools to the automobile manufacturing industry. The causes of difference in sales and profit will be explained later.

Page 6 shows construction, mining and utility equipment sales by region. Sales of construction, mining and utility equipment increased by 10.5% from the corresponding period a year ago to JPY 603 billion, while sales declined in Japan due to the drop-off from the new emission standard-related prebuy demand in the previous fiscal year. Sales expanded sharply in North America, Asia and Oceania. The ratio of sales in strategic markets increased to 55% of total sales from 52% in the same period last year.

From Page 7 are the highlights of the first half or first 6 months of fiscal 2018. FX rates were JPY 109.7 against the dollar, JPY 129.9 against the euro and JPY 16.8 against the renminbi. Compared to the same period last year, the yen appreciated against the dollar and depreciated against the euro and renminbi. Consolidated net sales increased by 13.7% from the corresponding period a year ago to JPY 1,318,000,000,000 due to higher sales volume and better selling price.

Net sales marked a record high for our first half sales. Operating income advanced by 80.2% to JPY 200.3 billion due to higher sales volume and selling prices as well as a decline in KMC temporary expenses. The operating profit ratio increased by 15.2%, up 5.6 percentage points. Both operating income and the profit ratio marked record highs on a 6-month basis. Net income improved by 23.2% to JPY 125.3 billion. Net income also reached a quarterly record high. Interim cash dividend per share increased by JPY 3 to JPY 51 a share from JPY 48 a share, which was planned at the beginning of the year. Interim dividends are up by JPY 15 on a year-over-year basis.

On Page 8, I will explain sales and profits by segment. Net sales for the construction, mining and utility equipment segment advanced by 12.8% from the corresponding period a year ago to JPY 1,200,500,000,000. Segment profit expanded by 79.7% to JPY 183.9 billion. Higher sales volume and selling prices led to an increase in sales. Profits also grew due to higher sales volume and selling prices as well as a decline in temporary expenses at KMC.

Retail finance revenue declined by 5.8% year-on-year to JPY 29.4 billion. Segment profit expanded by 62.2% to JPY 9.5 billion. Revenue declined because of sales of used equipment were recorded in the previous fiscal year as a result of the cancellation of a leasing contract in Chile. Profit increased mainly due to a reversal of allowances for bad debts in China. Industrial machinery and others sales advanced by 22.6% to JPY 97 billion. Segment profit improved by 56.2% to JPY 7.5 billion. Both sales and segment profit improved, supported by increased sales of machine tools to the automobile industry and Excimer laser-related and other businesses due to a buoyant semiconductor market. The causes of differences will be elaborated later.

Page 9 shows sales by region for the construction, mining and utility equipment segment. Sales for the construction, mining and utility equipment business advanced by 13.1% from the corresponding period a year ago to JPY 1,195,100,000,000. Sales improved in all regions except Japan and the Middle East. Sales expanded sharply, especially in North America, Asia and Oceania. The ratio of sales in strategic markets increased from 54% in the previous fiscal year to 56%.

Page 10 shows the causes of differences in sales and segment profit for the construction, mining and utility equipment segment. Sales increased by JPY 136.1 billion from the corresponding period a year ago, supported by increased sales volume and price hikes at Conventional Komatsu, which takes out KMC as well as a higher sales volume at KMC as well. Segment profit was hit negatively by foreign exchange rates. However, due to higher sales volume and selling price as well as a decline in temporary expenses at KMC, the segment profit ratio improved by 5.7 points, reaching 15.3%.

Page 11 shows KMC's business results. Sales in the first half of FY 2018 were JPY 180.8 billion, up 19.8% year-on-year. Equipment sales were JPY 31.5 billion, up 18.7%. Parts were JPY 65.5 billion, up 17.5% year-on-year; and service and others were JPY 83.6 billion, up 22% year-on-year. Operating income, excluding temporary expenses, was JPY 30.5 billion and when including temporary expenses of JPY 5.5 was JPY 24.9 billion and both went up drastically. Temporary expenses were down by JPY 31.1 billion due to the absence of JPY 25.8 billion depreciation related to the inventories after a PPA, purchase price allocation, which occurred in the previous year. In the sales by segment shown in the middle pie chart, mix between surface and underground was 50-50. By region, on the right, shown in the pie chart, North America accounted for 45%, up from 42% of the previous year.

Page 12 shows retail finance assets, revenues and segment profit. Assets in the retail finance increased JPY 80.7 billion from the end of the previous fiscal year, mainly due to the depreciation of yen and the increased contracts in North America, Oceania and Europe. While assets increased in North America, revenues declined because sales of used equipment were booked in the same period of the previous year as a result of the cancellation of a leasing contract in Chile. Segment profit increased mainly due to the reversal of allowances for the doubtful accounts in China. And a part of the credit that the allowance was booked in FY 2016 was recovered in the first half of this year.

Page 13 shows industrial machinery and others sales and segment profit. Sales increased by 22.6% to JPY 97 billion year-on-year, supported by the increased sales of machine tools to the auto manufacturing industry and Excimer laser-related and other businesses, buoyed by the robust semiconductor market. Segment profit increased by JPY 2.7 billion year-on-year to JPY 7.5 billion, and segment profit ratio went up by 1.6 percentage points to 7.7%.

Now I'd like to explain the orders received and the sales of industry machinery. So please turn to Appendix, Page 40. This chart shows a book-to-bill ratio for industrial machinery. It is the index of orders for the latest 6 months divided by the sales for the same 6 months. Komatsu Industries covers sales and services of press and sheet metal machineries. Latest orders have been firm, and the index has been above 100%. Right below, Komatsu NTC covers design, manufacturing and the sales of machine tools, including transfer machines, machining centers and [ a plenction ] processing machines. Latest index is below 100%, but orders received have been firm as Komatsu Industries.

Page 14 shows balance sheet. Total assets grew by JPY 208.9 billion from the end of the previous fiscal year, mainly due to the foreign exchange and the increased inventories. Foreign exchange impact was JPY 120.4 billion. Inventories increased JPY 114.8 billion from the end of the previous fiscal year. Excluding the foreign exchange impact of JPY 27.5 billion, the growth was JPY 87.3 billion. This inventory buildup was to respond to the demand increase.

Interest-bearing debt increased by JPY 106.7 billion to JPY 917.3 billion. This is due to the increased inventories and accelerated payments to suppliers in Japan. As a result, the shareholders' equity ratio went up by 0.3 percentage point to 49.7% from the end of the previous fiscal year. Net debt ratio is 0.44. And excluding the retail finance business, net debt-to-equity ratio is 0.11.

Next, Mr. Imayoshi is going to talk about the forecast for fiscal year 2018. Mr. Imayoshi, please.

[Takuya Imayoshi, executive]

I am the General Manager of Business Coordination Division, my name is Imayoshi. I would like to talk about the outlook for fiscal year 2018 and the situation of the various markets. So based on the first half performance and the current market condition, we have conducted a revision for the full year forecast.

Going to Page 16, this is the outlook of this fiscal year. From the left, this is the actual fiscal year performance of FY '18, the latest outlook. And on the right, we have the initial forecasts. So this basically shows the Conventional Komatsu and KMC. In terms of the year-over-year comparison, we have the latest outlook for 2018, and the difference between last year.

For the first half, the sales has been better than expected in North America and in Asia. In the second half, North American mining has shown a very strong -- will be showing a very strong demand. In terms of the exchange rate, is -- the yen is weaker than expected, and we have revised our exchange rate outlook, that will be the precondition of the [ performance ] outlook. And from this April, we have conducted an upward revision for the sales and operating income.

In terms of the exchange rate, considering the current exchange rate, in terms of the second half, U.S. dollar is going to be JPY 105 to the dollar, a weaker yen. In terms of full-year average exchange rate, U.S. dollar will be JPY 107.4; EUR 1, JPY 126.4; CNY 1, JPY 16.3. Consolidated net sales against initial outlook will be upward revision of JPY 159 billion to JPY 2,662,000,000,000. Operating income against initial outlook, this will be an upward revision of JPY 42 billion, JPY 381 billion. As a result, operating profit ratio will be 14.3%. We have made an upward revision against the initial forecast on net income to JPY 240 billion.

In terms of ROE, it will be improving by 2.0 points year-over-year to 14.1%. As I've said before, in terms of the dividends, we have revised our outlook. Our dividend has 2 important points that we want to reflect: returning the profit to the shareholders in terms of the profit and steady dividend payments. So in terms of the payout ratio, it will be 40% or more as long as it does not go over 60% and will not reduce their dividend payment.

Looking at our performance outlook and looking at the future business development. In terms of the outlook of the dividend payment of April, we will revise that. And with the interim payment together for the full year, annual dividend payment will be JPY 102. And consolidated payout ratio will be 40.1%.

Going to Page 17, this will be the projection for segment sales and profit. For the construction, mining and utility equipment sales, as I said before, because in the North America and Asia, general construction equipment and the mining equipment, sales has been over our initial projection, and exchange rate is on the weaker yen trend and we have revised our sales upward by JPY 145 to JPY 2,415,000,000,000. Segment profit will be upward reaching JPY 35 billion to JPY 353 billion.

Going to retail finance. Net sales will be up with revision from the initial forecast by JPY 5 billion to JPY 58 billion. Segment profit will be up with the revision of JPY 4 billion to JPY 16 billion. For industrial machinery and others, basically, business is growing in line with our projection. We have not revised our outlook. In terms of the factors of the difference of the numbers for each segment, I will explain about that later.

Going to Page 18, this is the construction, mining and utility business by region sales outlook. Year-over-year, North America and Asia is going to see an increase of sales against the initial projection. North America has been better than expectations. And in the second half, we are expecting North American mining business will be very strong because of the demand. We're going to increase our sales outlook. China, we're going to make a downward revision on the outlook. For strategic markets, the ratio is 54%. This is the same ratio as 2017.

Going to Page 19. This is the construction, mining and utility equipment sales and segment profit difference analysis. On the left, sales of Conventional Komatsu and KMC, there has been a negative impact on -- from the exchange rate, but we have been able to see a positive impact on growth in sales price increase. So it is increased year-over-year against the initial forecast with Conventional Komatsu and KMC because of the increase of volume and this negative impact on currency, that is upward revision. So -- and initially, we had been projecting a decline in sales, but the latest outlook is that it will be an upward increase of JPY 103.1 billion. In the segment profit, there is a negative impact on exchange rate, but we have been able to increase our selling prices and the decline of the one-off expenses for KMC. This will be an increase of profit by JPY 80 billion year-over-year.

Page 20 shows the projection for the KMC business. The latest projection for net sales for fiscal 2018 is an increase of 16.6% year-over-year, reaching JPY 370.7 billion. Equipment sales is expected to be JPY 78.1 billion, up 27.8% year-on-year. Parts sales is projected at JPY 130.7 billion, up by 15.3% year-on-year; and service sales, JPY 161.8 billion, up by 12.9% year-on-year. We anticipated an increase in equipment sales. And as we see first commissioning utilization, we also expect an ongoing increase in parts and service and other sales. Operating income is expected to reach JPY 57.1 billion before temporary expenses. Including temporary expenses worth JPY 11.3 billion, the operating income outlook is JPY 45.8 billion. The operating profit ratio before temporary expenses is expected to be 15.4%. And even after including temporary expenses,12.4% is projected, which is a significant improvement.

I would like to now explain the order and sales situation at KMC in the Appendix on Page 39 that shows the book-to-bill ratios. This page shows the book-to-bill ratio for our KMC Mining Equipment since September 2015. The top chart shows the ratio for KMC surface mining equipment comprised by rope shovels, blasthole drills and others. Although there is some fluctuation in orders, risk conditions continue and the ratio is trending around the 100% mark. The bottom chart represents KMC underground mining equipment comprised by continuous miners, sheerers and others. Although the ratio has dipped below 100% lately, orders continue to be firm.

Going back to the main presentation, Page 21 shows the outlook for the retail finance business. Total assets in the retail finance business are expected to increase from the previous fiscal year-end, reflecting an increase in finance contracts, mainly in North America. Revenue on the right-hand side is expected to decline due to the absence of sales of used equipment recorded in Chile in fiscal 2017, which had resulted from the cancellation of a leasing contract. Segment profit is expected to increase due to the success and partial recovery of receivables in China, which we have provisioned against in fiscal 2016 as well as other factors.

Page 22 shows the sales and segment profit outlook for the industrial machinery and others segment. Sales are projected to increase by 12.2% from the previous fiscal year to JPY 208 billion. Segment profit is expected to advance by JPY 3.6 billion to JPY 18 billion. Although there are some ups and downs on a company by company basis, there will be no change to the sales and segment profit initial outlook.

From here on, I will talk about demand. On this page, the annual demand trends and outlook for the 7 major products will be discussed. Demand for the 7 major products and mining equipment are shown on a Conventional Komatsu basis. This applies to Pages 23 through 29.

In the first 6-month period of fiscal 2018, demand presumably increased by 13% from the corresponding period a year ago. Demand for construction equipment was firm in North America, China, Indonesia and Europe. Mining equipment demand was also firm. Fiscal 2018 second half demand growth rates are expected to slow down as demand was already high in the second half of the previous fiscal year. Therefore, we will not change the demand outlook from the initial forecast of 5% to 10% growth.

From the next page onwards, I will talk about major market conditions. On Page 24, I will talk about Japan. In the first half of fiscal 2018, demand presumably dropped by 26% from the corresponding period a year ago. Demand for new equipment dropped sharply, mainly around rental customers due to the absence of prebuy demand from the last fiscal year in anticipation of the new emission controls regulations enforced in September 2017. Fiscal 2018 second half demand is expected to turn positive year-on-year as the absence of prebuys were already kicking in from the second half last fiscal year. We are revising the projection for the full year demand growth downwards to minus 10% to minus 5% from the initial outlook of minus 5% to 0%.

On Page 25, I will explain the demand trends and outlook for North America. Fiscal 2018 first half demand presumably increased by 23% from the corresponding period a year ago. In the United States, demand remained steady, centering on energy sectors namely oil sectors and the central part of the U.S. and civil engineering. Canada demand was also firm in both residential and nonresidential sectors. The current demand projection has been revised upwards to plus 10% to 20%, instead of the initial projection of 5% to 10%.

On Page 26, I will talk about the demand trends and outlook for Europe. Fiscal 2018 first half demand presumably increased by 7% from the corresponding period a year ago. Demand remained firm in the major markets such as Germany, the U.K. and France; in addition, demand recovered in Southern Europe. And this led to demand growth in Europe for 12 quarters in a row. The annual demand growth projections will be unchanged from the initial projection of plus 3% to 8%.

Page 27 shows demand in China. In the first half of FY 2018, demand presumably increased to 36% year-on-year. By quarter, for 9 consecutive quarters, demand has continued to increase since the second quarter of FY 2016, and demand in this year will be close to that of FY 2011. As the demand has already reached to high level, the growth in the second quarter was 12%, with some moderation from 54% in the first quarter. Although the policy was announced to boost infrastructure investment, future uncertainty in Chinese market still continues. First half demand was below the initial projection, and the full year projection was revised down from the initial 20% to 30% to 10% to 20%.

Page 28 shows demand in Southeast Asia. In the first half of FY 2018, demand presumably increased 22%. Demand in Indonesia, the largest market in the region, remained strong. Due to the high demand in the second half of the previous year, we expect the growth in the second half will be slowing down. Full-year demand projection of 8% to 13% remains unchanged.

Page 29 shows the actual and the projected demand for mining equipment. In the first half of FY 2018, demand presumably expanded 52% year-on-year. Demand has been growing, especially in North America, Latin America, Oceania and Indonesia.

I would like to explain the orders in a series of mining equipment. Please refer to Appendix, Page 38. This shows book-to-bill ratio for mining equipment. This index shows the orders received for 6 months divided by the sales for 6 months. Komatsu America Mining Equipment manufactures ultra-large dump trucks. Latest ratio has been around 100%. No major change was observed either in orders nor in sales. Komatsu Germany Mining Equipment manufactures ultra-large hydraulic excavators. Compared to these dump trucks, absolute volume of sales are smaller and the index tends to show volatility and it shows certain cyclicality fluctuating around 100%. Komatsu Ltd. Mining Equipment has been around 100%. Both the orders and the sales have been strong. Coming back to Page 29. Latest full-year demand projection was revised upward from the initial 10% to 20% to 20% to 30%.

Page 30 shows the sales of mining equipment. This page shows our mining equipment sales, including KMC from 2017. Sales in the second quarter of 2018 increased 23% year-on-year to JPY 272.8 billion. On the Komatsu-conventional basis, excluding KMC, sales were up 23% to JPY 179.2 billion. Demand growth in Oceania and Asia, among others, pushed up sales. Based on the first half results and the latest decision, full year sales projection was revised up to JPY 1,015,000,000, up 9% year-on-year as shown in the left chart.

Page 31 shows the sales of parts. For the second quarter of FY 2018, sales of parts increased by 9% year-on-year to JPY 158.6 billion. Excluding the FX impact, the growth was 10%, construction equipment was plus 1%, mining equipment was plus 14%, and the KMC was plus 17%. Sales increased because Komatsu steadily captured aftermarket demand. Because we anticipate an increase in demand for parts of both construction and mining equipment in strategic markets, full year sales projection is revised up to JPY 604.6 billion, up 5% year-on-year.

Finally, please turn to Page 41. For the relocation of our head office plant of KMC. KMC will relocate its current head office plant in Milwaukee, Wisconsin to a coastal new location in the city, investing about $300 million. The new plant will feature cutting-edge technological advantages. The new plant will be the production base with our latest technology to produce rope shovel and blasthole drill with P&H brand as shown with pictures. Offices in the plants are consolidated to improve efficiency and productivity. And by deploying the latest energy-saving technology, almost 0 emission operation will be realized. KMC plans to promote the steady relocation in collaboration with State of Wisconsin and the City of Milwaukee for the total completion in 2022.

Page 42, a brief introduction of our first booth in CEATEC JAPAN IoT exhibition in Makuhari Messe in Chiba from 16th of October. We presented new technologies of SMARTCONSTRUCTION under the theme of safer, more productive and smarter construction job sites of the future. Komatsu was in the venue, and the Komatsu IoT Center Tokyo Mihama, Chiba City was connected for the demonstration of remote control of 5G bulldozer. And as shown in the picture, through autonomous hydraulic excavator and the crawler dump working together were represented in live video and they drew great attention from the participants.

Thank you very much for your attention.

[Tetsuji Ohashi, executive]

Thank you for your attention. We would like to go into the Q&A session. So when you are asking a question, we'd like to ask you to raise your hand and answer to the microphone, state your company and name.

[Yoshinao Ibara, analyst]

So I'm Ibara from Morgan Stanley MUFG Securities. I have 3 questions. So this is in Slide #19. This is the causes of differences in projected sales and segment profit. On the right-hand side, you have a bar stating volume and product mix differences. So this portion, you have reduced the outlook against your initial forecast. I think in terms of the volume differences, if we look at the left, it has increased. I think from my understanding, maybe it should be higher by JPY 20 billion against the initial forecast. I would like you to explain the background of this.

[Takeshi Horikoshi, executive]

This is Horikoshi speaking. So the net sales increase is JPY 126.5 billion and the profit has only increased by JPY 17.2 billion. I think you're referring to that point. And I think there are various reasons behind this. In terms of the volume difference and the peer volume differences, it's JPY 43.8 billion. And if you look at the difference in terms of the regional mix, because the proportion of strategic markets has increased, that accounts for JPY 6.2 billion. In terms of cost, manufacturing cost that is, it has been an increase of JPY 19 billion. And in terms of the mix, the parts has declined and the equipment has increased, so there's a JPY 2 billion negative coming from the difference of the product mix. So the remaining would be that because we have a good performance, there has been a one-off bonus payment, and we have explained this in the shareholders' meeting. We have issued some shares with restructuring to transfer. And because we have a capacity constraint, we have been transporting our products by air freight, so there has been a cost increase here. In terms of tariffs, there is an impact of the tariffs imposed by the United States to China for imports. So all in all, this is about a loss of about JPY 12 billion.

[Yoshinao Ibara, analyst]

This is Ibara again. So putting aside whether this has been reflected initially at the beginning of the year or not, I think you talked about tariffs in April. And bonuses, of course, will be linked to your performance. But if you look at cost, I think you know that your competitors are talking about a cost increase. Is there a change against your initial plan?

[Takeshi Horikoshi, executive]

Horikoshi speaking. If you look at the full year numbers, I think the biggest impact is coming from KMC. So against the initial forecast figure that we have announced in April, there has been a positive impact of JPY 23.5 billion on our profit. In the first half, in terms of the exchange rate, we had been using JPY 100, but this has been JPY 110. And the second half, we are forecasting JPY 105. Beneath that, in terms of the exchange rate, there is a JPY 25.5 billion gain coming from exchange rates. In terms of the pure volume differences, and this doesn't account for much, that is about a JPY 7 billion increase. And in terms of the regional mix, we have a lesser proportion of China and the proportion of North America has risen, so there is a difference in the regional mix, meaning that against the initial forecast, is a negative impact of JPY 4.6 billion. And another factor is that, in terms of cost, it has been slightly worse than initially expected by about JPY 6 billion. These are the major reasons.

[Yoshinao Ibara, analyst]

So Ibara speaking. The second question, I would like to turn to Mr. Ohashi. In terms of the mining equipment, I think you have a lot of opportunities to talk with your customers, that would be the mining majors. In this past 6 years, have there been any changes in their behavior? The copper prices have come down, but in terms of the coal prices, it is at a very high level. I think it's different by region, by customers. But compared to what you said in April, are the customers still have a good appetite to invest? Are there any changes?

[Tetsuji Ohashi, executive]

Yes. This is Ohashi. When I meet with the resource major people, I think that basically, nothing has changed. So in the past 4 years, because the commodity prices has been dropping and most of the companies have gone through structural reform, and more or less a lot of companies are reaching the end of this structural reform, and they are more focused on conducting new investment. And but in terms of greenfield investment, I think that there's more in copper because globally, this is where the demand and supply is most tight. So the copper prices has gone up a bit recently, but basically, the demand/supply situation is very tight for copper. Especially, going forward, you're going to see more electric vehicles, and then they'll be using more copper. And the emerging countries, the population will increase and urbanization is going to proceed. Meaning, that in terms of the outlook for demand for copper, I think you can look at it conservative or aggressively. But in any case, the demand/supply will continue to be tight. So I think investment towards copper is continuing. In terms of iron, in terms of the coiled steel production volume, it has been reduced in China. But in terms of the so-called high-grade iron ore, which is produced in the western part of Australia or Brazil, there is a lot of demand for these type of iron ore at China. So as a result, when I met with these people, they were saying that they're enjoying a record high level of shipment this month. So in that sense, currently and going forward, I think they will be very proactively investing, specifically, in West Australia and Brazil. I don't know whether it's going to be a greenfield investment or not. I think there'll be investment to expand the capacity of existing mines. And going to coal. Well, there are some resource majors that has sold their coal interest to other companies. So maybe what I'm saying will not apply to all the companies, but overall, I think for coal, the demand is still strong in the emerging countries. And I think basically, the investment towards coal is continuing. And I don't know whether we can call them resource majors, but if we look at Indonesia, the Indonesia has a plan to increase their total output of coal. This is because in Indonesia, domestically, their electricity demand/supply situation is very tight. And they are saying that they will have to generate more electricity in Indonesia. And they are saying that they'll be using domestically produced coal and that has been legalized within Indonesia. So as a result, they will have a contract with the Indonesian mines to provide coal at a relatively low price. So as a result, these mining companies, of course, they will continue to do their business looking outside of Indonesia, but they will be, of course, taking care of the business domestically. So as a result, we're going to see increased production. Maybe there will be a fluctuation in the price, more or less, but I think, overall, everybody is bullish.

[Yoshinao Ibara, analyst]

Ibara again, so towards the next fiscal year, your outlook is that capital investment will continue to be very active, that outlook is unchanged from 6 months ago?

[Tetsuji Ohashi, executive]

Ohashi. Yes. I haven't changed my view. In terms of how the demand is going to be, in the past 10 years, there has been 50,000 or 55,000 mining equipment that has been introduced into the market. And as a result of this, the production volume of mining products has increased by 1.5 to 2x. So you have to maintain this level. So if you assume that the equipment's life is about 10 years, it means that there will be a renewal demand every year of about 5,000 to 5,500 units every year. So in that sense, we have conducted an upward revision of our demand outlook, but even so, it's at 4,000 units. So I think we are going to see a stronger market going forward.

[Yoshinao Ibara, analyst]

Ibara speaking. Lastly, I'd like to ask about KMC. And I think they have been the driver of the upward revision. So compared to before you have acquired KMC, and compared to the peak sales back at the time, I think the proportion of the parts sales has gone back to about 80%, but in terms of the equipment, it's still around 30% of the peak. So I have 2 things to ask, Mr. Ohashi. So in parts, I think you have done a substantial upward revision, and things has gone much better for parts. Is it because Komatsu has conducted initiative and this has been very effective? Or is it that the mines are very profitable, so the users are thinking that they want to stock more parts this year? Because we don't have a transparency what KMC is doing, so I would like to ask about why parts are strong. And in terms of the Conventional Komatsu business, you talked about a 5,000, 5,500 renewal demand potential, but I don't know at all about KMC's new equipment situation. But compared to their peak, I think they're still at about 30% of that level. So in the future, how much do you think that they have the potential to recover? And I would like to ask about the parts and the new equipment.

[Tetsuji Ohashi, executive]

Ohashi speaking. Well KMC, we have conducted an upward revision, specifically the aftermarket business. The parts and service business has been strong, especially for the underground mining, aftermarket has been very strong. So this means that the underground machinery that we have sold, the utilization rate has gone up. So this is mainly for coal, but when you start to dig, you -- there is a various change in strata. So then, you want to do overhauling at the same time, so you bring back the equipment. And then you do a little bit of modification for the equipment, so that it will adapt to the various types of strata. And that happens often at the underground mining. So this is mainly for the coal mines, but for the -- in terms of existing underground mining, the utilization rate is going up. Furthermore, for parts in the surface mining part, with this aftermarket business, overall utilization is up. Therefore, we have been receiving orders for parts as well as overhauls. Regarding equipment, earlier, the BB Ratio graph was presented. Especially for underground, which is at the bottom, high numbers have been continuing for the past 1 year, and we have been seeing a dip lately. This is due to some orders we received in the past, but haven't shipped at this moment in time. To that end, going forward, we are expecting sales recognition and shipments to occur from the past orders received. Whatever the case may be for mining, from around the 2012 timeframe, we were in the ice age for a while when activities stopped. However, from the second half of 2016, broadly speaking, we started to see a pickup, and we expect a further pickup is going to continue. Thank you very much. We would like to take the next question.

[Katsushi Saito, analyst]

I am Saito from Nomura Securities. I have 2 questions. Here's the first question. Related to the previous question, Mr. Horikoshi, I would like to ask you a question on Page 19 about volume and product mix, et cetera. I would like to confirm with you one more time. When you just look at the second half -- sales is shown on the left, but the full year says JPY 126.5 billion, and the first half JPY 100.4 billion, which means that this portion should increase by JPY 26.1 billion for the second half. As for volume product mix, et cetera, it's projected to be JPY 17.2 billion for the full year, but the results in the first quarter was JPY 30.3 billion, which means that the second half numbers should look like minus JPY 13.1 billion. Am I doing the math right? So when you look at the second half, this portion will have a positive factor on sales, but a negative factor on profits. I think the cost risk difference, or COGS difference, is probably going to be higher in the second half where you're going to recognize some lump sum. So is this due to special factors? Are you estimating the cost side conservatively? Because the impact on sales may be positive, but it might have a negative impact on profits, and I was wondering what that is going to affect the next fiscal year? Can you please elaborate on that? And you also talked about incentives and bonuses as well as the air shipments that was made due to production tightness and tariffs that added up to JPY 12 billion of cost impact. Can you give me the breakdown of this number? And if possible, the results in the first half by line item. That's my first question.

[Takeshi Horikoshi, executive]

First, regarding first half results. We said it was JPY 30.3 billion for volume product mix, et cetera. Actually, we have a number for pure volume impact. That's why according to your math, Saito-san, you ended up getting a negative number for the second half. However, when you look at pure sales volume for the first half, it was JPY 34.8 billion, and the regional mix impact was JPY 8.5 billion. And the impact from COGS deterioration is about JPY 10 billion. And direct sales and cost and other items, which includes air shipments, this increased by approximately JPY 3 billion. So if you do your calculation based off the first half number of JPY 34.8 billion in volume, the full year should be JPY 43.8 billion, so the second half ends up being JPY 9 billion for this item. Furthermore, with regards to the full year outlook, regarding bonuses as well as direct sales cost and tariffs, if I give out all the details, I will be disclosing everything. And so I hope you can spare me from giving you the numbers. However, for the retaliatory tariffs between U.S. and China, at the beginning of the year, we set forth an estimate of JPY 4 billion on a company-wide basis, which was going to be the cost impact, and this hasn't changed.

[Katsushi Saito, analyst]

My follow-up question is with regards to the cost increase or COGS increase, in what region are you seeing this, and with what material? And are there any special parts that you are seeing tightness in, that you're still shipping by air?

[Takeshi Horikoshi, executive]

This is Horikoshi. We don't have information up to that detail. However, with regards to the changes from Tier 3 to Tier 4, COGS has had a large increase due to this change.

[Tetsuji Ohashi, executive]

This is Ohashi speaking. Let me follow up on his point. Regarding COGS, when we go through model changes, new functions are added. Therefore, this leads to higher cost and we account for that. And there was also a mention that the impact from tariffs is going to be JPY 4 billion. Due to the U.S.- China frictions, steel prices in the U.S. has went up significantly. It used to be around $600, but now it's around $800 to $1,000. In our company's case, procurement of steel materials inside the United States is only 10% or less out of total Komatsu steel sourcing, so the impact is going to be 1 billion or less, so it is not a big deal from that extent. With regards to air shipments, some were shipped by air due to the typhoons that occurred in Japan. Components for local production as well as spare parts shipments were made by air in some cases. And where production is tight, we have shipped supplier parts by air. And because of Typhoon #21 as well as other natural disasters, we saw a lot of this -- instances this year.

[Katsushi Saito, analyst]

My follow-up question is, can I believe that next fiscal year, if sales were to increase, profit will grow proportionately? That in this fiscal year's case, the second half is seeing higher cost? Therefore, the volume and mix has a negative impact. However, it's going to be normalized next fiscal year.

[Takeshi Horikoshi, executive]

This is Horikoshi speaking. Yes, you can look at it that way.

[Katsushi Saito, analyst]

Another question I have is for Mr. Ohashi, which is with regards to your view on China, emerging markets and mining. Currently, China is in a very uncertain situation. With that as a backdrop, emerging markets and mining are indirectly impacted by the Chinese market, although their demand is fairly brisk at this moment. Maybe it was too strong in demand when you set forth your outlook for China at the beginning of the year, but you revised it down. And it seems that you made an upward revision for mining because the first half was good. But how do you view the situation, Mr. Ohashi?

[Tetsuji Ohashi, executive]

This is Ohashi speaking. First of all, the initial outlook was reduced down to 10% to 20% growth compared to our initial outlook of 20% to 30%. The initial outlook was too bullish. Also last year, second half was already high levels, so we accounted for lower growth rates. And for fiscal 2018 and its full year outlook, we believe demand is going to be at its second-highest. Of course, precisely speaking, it may turn out to be the third-highest. However, we do believe that it's probably going to be the second-highest level of demand as you can see in the graph. There is a debate around economic slowdowns due to the trade issues between the U.S. and China. However, when you look at our KOMTRAX average operating hours, due to the addition of new machines the average operating hours are down year-over-year. However, if you do calculation and multiply the total machine population with average operating hours, total operating hours continue to increase year-on-year. Also, this may be associated with U.S.- China frictions, but at the end of July, the Chinese government made an announcement that they're going to increase infrastructure investments, especially in the rail-related projects. However, so far, we haven't really observed signs of reacceleration of investments being made. When you look at fixed asset investment, the national development reform commission announces the VHI construction permits numbers for projects that are CNY 10 million or above. The numbers continue to be flat year-over-year, and this trend is ongoing. Therefore, for China, we hope to watch the market closely going forward as well. However, overall, in China, politics and the economy are managed in an integrated manner. So we believe they are a strong country and we are not anticipating that the economy of China is going to crash. With that as a backdrop, considering emerging markets, of course, they may have trade relationships with China. However, overall, we're not thinking that the current situation is going to have a adverse impact on the emerging countries in the near future. One more thing is that our company is often referred to as a China play. However, as Mr. Imayoshi presented, China only accounts for 5% to 6%. Therefore, I hope that people spare us from being called a China play. That's all for myself.

[Unknown Executive]

Thank you very much. We would like to take the next question. [Operator Instructions]

[Graeme McDonald, analyst]

I am McDonald from Citi. I have a simple question with regards to the profitability of KMC. On Page 20, before temporary expenses, the profitability is 15.4%. I believe that Mr. [ Hudizika ] also said that you are striving for a 15% profitability. But in the past, during the Joy Global days, profitability once reached the 20% level. Of course, depending on the mix as well as if equipment sales is going to grow, there may be a chance that profitability is going to worsen. However, my question is, how you view future profitability? Do you think that current levels are already at peak? Or do you think there's opportunity for further improvement? Related to that, in April, you set forth a presentation, and at the pretax level, you were talking about a positive impact of JPY 2.5 billion. So can you talk about your views with regards to the first half as well as your outlook for this fiscal year? Also related to this, you also mentioned in the presentation about KMC's HQ investments as well as the factory transfer. But I was thinking that the investment of $300 million was fairly high. Do you really need to make this investment? So can you briefly respond to this question as well?

[Tetsuji Ohashi, executive]

Ohashi speaking. With regard to the profitability of KMC, I remember that at the time of Joy Global, it was 21% or 22%, vis-à-vis the current margin is about 15%, excluding the temporary expenses. I assume your question is how far it can be boosted. The current sales are much smaller than the time when Joy Global achieved the margin of 21% or 22%. Talking about the plant utilization, the plant for the aftermarket is fully utilized, but the utilization of the plant for the new machinery is still not very high. If the series of new machinery increase, we need to monitor several factors. Plant utilization may be up, but the margin of new machinery is not good as aftermarket, so we need to continue to keep close watch in the set timeframe. However, that said, I think the overall sales and the profit still have some growth potentials. As for the synergy effect, we cannot comment quantitatively as we have not finalized the figure for the half year, but it is proceeding steadily. And as for your third question about the relocation of the plant in Milwaukee, whether it is necessary or not, of course, it is necessary. Because the plant building structure age is more than 100 years, and we have been manufacturing in that aged facility, although the equipment inside have been renewed. And as for location, commercial and residential areas were developed later, in that they are in close proximity. Therefore, we decided to relocate the plant in addition to the renewal. This is not the decision only by KMC, but Komatsu Global Production was involved and headquarter was involved as well and discussed the optimum size, the core sourcing between Komatsu and KMC or former Joy Global, and also energy-saving effort, and concluded that the relocation would pay off and made the decision.

[Graeme McDonald, analyst]

McDonald. Another question, in the variance analysis on Page 19, selling price impact is shown as JPY 25 billion. Hitachi Construction Machinery said that due to the dealer issues in America, they put off the price hike in America. But in your case, Mr. Horikoshi said that the first half results in America were good, and the full year projection will be revised up. So I don't have any impression of more intensifying competition, but are you really able to increase selling price in America?

[Tetsuji Ohashi, executive]

Ohashi speaking. Yes, we have been able to increase price as planned in the U.S. And as far as I know, the selling price condition in the U.S. is not getting tougher. Thank you.

[Unknown Executive]

Next question, please?

[Hirosuke Tai, analyst]

I am Tai of Daiwa Securities. I have 2 questions. Firstly, although you said that proportionally, it is small, but my question is about China. At the beginning of autumn, I heard from Mr. Inagaki on site, and I feel that he was more upbeat and PPP might move. So the initial projection was rather high. But still, even with that, I felt that we can expect some upside. And this time, you changed the forecast. But how about the forecast for the next year? Is it still dwindling? Or rather remain unchanged?

[Tetsuji Ohashi, executive]

Ohashi speaking. I cannot comment on the next year. On 28 or 29 of July, at the standing committee, they decided to take stimulus policy. And then some investment project were announced for railway-related businesses, but they need to go through the environmental verifications that we need to keep close eyes. And besides, One Belt One Road-related project might emerge. When that country considers a stimulus package, presumably, the investment will be on the fixed assets. Therefore, we are continuing to monitor closely. After the Communist Party Convention in this month, and in December, Central Economic Work Conference will be held. And in the meantime, the number of new initiatives will be presented. And in the Central Economic Work Conference, certain direction will be unveiled. So we'll keep monitoring that development.

[Hirosuke Tai, analyst]

Tai. Do you think the number of the investment project are planned by the government increasing?

[Tetsuji Ohashi, executive]

Ohashi speaking. As I said before, the [ BHEI ] number has been flat. But it includes some project with the private sector involvement, so I cannot give you the simple answer.

[Hirosuke Tai, analyst]

Tai again. Another question is also related to next year, which you would find it difficult to comment, but Page 23 shows the demand for 7 major products as usual. In the process of making the new midterm plan, I am not sure what the key point is in the plan yet, but I personally feel the potential growth of the gray part in the left chart can be the key. You said before that Europe has been growing smoothly so long and the U.S. is already at a high level. So even if they slow down, if only the gray part of others stretch, then there'll be the overall growth. Can you give us any colors about the prospect of this others that is partly overlapped with the previous question by Mr. Saito?

[Tetsuji Ohashi, executive]

Ohashi speaking. As I said before, some part of this year is still unknown yet, so I cannot comment on next year. As Imayoshi mentioned before, the emerging market ratio or strategic market ratio is around 54%-or-so. When this ratio, especially that of Asian countries is high, that is good for us. And that is represented by this gray part. The current ratio is 54%, and in the first half it was 56%, so we'd like to keep the close watch on this. As was previously asked about China, when something happens in China, what would happen in emerging economies? I think China would have a good control in politics and economics. And then emerging economies will be strengthened as well to some extent. Thank you.

[Unknown Executive]

Next question, please? Any questions? Gentleman in the center, please.

[Mitsuyuki Oodaira, analyst]

I'm Oodaira of Tokai Tokyo Security. One question. Latin America is not taken up so frequently, but I have small 3 questions on it. It's showing the sales declined the first half or the full year weakness, in any country in this region, we cannot see the strengths. But even so, your decline is controlled at this level. Is this due to the mining equipment? Just for confirmation. Second point is about the aftermarket. If the aftermarket turned sluggish in Latin America, that might affect the new machinery market in North America. Can you comment on that current situation with that regard?

[Takuya Imayoshi, executive]

Imayoshi speaking. As for the sales by region, that is a combination of construction and mining equipment and the split varies substantially by region. At this moment, I don't have the precise data, but in Latin America, the mining accounts for more than 50%, so mining affects more, especially in Chile and Brazil. Construction has a number of issues, and we cannot say the environment is good. But impact is not material. Because in the construction, besides equipment, we do have the parts and the services business.

[Mitsuyuki Oodaira, analyst]

Oodaira. If the aftermarket slows down, will it affect the sales in North America market in the next year and onwards?

[Takuya Imayoshi, executive]

North America construction would go to the Latin America as the used product, so generally speaking, if Latin America weakens, that would affect North America.

[Mitsuyuki Oodaira, analyst]

Oodaira again. At present, the second-hand product from North America to Latin America, is it increasing or decreasing?

[Takuya Imayoshi, executive]

Sorry, I don't have that data now.

[Unknown Executive]

Next question, please? The gentleman in the front, please. Thank you.

[Shinji Kuroda, analyst]

I'm Kuroda of Credit Suisse. There are not many questions about fundamentals, but this might be the last question for Mr. Ohashi. So I'd like to have your comment on this. And you said that you wouldn't like to be regarded as China stock, but although fundamentals are very good, share price has been weak, which frustrates us. How do you view the current Komatsu share? I'd like to have your comment on that finally.

[Tetsuji Ohashi, executive]

Ohashi speaking. I'm not in a position to comment on share price, but I think there is a trend of sell-off globally. So I expect you to manage to raise share prices. And as for Komatsu, if only you wouldn't call us China stock, I personally think share price will be up. Thank you.

[Unknown Executive]

Any other questions? Although we are slightly ahead of schedule, I'd like to conclude our business results meeting with this. I hope your continued support and cooperation for the management of our company. Thank you very much for joining us today.