NEC Corp

TSE:6701

Earnings Call Transcript 2022-Q4

[Takayuki Morita, executive]

Thank you for your participation today. I would like to present to you the financial results for FY '22 March and financial forecasts for FY '23 March that were announced today.

This is what I will explain to you today. First, I will outline the full year results for FY '22 March. Page 5 shows the summary for FY '22 March.

Revenue was JPY 3.0141 trillion. Although impacted by decline in special demand for the GIGA school project and a negative impact from component shortages, growth business expanded through increase in 5G base station shipments and ABeam collaboration for core DX.

Adjusted operating profit was JPY 171 billion. I will detail this later on, but although strategic expenses grew and there was impact by component shortages, we achieved a substantial business improvement of JPY 31.5 billion versus last year. Versus the forecast from January 31, this is an upside of JPY 11 billion. Adjusted net profit increased for 3 consecutive years due to a decrease in tax expenses.

Please reference Page 6. Here we are showing the main indices and performance by segment. Free cash flow was JPY 84.1 billion. Details will be explained later on.

Page 7 shows the factors for changes in adjusted operating income. I will use FY '21 March actual JPY 178.2 billion as the baseline. In contrast to the JPY 33 billion in onetime gains recorded in FY '21 March, JPY 17 billion was acknowledged in FY '22 March; next, an JPY 8 billion impact due to component shortages; JPY 26 billion increase in strategic expenses. And unprofitable projects in public infrastructure was a negative impact of JPY 1.7 billion. On the positive side, the nonconsolidation of the displays business due to portfolio changes and newly consolidated Avaloq business resulted in a positive JPY 13 billion.

Business improvements were seen in global, Network Services, Enterprise and Public Infrastructure, totaling JPY 31.5 billion. All in all, for FY '22 March, profit was JPY 171 billion.

Page 8 details strategic expenses. For FY '22 March, we will spend a total of JPY 73 billion, an increase of JPY 26 billion over the previous fiscal year. The breakdown is as follows: JPY 13.5 billion in global 5G to enhance network abroad and product lineup, JPY 5 billion to strengthen internal IT infrastructure and business infrastructure arena, JPY 2.5 billion to strengthen and expand offerings in core DX and to launch in new areas, JPY 1.5 billion for investments in others and HR and JPY 3.5 billion for base business and structural reforms. We have increased each of these amounts to invest in future growth.

Strategic expenses for beyond FY '23 March will be based on the current level. And if any increase is required, it will be for the improvement of profits in relevant areas and will be managed so as not to worsen the business performance.

Page 9 shows NEC order trends. Excluding submarine systems, which is subject to quarterly fluctuations due to large projects; and display, which was nonconsolidated in November 2020, orders increased by 4%. In IT Services, orders increased steadily 3%, mainly in Enterprise. By segment, Enterprise sales were up 7% with strong sales in all segments. In Network Services, while 5G base stations expanded, sales declined with the absence of large fixed-line projects. And the overall results were flat. Global, excluding submarine systems and display, Avaloq's strong consolidated contribution and large orders for digital government and digital finance, resulted in a substantial increase. Quarterly trends are shown on Page 31 as supplemental material.

Page 10, Free Cash Flows. Operating cash flow saw an outflow of JPY 60 billion in working capital due to strategically increasing inventories in light of the tight component supply situation. CCC activity improvement shrunk versus the previous year, accounting for a minus JPY 32 billion. Corporate tax payments increased and adjusted operating profit declined. This resulted in an overall decrease of JPY 127.4 billion versus the previous year.

On the other hand, for cash flow from investing activities, excluding the impact of special factors such as the acquisition of Avaloq and the sale of assets held in the previous fiscal year, cash-out decreased by JPY 7.1 billion from the previous year. Thus, free cash flow totaled JPY 84.1 billion.

Page 11 is about our CCC reform efforts. At the end of March 2022, the number of days on a CCC reform project basis was 58 days, which was 14 days less than 2019 end March, the end of the fiscal year when this project commenced; and 2 days less versus 2021 end March. If we include the tentative deterioration due to strategic inventory buildup, the number of days is 66. This will be normalized in FY '23 March in accordance with the resolution of component shortages. We will continue our improvement activities to generate funds for growth and enhance capital efficiency.

Page 12 summarizes the status of investment securities. We set a target of 0 holdings in principle in April 2020 and we are proceeding accordingly. In terms of the number of shares held, listed shares decreased from 108 at the end of March 2020 to 52 at the end of March 2022, a decrease of 52%. The number of nonlisted shares, excluding alliance shares, also decreased from 206 to 176. The total amount sold was JPY 115.8 billion, taking into account changes in market value since the end of March 2020, making a significant contribution to free cash flow.

We have made progress in the sale of approximately 70% of listed shares since the end of March 2020, including those that we have already agreed to sell. We will continue our efforts in this area.

Next, I will explain the progress of our mid-term management plan 2025. Page 14 shows the goals of our medium-term management plan 2025, the actuals for FY '22 March and forecasts for FY '23 March. I will now outline the progress of each of our initiatives to attain our FY '26 March targets.

Growth businesses, Page 15, please: DG, digital governance; and DF, digital finance. In FY '22 March, due to the impact of newly consolidated Avaloq, both revenue and adjusted operating profit increased, standing at JPY 252.7 billion and JPY 15.9 billion, respectively. FY '23 March, we expect a decrease in revenue and an increase in operating profit on the back of disposing low-profit businesses of Avaloq and KMD. Core businesses are expected to trend favorably. The assumption of FX is JPY 110 to $1. As regards to the synergy with 3 European entities, Avaloq is driving sales in Asia. And along with [ SWS ] and KMD, we will expand businesses globally, including Japan.

Cost-wise, offshore resources have been consolidated for efficiency, and positive impact is already achieved. Going forward, we will further promote this measure.

Page 16, global 5G. In FY '22 March, revenue increased to JPY 67 billion due to a steady year-on-year growth of domestic base station business despite the impact of component shortage. While marginal profit from increased revenue contributed to our financial results, strategic expenses increased by JPY 13.5 billion from FY '21 March, resulting in an adjusted operating loss. In FY '23 March, we plan to achieve revenue of JPY 110 billion by continuing to increase domestic sales and steadily executing the commercial projects we have already received from overseas. Although we plan to maintain the same level of strategic expenses as that of FY '22 March, we aim at dramatically improving adjusted operating profit by increasing revenue.

Page 17, core DX. In FY '22 March, revenue increased, driven by consultation-led projects, namely the expansion of common infrastructure businesses, including the cloud, which enabled the company to register profit. In FY '23 March, we plan to invest for growth, but we anticipate increase in both revenue and profit but anticipating expansion in the same areas as that of FY '22 March.

In FY '22 March, we were able to accelerate collaboration with hyperscalers and strengthen DX offerings. There has been an increase in large-scale projects through partnership with ABeam Consulting. Through further collaboration, we will expand value offerings to our customers.

Page 18, status of underperforming businesses. Among the base businesses, we focused on improving those with low profitability and achieved an improvement of 2.6% in adjusted operating profit in FY '22 March. While started FCO-led (sic) [ CFO-led ] monitoring in FY '22 March, which has already generated positive results, in FY '23 March, we plan to accelerate these activities and optimize the business structure, including decisions to downsize some businesses and shift resources to improve profit margin by more than 1% against FY '22 March. NEC Energy Solutions was deconsolidated in FY '22 March, and we expect to see its positive effect in our FY '23 March business performance.

Page 19, culture. First, the engagement score, which is our KPI in the mid-term management plan 2025, it rose to 35%, an improvement of 10 points from the previous year. A 10% improvement for a company the size of NEC is quite unheard of. Communication programs carried between employees and management, which started in the previous mid-term management plan, have been continued. A total of 36 town hall meetings have been held in Japan and overseas to improve engagement. In Japan, after I covered the topic of the day, I took questions from employees and provided answers. We will continue this program going forward.

Page 20, creating a shared vision for a brighter future. By conceiving and communicating a vision of the future that society can relate to, we collaborate with like minds, co-create and conduct demonstrations, eventually implementing those solutions in our society. Examples of such activities are shown here.

Next, FY '23 March forecasts.

Page 22, FY '23 March forecasts summary. We are forecasting a 3.8% increase in revenue, mainly from 5G and core DX, which are growth businesses; and JPY 185 billion in adjusted operating profit, factoring in the increase in line with that of the revenue. Although the current IT investment trend is relatively firm, there are some uncertainties that make forecasting for FY '23 much quite difficult. Given that, somewhat conservative numbers are shown here as compared to the market consensus.

First and foremost, we will ensure that we achieve our profit plan for FY '23 March. Then, after, we will seek to top it up by capturing additional business opportunities and by properly managing risk. Although adjusted net profit is expected to go down due to a decrease in onetime tax expenses in FY '23 March, we plan to pay an annual dividend of JPY 110 per share, an increase of JPY 10 per share from FY '22 March.

Free cash flow will be explained in detail later. Page 23 is on financial forecasts by segment. Please refer to it at your leisure.

Page 24, adjusted operating profit change. Excluding onetime factors recorded in FY '22 March, the baseline operating profit is JPY 154 billion. By factoring in the expansion of growth and base businesses, a total increase of JPY 31 billion is expected from business improvements, which will lead us to reach an adjusted operating profit of JPY 185 billion in FY '23 March. As already explained, strategic expenses will be invested in targeted domains and will be kept within the scope of each domain's profit improvement so that overall performance will not be negatively impacted.

Page 25, free cash flow plan. Firstly, operating cash flow: A JPY 15 billion increase in working capital is expected due to the revenue hike. On the other hand, normalization of strategically increased inventories with component shortage will bring a positive impact of JPY 120 billion and which will result in a JPY 14 billion increase in adjusted operating profit. Given this, operating cash flow is expected to reach JPY 280 billion, up JPY 132.5 billion from FY '22 March.

Meanwhile, cash flow from investing activities is projected to be JPY 100 billion, an year-on-year increase of JPY 36.6 billion. This is due to the impact of asset sales in FY '22 March and increased investments toward the realization of the medium-term management plan. Given all of these, free cash flow is projected to be positive JPY 180 billion.

Page 26, countermeasures against market environment risks, including component shortage. In FY '22 March, the component shortage negatively impacted our operating profit by JPY 29 billion. As countermeasures, we [ changed designs ] to enable the usage of alternative components, switched to alternative products, optimized selling prices and cut unnecessary costs and pursued efficiency. These efforts created a positive impact of JPY 21 billion. As a result, we succeeded in minimizing the impact to JPY 80 billion (sic) [ JPY 8 billion ] on a net basis as forecasted on January 31.

With regard to market environment risks in FY '23 March, we will take the aforementioned measures to address the continuing component shortage. And we will appropriately address geopolitical risks by complying with the regulations of each country. Although uncertainties prevail, we will minimize the impact on our business performance by implementing these measures.

Finally, Page 27, the non-GAAP-based financial forecasts disclosure. Starting with the forecasts for FY '23 March, we will be providing information on a non-GAAP basis. This is because M&A remains an important part of our efforts to achieve the mid-term management plan 2025. And we are focusing on non-GAAP-based indicators considering PPA amortization to be the measure of our underlying profitability.

This concludes my explanation. Thank you very much for your attention.

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