NEC Corporation (6701) Earnings Call Transcript & Summary

Good afternoon, everybody. Thanking you for your precious time. That said, I'm quite happy to explain the announcement we made today. I'd like to first explain the summary of financial results for FY 2021 March and then 2025 Midterm Management Plan. And also now I'd like to explain forecast for FY 2022 March. First, I'd like to go through the actual numbers for FY 2021. Would you please turn to Page 5. And I'd like to go through the outline of the annualized numbers. The revenue down 3%. Without the COVID-19 impact in the original budget, first, we had thought that we'll be affected by 5% to 6%, in line within Japanese GDP. But thanks to the good traction of the 5G base stations [ deliveries ], remote work opportunities and also on GIGA School, those are special demands under the new normal days, we're able to reduce negative impact by the COVID-19 to some extent. Adjusted operating profit, JPY 178.2 billion. We were able to exceed 2020 midterm management plan, namely JPY 165 billion. Year-on-year basis, Network Services and Global Businesses improved. And we're able to restrict the unprofitable projects. In terms of the market depreciation, how -- we have decided to further cut cost. And also, we worked on the special measures. At the corporate level, we were able to make a quick response to the changes taking place in the environment. Adjusted operating profit, on top of the adjusted operating profit, we are able to also reduce the tax and we are able to actually record the profit 2 years in a row. In today's Board of Directors meeting, decided to increase the per share dividend from JPY 40 to JPY 50, up JPY 10. As for the annual dividend, it is going to become JPY 90 from the original JPY 80. Page 6, next, please. This shows the major indices. 2020 midterm management plan, our goals, operating profit percent to revenue as well as net profit as well as free cash flow, we are able to achieve these numbers, but clearly, in all to the free cash flow. We actually now executed to acquire Avaloq which was not included in the original plan. But still, we were able to naturally achieve the original free cash flow target. I will give you details about this later. Page 7, adjusted operating profit. This shows ups and downs since FY '20 March. As you see here, the major factors that can be separate into new factors for FY '20 March and FY '21 March. In regard to the market deterioration and measures for FY '21, I'd like to use the next slide to go through the details. This shows the analyzed impact coming from the deteriorated market in FY '21 March and what are the measures we have conducted on a quarterly basis. Impact from the deteriorated market in terms of the operating profit actually became JPY 42 billion for the full year. We announced [ JPY 150 ] billion. That was -- we had assumed in the previous earnings calls. So it became smaller. As for the cost reduction, actually, it was the same, JPY 17 billion since last time. And actually, we're able to gain more opportunities for new normal days as much as JPY 3 billion. So it was an improvement of JPY 12 billion. Real estate and other assets and sales became [ JPY 32 ] billion. All in all, we were able to actually then improve the impact from the COVID-19 as much as JPY 20 billion. On COVID basis, and here I'd like to share some of the specific moments in terms of operating profit. Looking at the fourth quarter only, again, it was positive JPY 8 billion. In terms of operational basis, we're able to actually overcome impact from the COVID-19. We had a peak in terms of the impact from the COVID-19 in the first half. And second half, it became smaller. But we need to keep an eye on its possible impact for some time to come. Next, Page 9, please. This shows the specific initiations per segment and on a quarter basis in terms of the orders. For the full year, for the entire NEC, actually, it's grown 2% by segment. The GIGA School actually gave us good opportunities in the public infrastructure. And 5G base stations and business actually became fully. And also, we are able to actually achieve a much better number on year-over-year day basis. In contrast, the biggest impact was found in Public Solutions and Enterprise. And we had a decline in the first half year-on-year basis. But for the Public Solutions and Enterprise, actually, now we started having recovery in the fourth quarter and the third quarter, respectively. And in the Global business side, the second half Display business became nonconsolidated. And actually, it shows a smaller number on year on year basis. Next, Page 10, free cash flow. Operating cash flow actually due to an increase on payment tax had a negative impact. But the adjusted operating profit improved JPY 32.4 billion. Operating balance actually improved JPY 36 billion. Actually, investment improvement year-on-year basis by JPY 13 billion. That said, in terms of the investment cash flow, we acquired Avaloq. Actually, we had to spend as much as JPY 198 billion. But we went through the business portfolio as much as JPY 14 billion and also sold the fixed asset of JPY 35 billion. And also the sales of investment securities, JPY 97 billion. We had those improvements. So year-on-year basis, actually, we're able to reduce the increase of the spend up to JPY 38.5 billion. All in all, the free cash flow actually became JPY 152.4 billion. We are able to naturally achieve our 2021 March budget as well as the midterm management plan. And as shown in the blue color, in terms of hold basis, excluding all the special factors, free cash flow actually improved by JPY 26.6 billion in success from the previous year. Page 11, please. This looks into the reduction of the investment securities. As of April last year, we decided to actually hold non-investment securities in principle. We actually worked on this important initiative. And the result, as of the end of March and FY '22, non-consolidated book value became JPY 105.4 billion. Taking into account the market devaluation since the end of March 2020, actually, we sold as much as JPY 96.3 billion. We're able to make a great advancement in this regard as much as JPY 50 billion. In terms of number of shares, actually, we used to have 108 stocks 1 year ago. Now, that became 63 stocks. Actual reduction by 42%. Next on Page 12. In regard to our cash convergence cycle, CCC. The first year of 2020 Midterm Management Plan, starting from FY '19 March, we started working on all the generation of the growth funds by reducing CCC and enhancement of management considering capital efficiencies. Well, as of the end of March, CCC days actually became 60 days compared that the FY '21 March, reduction by 6 days. And actually, we're able to now reduce as many as 12 days in 2 years. We would like to actually continue this effort as time goes on so that we can further create more funds for growth and also improve the capital efficiency. Page 13 is looking at the balance sheet statements. I have explained those activities in the name of CCC and also sales of investment securities. Operation has been improved. And also, we actually received funds from the third-party, resulting on the owner's, in capital -- all the -- as much as JPY 1.3 trillion. And the owners equity ratio became 35.7%. And net D/E ratio actually improved by as much as 0.14x. This concludes our actual statements for FY 2021 March. Next, I'd like to talk about 2025 midterm management plan. Thank you. The slide shows the content of my presentation. I will begin with the purpose management: Orchestrating a brighter world. NEC aims to create social values of safety, security, fairness and efficiency to realize a sustainable society in which everyone can fully demonstrate their humanity. This is NEC's purpose. In 2013, we defined our corporate direction as a company that creates social value, and this is our purpose. Our concept of purpose management refers to an integrated approach that firmly brings purpose with strategy and culture and realizes it through corporate actions. As society changes dramatically, NEC will make the most of technology to present a vision of the future one step ahead of the rest of the world and create a sense of empathy for the future. Society, customer, partner and employees or everyone involved with NEC, we would like to realize the vision of the future. Going to Page 6. We have compiled the social vision that we envision beyond 2025 Midterm Business Plan as NEC 2030VISION. Representatives and executives of each division participated in the creation of this vision. And with future consumers in mind, we have begun to specify the ideal environment, society and lifestyle and clarified how we will implement these visions in society in each of our businesses. Page 7. First, in terms of the environment which will be the basis of future human activities, NEC will realize the concept of coexisting with the planet earth to protect the future. In other words, we will contribute to the realization of a green society, decarbonize the society with the measures to combat global warming and assurance of water and food security. Next is society. We will create cities that will be inclusive and where the individuals in the society are in harmony and a resilient society by supporting industries and jobs in a society that goes -- does not stop even in emergencies. Thanks to our communication and cyber technologies, and contribute to the creation of empathy across time, space and the generations. In the area of life, we will support people's well-being through health care and life sciences to bring people together and feel each day with inspiration using the technology. In education, we will use the power of digital technology to provide free and open learning opportunities. In order to realize the future embodied in the 2030VISION, our purpose, strategy and culture are to work together as one. So that's the purpose management for NEC. Now I'm going to take you through our plans and actions towards 2025. First, review of 2020 Midterm Management Plan. The 3 pillars of the plan were: reform of the profit structure; realization of growth; and reform of execution capabilities. We have continued to reform our profit structure by reviewing our cost structure and the business portfolio and reformed our execution capability. As a result, we were able to overachieve our operating profit margin target of 5%, which is a minimum for sustainable investment for growth. In the 5G domain, we promoted strategic collaboration to lay the groundwork for the next Midterm Management Plan these are Midterm Management Plan objectives. For strategy and culture, to promote purpose management. In strategy and culture, we have formulated the specific objectives. For strategy, we will leverage our strengths in technology to accelerate global growth and domestic business transformation. The first priority is maximize earnings in the long term while optimizing short-term earnings. We will achieve an average annual growth rate of 9% in EBITDA. That's the target. In culture, the strength of our culture is the strength of the people who execute our strategies and realize our purpose. Under the NEC Way, we aim to be a company where diverse human resources work together, pursuing innovation. And we would like to be a company which is chosen by employees with a target engagement score of 50%. Next is the management targets. In the final year of FY 2025, we plan to achieve revenue of JPY 3.5 trillion and adjusted operating profit of JPY 300 billion with a margin of 8.6%. EBITDA target is JPY 450 billion or 12.9% as a percentage of revenue. Next is business strategies. This slide shows NEC's growth model, which is the source of the business strategies. In the middle, there is a dark blue box, which is the sources of NEC's strengths. And the left and light boxes show the of growth businesses that leverage those strengths. NEC strengths are its efficient R&D and its high-quality implementation capabilities which have supported the infrastructure of society networks in Japan for many, many years. In order to convert these strengths into value, we will develop technologies as a common platform and complement them with M&As so that we can achieve high cash flow and profitability in Japan and overseas. On the left-hand side are 2 major business areas that we will focus and expand globally, including Japan, digital government and digital finance and global 5G. On the right-hand side is the transformation of the domestic IT business. We will position our strength, which range from consulting to implementation based on the common infrastructure of our superior technologies, business domains. We define them as core DX and make them key drivers of growth. In the existing IT business, we will promote business transformation by improving low-profit businesses to achieve high profitability than the competition. Going to Page 17, growth businesses include digital government, digital finance, Global 5G, Core DX and the next pillars of growth. All other businesses are classified as base businesses. In the growth businesses, we will prioritize the allocation of resources in order to gain and strengthen our competitive advantage and aim to lead the increase in revenue and profit. In the base business, we will aim for steady growth in profits by focusing on improving profitability while making cautious assumptions about the business environment. The slide shows major drivers of EBITDA growth. In the base business, we will aim for a steady increase from FY 2020 level. On top of that, we will significantly increase adjusted operating profit in the growth businesses, such as digital government, digital finance, Global 5G and Core DX and plan to achieve EBITDA of JPY 450 billion by FY 2025. Let me explain about growth businesses. The first is digital government and digital finance. We aim to further expand the business by integrating, optimizing and stabilizing these existing assets of NEC and the 3 European companies that have -- we have acquired so far, realizing synergies and deepening the area of convergence between government and finance by utilizing our ID. We aim to become one of the world's leading vertical SaaS vendors in the DG and the DF market with revenue of JPY 300 billion and an adjusted operating margin of 12%. The EBITDA margin should go up from the current 70% to 20% for the 3 core European companies. Second, Global 5G. At the moment, we are working on the development and the global business structure enhancement at a very fast pace. And based on that, by 2022, in Phase 1, we will acquire the leading Open-RAN vendor position in overseas markets with a overwhelming TCO performance and differentiated technologies based on the world's first commercialization achievements with NTT and Rakuten. In Phase 2, which will last until FY 2025, we will strengthen our E2E, end-to-end capability, including the application area to significantly expand our software and service businesses and develop them into highly profitable businesses. Next is M&A. Our approach to M&A is to focus on areas where we can achieve growth in the mid- to long-term. On this occasion, I would like to review the results of past large-scale M&As. Prior to fiscal 2010, we have ABeam acquired in 2005 for approximately JPY 30 billion and generated an IRR of about 20%. NetCracker was acquired in 2008 for $430 million, and the IRR is higher than 10%. For recent M&As, it is too soon to evaluate in terms of IRR, so I will use EBITDA margin. First, NPS from the U.K. has been improving its performance steadily since the acquisition. While KMD has remained flat, but it has overcome the impact of the business mix review. In the future, we will continue to maintain strong governance and transfer our culture with the investee companies, including Avaloq, in order to realize our purpose. We will continue to evaluate and monitor IRR and other factors and share those with you at appropriate timings. I would like to talk about the domestic IT business and the social infrastructure business. The overall situation is as shown here. In the domestic IT business, we will accelerate our investment in Core DX, promote improvement and proceed with reform. In terms of management, the businesses are grouped according to their operating profit margins, and the low profit businesses are followed up with individual improvement plans. This shows our ideas for the transformation of IT business in Japan. From the ongoing customized vertical one-to-one to cross-industry solutions, transformation base business, by leveraging our Core DX business will actually improve our operating profit ratio from 8% to 13%. with this point in mind, of course, we need to depend upon the strength of NEC, engineering and R&D in our capabilities. We need to actually build a very good platform to offer this strength so that we can actually visualize what we can offer to our customers. Being more specifically and actually from consultation or to delivery, we need to actually integrate all these procedures so that we can actually act upon the customers, always customer-centric. And also, we have our differentiation via technology. So in ICT and other technologies, actually, we have this standardized offering of technologies. This is going to give us repeatable capabilities. And also we should give -- this is going to give us better cost competitiveness. And also, we should be able to meet with in hybrid and IT offerings in demand. The first item for the Core DX is not -- we'd like to expand our value proportion through the comprehensive approach, encompassing the consulting to delivery. We need to expand the value through in a combination of ABeam's approximately 5,000 consultants at the upper stream and delivery capabilities. We need to strengthen and expand internal consulting and the DX human resources, including ABeam. We need to be able to reach out to the CxOs and end-user departments of customers. We'd like to actually work on this path as strongly as possible. Second one is price strategy and gross profit improvement through common ICT platform technologies and offerings. This is going to be quite important for us to improve our numbers, specifically our profit and operating numbers. We need to now create platforms, common ICT infrastructures from NEC's strong technologies that deliver in both cost-efficient and high-margin solutions. Also, we need to improve profitability by developing offerings and pricing based upon value provision. This should be carried out based upon standards. This is what we'd like to do very much. The third one is the -- we would like to strengthen the competitiveness through hybrid IT, cloud, data centers and on-premise alliances and in-house optimizations. We like to combine mega-cloud and NEC's cloud through the global strategic collaboration with AWS as well the Microsoft in order to strengthen multi-cloud provision capability. With this done, we should be able to actually -- our work on the specific levels of security our customers do want. The fourth item is, again, here, we are looking at new business opportunities based upon those strength of NEC in social as well as enterprise transformation. Now we have digital government initiative and we have Japan Digital Agency created. This is going to give us really good opportunity for us to work on the flagship projects. This is going to actually help us to make our specific contributions to those customers in this area. Another important core of the base business, this is our strength also, namely our social infrastructure business. We need to maintain and develop deep domain knowledge based upon the long-term customer relationships and provide a full layer of value in sensing and networking and IT, particularly Public Solutions and the space and defense, network and other segments. We need to be able to construct and operate mission-critical infrastructure by combining highly functional and absolutely reliable technologies that can withstand harsh environments. And furthermore, in the midterm business plan, we are actually going to have those activities in network security and robotics. Actually, we have really good track records, and we'd like to apply them globally. Page 27, please. Here, I would like to talk about improve the profitability of the base business of NEC. We need to actually maintain profitability in regard to our -- compared with competitors for our high- and medium-profit base business. And also we need to improve potability by establishing a monitoring system for low-profit business. We need to actually be quite specific on identifying the specific of the numbers. Again on specific turnaround the plans they need to be built for the low-profit businesses. Actually, we have assigned the directors to be resourceful for this. Actually, we need to make a really good monitoring vis-à-vis the progress we are making. And in case they are missing the plan, the goals, we have to make addition for exit. Again, going through these physical activities will actually achieve our goals. Next page, please. In this midterm, the management plan, it's very important for us to work on the digital governance and finance and our Core DX. On top of that, we'd like to actually go above the targets we have defined in the now current midterm management plan so that we can actually R&D start working for the journey of the next future growth. Here now, we'd like to actually looking into the quantum cryptography and the laser communication, and it is going to be disruptive technologies. Yes, we actually often deliver these sort of solutions to our domestic as well as in global advanced customers. Of course, we have lot of track records in that data and in other areas. Definitely, and that is going to help us being more specifically, of course, NEC 2030VISION is going to be the good guideline. We are going to actually make further contributions to social as well as environmental initiatives we had to overcome. And here now I'd like to talk about a specific idea of what we call the living life to the fullest. Again, we need to be able to deliver on health care, tailored to people's health conditions. It's got to be personal services. We are now working on the AI drug discovery and visualization of the -- in terms of the live support as well as integrated hospital services. The second point here is the contribution to decarbonize society. This is under the important goal of the living harmoniously with the earth to secure in the future. Yes, we started working on specific objectives. Again, decarbonization solution is going to be quite important and circular economy as a theme is going to be quite important. Again, again, it's important for us to come up with the best contribution so that actually we can actually be successful in terms of CO2 reduction economically as much as JPY 90 trillion. Next, I'd like to go through the financial strategies. In the previous Midterm Management Plan for 3 years, of course, we worked really hard in order to improve our financial capabilities. Again, our cash flow is going to be a source of the structure of the growth. Again, we need to actually work on the best possible capital allocation from the midterm and long-term perspectives. We need to now look at both financial as well as nonfinancial aspects. With this point in mind, of course, we have to now work on and improve the capital efficiency. And also, we need to make sure that we have access to the money for the future growth investment. We need to actually have quite a strong capital structure, which is going to give us a good opportunity for sustainable growth. And we should not miss good opportunities in front of us. Page 33, please. Here we are looking at profit cycle as well as the capital allocation on the side of NEC. It's important for us to grow our business in order to meet with expectations coming from in our markets. At the same time, we need to be able to naturally improve financial soundness and also we need to enhance corporate value through cycling of profits. We are going to aim at JPY 1.3 trillion for operating cash flow. And also, we'd like to actually work on investment in cash flow financial holding on the cash flow and leverage needs to be maintained in and around the sound situations. And the dividend -- on the payout ratio is now set at 30%. I think this is going to give us really good investment opportunities for the base -- the business opportunities. And also, it is going to give us a good opportunity to make an investment into our future in growth opportunities. With this point in mind, I would like to go for the specific results, we can actually [ read ]. Of course, NEC has growth and strategy and also, we have a really good solid plan in order to improve the financial initiations by the 2025. Again, on adjusted operating profit, we are going to aim at JPY 300 billion. This is the instruction we are going to actually commit ourselves. With this point in mind, in order to accelerate our efforts for this, in light of the current situations we are now faced with, we need to be quite an aggressive and actually putting more -- money into the aggressive strategy. For FY '22 March, year on basis, actually, JPY 32 billion increase in terms of cost as well as JPY 12.5 billion for CapEx. Put them together, it is going to be JPY 44.5 billion year-on-year basis. Yes, we are planning to do so. With this then, R&D for FY '22 March, it is going to actually go up to JPY 130 billion from JPY 110 billion and back in FY '21 March. Starting from FY '23 March, we should be able to observe the cost we have to incur. And also starting from FY '22 March, definitely, it's important for us to keep an eye on cost benefit relationship. We have to have the continuous monitoring. And also, on the -- we are now assuming the JPY 120 billion increase. In terms of the net, compared with FY '21 in the year [ FY '26. ] And actually, we are going to have JPY 20 billion in order to further strengthen the business strategy. Next page, here, now, I'd like to go through the sustainable growth of the nonfinancial activities, the climate change, security, AI, human rights, diversity and corporate governance, supply chain and compliance. And we have KPIs for each domain. Next, I'd like to talk about the culture. Again, in order for us to be successful in our purpose in operations, it's important for us to have highly motivated people so that we can become employer of choice. And we like to actually accelerate on activities. Actually, we would like to aim at engagement score as high as 50% in FY [ 2026 ] March. And we'd like to join Global Tier 1. Three specific initiatives here. First, people and culture and here. And here diversity is going to be an important pillar. And women and also non-Japanese employees need to be leveraged as much as possible. So that we can accelerate diversity. In order for us to accelerate the transformation, it's important for us to actually identify the specific goals on top of it. Right now, we are working on the NEC digital workplace. We need to further advance this digital workplace. Again, it is going to give us location-free and productivity. On the office side, we have the communication hub and also innovation in our creation space. It is going to become hybrid space. Workstyle mindset actually are going to be the driving force behind these projects. Next. Next, in terms of establishment of business infrastructure, of course, each department has been working on this and actually produce good results. But now in order for us to have a thorough transformation in the name of corporate transformation, we decided to have the business process reform and the company-wide financial improvement systems and also the company IT systems, all these departments actually are going to be belonging to transformation office. And this office is reporting directly to the CEO, and they are going to be important core 3 domains. IT systems, of course, it's very important for us to have the integrated group, the mission-critical systems, cloud shift and IT integrated business process and also the system need to be redesigned. Page 40, please. As the market leader, it's important for us to actually send our initiatives. Again, on sharing our future vision vis-à-vis the future and the customers. And this has become important as opposed to on NEC side. I think this is going to help us to make further contributions to create new values. We need to strengthen general resource capability and collaborate with other thought leaders. This is going to be [ nothing ] for us to do so in order to become really good communicator. Lastly, I'd like to make a summary. In order for us to realize purpose on the goals, it's important for us to integrate strategy and culture. And we need to work on entire journey looking into 2025 Midterm Management Plan. Last but not least, let me take you through the forecast for fiscal year ending in March 2022. Please go to Page 5. Although sales revenue will increase due to the expansion of 5G and the contribution of Avaloq, due to the absence of the special demand for GIGA School we had in the previous year, the consolidation of the display business, the forecast is JPY 3 trillion compared the same level as last year. Adjusted operating profit is JPY 155 billion, in line with the midterm plan. As explained, we will actively invest in strategic expenses to maximize long-term profits. On next page, I will explain the variance from the previous year. Page 6 shows the variance in adjusted operating profit. The special measures recorded in the previous year is JPY 33 billion. And the decrease in large projects in social infrastructure and others, including the special demand for GIGA School, is JPY 12 billion. These are the negative factors for the earnings of the fiscal year ending in March 2022. On the other hand, contribution from 5G and Avaloq is positive JPY 53.8 billion. As a result, adjusted operating profit for the year could be JPY 187 billion. However, as explained earlier, in order to maximize long-term earnings, we will be making strategic investments of JPY 32 billion. So the projected adjusted operating profit is JPY 155 billion. Page 7 summarizes the breakdown of JPY 32 billion, as explained in the 2025 Midterm Management Plan. Page 8 shows a breakdown of revenue, adjusted operating income and strategic expenses by segment. Page 9 shows the measures to be taken in the first year of the MTMP in the 3 business areas. In digital government and digital finance, the first step is to accelerate the creation of synergies through the 3 companies acquired. In the top line, we will expand the business, including APAC. And in terms of cost, we will increase profitability by utilizing offshore operations. In Global 5G, we will continue to expand our market share in Japan. And at the same time, in overseas, we will acquire several commercial projects and strengthen our production and sales structure. In addition, we will reinforce the development of base stations, cores and operation management software by investing over JPY 10 billion in additional strategic expenditures. In the area of Core DX, we will increase the utilization of resources and acquisition of projects through ABeam collaboration and accelerated government digitalization. In addition, we will expand our offering menu by strengthening our collaboration with Hyper Scalers, such as AWS and Azure, mainly for private sector. Page 10, free cash flow. For operating cash flow, adjusted operating profit is down JPY 23.2 billion. In addition, CCC activities are down JPY 32 billion due to a decrease in the amount of improvement to 2 days from 6 days in the previous year. As a result, operating cash flow is JPY 220 billion, down JPY 54.9 billion year-on-year. On the other hand, investment cash flow is an outflow of JPY 90 billion, an improvement of JPY 32.5 billion year-on-year due to an increase of JPY 19.5 billion related to capital investment under MTMP and the special factors we had in the previous year. As a result, free cash flow is expected to be JPY 130 billion. That was our explanation of the results for fiscal year-ended March 2021, forecast for fiscal year ending in March '22 and the first year update of 2025 Midterm Management Plan. Thank you very much for your kind attention. [Statements in English on this transcript were spoken by an interpreter present on the live call.]