NEC Corporation (6701) Earnings Call Transcript & Summary

Hello, everyone. I am Osamu Fujikawa, the CFO of NEC. Thank you for taking time out of your busy schedule to join us today. This is the fourth annual ESG briefing, which we see as an opportunity for us to explain our ESG initiatives and achievements in purpose-driven management and to engage in dialogue with our stakeholders. Your feedback is essential to improving our initiatives. Once again, we would like to thank you for joining us, and we welcome your frank opinions. Today, I would like to start by explaining NEC's general approach to purpose-driven management and its aim to achieve sustainable growth for the company and society as well as the main initiatives of ESG. This will be followed by an explanation by our CLCO and CHRO, Mr. Matsukura on the aim of Corporate Governance Reform and the [ human ] capital management initiatives that drive the culture of purpose-driven management. I will now explain the ESG initiatives in AEC's purpose-driven management. This is NEC's purpose. The midterm management plan 2025 announced in May 2021 defines this purpose as NEC's reason for being and summarizes the business plans to achieve this purpose. NEC's purpose-driven management integrate strategies based on NEC's purpose with a culture that supports the people responsible for executing these strategies. Today's topic of ESG initiatives is positioned in this strategy as nonfinancial measurement methodologies to underpin sustainable growth for the company and society. We also promote initiatives around our 7 material entities, which will be introduced later. By disclosing the results of these initiatives in a highly transparent manner, we aim to continuously be incorporated in ESG indices. As a result of these efforts, we have been highly evaluated by Down Jones Sustainability Indices World and Asia Pacific and received A ranking from global NPO, CDP, among others. However, current ESG indices tend to evaluate from a risk management perspective and do not fully serve as an appraisal of initiatives leading to opportunities and growth. Further, it cannot measure how our nonfinancial activities are impacting our financial performance. So as shown here, the 7 ESD materialities are positioned as nonfinancial measurement methodologies supporting sustainable growth. Through risk management, midterm management plan capital costs will be reduced. And at the same time, insights and know-how accumulated in this arena can be linked to expanding opportunities in growth businesses under midterm management plan 2025 as well as increasing our free cash flow. I would like to explain using example the field of security where we have cultivated technology and expertise over many years. Recently, with the abrupt increase of cyber-attacks, it is said that ransomware attacks alone account for JPY 2.8 trillion worth of damages. To approach such social issues, we at NEC have set security as a materiality where we can maximize the potential of ICT. We are strengthening our efforts through the development operation of a Zero Trust platform where all access is not trusted. Because of such NEC's information security and cybersecurity initiatives in the aforementioned DJSI IT service sector, we acquired the highest class ranking for 3 consecutive years. To combat cyber-attacks, we also conduct third-party assessment based on U.S. National Institute of Standards and Technology, NIS framework. With the track record of such advanced security and technologies, NEC has mitigated its own risks and reduce capital costs. The technologies and know-how accumulated by protecting NEC itself through the growth businesses of Mid-term Management Plan 2025 shown on the upper right, contribute to solving customer issues and generates free cash flow as well. With security risks increasing throughout society, that in itself is extremely troubling, but our goal is to have our customers leverage NEC's technology and know-how and contribute to a safe and secure society. Let me now explain our main ESG initiatives for the current fiscal year based on the concept of corporate value. I will begin with the E, environment. NEC has been engaged in activities to manage environmental risks since the 1970s. In December last year, CDP recognized NEC's efforts and disclosure regarding climate change and water security. NEC was selected for the fourth consecutive year as an A-list company, the highest rating in these 2 categories. Also, NEC Group's FY 2031 CO2 emission reduction target relative to FY 2018 levels for Scope 1, 2 and 3 has been certified as SBT 1.5 degree Celsius. Taking advantage of CDP's recognition along with NEC's approach to environmental risks, we issued our first sustainability linked bonds in July 2022. This is one example of how we leveraged our ESG efforts to reduce capital costs. On the other hand, as an example of how we are taking advantage of our competitive edge to become carbon neutral, we have a disaster prevention and maintenance business. When a major disaster occurs, a large amount of energy is required to respond to the disaster and the rebuild society, and this is a major source of CO2 emissions, more than 10% of global emissions. We believe that disaster prevention solutions and infrastructure maintenance services using NEC's satellite, sensor and AI technologies can contribute to not only to extended service life of social infrastructure, but also to reduce CO2 emissions from post-disaster constructions. Next is G, the area of governance. At the end of January this year, we announced a tradition to accompany with the nomination committee, et cetera, as well as a renewal of the company-wide organizational structure based on the clear separation of oversight functions from execution and the strengthening of both functions. We are reviewing the risk management system to strengthen the governance of this business execution side, which should contribute to reducing risks as well as capital costs. Mr. Matsukura will explain the details to you later. This is the company-wide organizational chart as of April 1, 2023. We -- as an organization responsible for executing the growth strategy under the Mid-term Management Plan 2025, the digital government, digital finance business is transformed into the DGDF business unit. In addition, a public business unit is established to centrally handle the digitization of administrative functions in Japan. For the national security area, the aerospace National Security business unit is newly established. Furthermore, a new digital platform business unit is established to centrally plan, develop and provide products and services necessary for DX business development across the NEC Group. We will expand and strengthen our end-to-end DX offerings, leveraging our strength in everything from strategic consulting to platforms and delivery. By combining these offerings with the domain knowledge of each industry, we will contribute to solving our clients' management agendas and expand our DX business. Finally, S for social -- at last year's ESG briefing, we stated that we would contribute and continue the cycle of analyzing the financial impact of nonfinancial initiatives and implementing improvement matters to once again identify nonfinancial initiatives that would increase our corporate value and enable us to ensure an appropriate allocation of investments. However, it takes time to visualize the financial impacts of nonfinancial initiatives. And there is no [indiscernible] method for finding correlation, let along causality. In the correlation analysis between the PBR and the nonfinancial data that was conducted together with ABeam last year. We confirmed that the potential corporate value, particularly human capital, has a strong correlation to financial impact. So we decided to focus our analysis on human capital related data. In addition, using NEC's AI-based causal analysis solution, we found causal relationships that lead to improvements in such areas as the behavior of supervisors and psychological safety of subordinates within the organization. This year, again, we conducted the PBR analysis and the causal analysis of human capital-related data. However, in the PBR analysis, we conducted again this fiscal year, it became clear that the influence of external environment was large and that it was difficult to reproduce those same results. Rather than analyzing the correlation with financial data, we used the engagement scores, which is one of the KPIs in the Mid-term Management Plan 2025 as the objective variable to confirm the effectiveness of human capital-related initiatives and improved measures. As a result, we identified nonfinancial initiatives that are effective in improving engagement scores and the impact pathways that lead to improve in its scores. Mr. Matsukura will explain the results and details of the causal analysis later. That was my brief summary of the ESG initiatives this year in a purpose-driven management to translate both ESG risks and opportunities into corporate value. Going forward, NEC will continue to leverage our strength in AI and other digital technologies to verify and improve the effectiveness of various measures and to identify nonfinancial initiatives that will lead to increased corporate value. In addition, in order to realize our purpose, we will also establish materiality from an ESG perspective for the growth areas in the Mid-term Management Plan 2025 discussed today and further promote integration of financial and the nonfinancial factors that create both economic and social value. After this, our CLCO, CHRO, Mr. Matsukura will explain the intentions and aims of the changes in the governance structure as well as the details of human capital management. That concludes my presentation. Thank you very much for your kind attention.

Now I would like to continue with an explanation of NEC's corporate governance reforms and human capital management initiatives. As Mr. Fujikawa mentioned earlier, a major goal of the Mid-term Management Plan 2025 is the realization of purpose, which will be achieved through the integrated acceleration of strategy and culture as shown in this chart. I would like to talk about corporate governance reform and human capital management initiatives, which I believe will be important measures in this context. First of all, I would like to talk about corporate governance reform. Each company is taking various approaches to corporate governance reform, but I think the key point is why these reforms are being undertaken. Through corporate governance reform, NEC is committed to 2 goals to improve the quality and the speed of management decisions. For NEC to further evolve as a global technology company, we need to dramatically improve our speed and quality of management decisions. This reform is the final piece amongst the many critical initiatives and various corporate reforms that we have been promoting. Specifically at the General Meeting of Shareholders to be held in June, we decided to shift to a company with a nominating committee, et cetera. We believe that the purpose of this reform is not only to change the Board of Directors, but also to significantly review the executive structure. Authority will be transferred substantially from the Board of Directors to the executive officers. For example, M&A of less than JPY 100 billion will be shifted to a system in which various decisions can be made by the executive officers. Conversely, the premise of this change is that high-quality decision-making and proper risk management will be pursued by the executive side, enabling speedy management. On the other hand, the Board of Directors in charge of supervision must not only monitor business execution, but also supervised the overall direction of management, which direction NEC is heading and what's NEC's future image will be, which will be a critical function. While delegating authority for individual M&A initiatives to the executive side, it is important to accelerate a cycle where the Board of Directors set a clear direction for the Mid-term Management Plan and business portfolio and having the executive side manage the business promptly within this context. To achieve this, we believe the composition of the Board of Directors is key. We are planning to have the outside directors become the majority, 7 outside directors and 5 NEC directors from June onward. We plan to have 2 members from the Audit and Supervisory Board, Mr. Obata and Ms. Okada and 3 new members: Mr. Mochizuki, Mr. Okada and Mr. Yamada. Mr. Mochizuki is a former Vice Minister of the Ministry of Economy Trade and Industry and has many years of experience as the Chairperson of the Board of Directors at [ ITOCHU ] Limited. Mr. Joji Okada was not only the chairperson of the Japan Audit and Supervisory Board members Association but has also served as CFO and corporate auditor of Mitsui and company. Mr. Yamada possesses deep knowledge in technology and marketing as well as governance, and these 3 will become new members of the Board. This shows the skills metrics of these 3 individuals. As you can see, NEC is aiming to become a global company, so we have asked people with a great deal of insight and global business to join the Board. Further, since we want to expedite corporate governance reform, we have gathered people who have a high level of knowledge and insight in this area. As I mentioned earlier, we will not only monitor but also discuss important deliberation items of NEC at this meeting. In order to properly carry out such meetings, we assume that these 6 items from mid- to long-term strategies will be subject to in-depth discussions. In the past, in the evaluation of the effectiveness of the Board of Directors, some of the directors mentioned that the BOD took time to make detailed decisions when, in fact, it should allocate more time to discuss these issues. Improvements have been made through changes in institutional design and will now be positioned as an opportunity for in-depth discussions to determine the future of NEC as shown here. As for the executive side as shown here, for the decision-making process, we have enhanced the management meetings, which can be considered as the Executive Committee and below positioned several [ deliberated ] bodies. As for critical management decisions, we would like to improve the decision-making process at the executive side where risks can be appropriately assessed. For risks through the new establishment of the Chief Risk Officer, CRO, we can now oversee risk management across the entire company. Previously, individual CXOs have been responsible for their own domains, but we now plan to adequately manage at the company-wide Risk Control and Compliance Committee. Further, we would like to establish a third line of internal auditing, the group internal audit department, which will look at the first and second lines of risk management and enhance the system for auditing not only for NEC alone, but also NEC Group affiliates and overseas subsidiaries. This will deepen the overall management of the group. Finally, the revised compensation system. As an important aspect of corporate governance reform, the Remuneration Committee has repeatedly discussed the possibility of changing the remuneration system to ensure that executive officers and internal directors are fully committed to the realization of the medium-term management plan and medium- to long-term growth in corporate value. The compensation system has been reorganized in this way. The STI bonus is designed to commit to the amount and rate of EBITDA, which is a key indicator of the Mid-term Management Plan, along with the engagement score. As shown here, we will update the stock-based compensation system to a 3-year long-term commitment based on TSR. The expectation is to commit to our shareholders in realizing the Mid-term Management Plan as well as beyond that, our purpose and manage our compensation system accordingly. In order to realize the Mid-term Management Plan 2025, we will, as I have mentioned, separate supervision from execution and revise the executive compensation system, thereby speeding up and improving the quality of management decisions. We intend to achieve these goals under the new corporate governance structure. This brings me to the second point, our human capital management initiatives. We have been continuously strengthening our human capital management initiatives since FY 2019 based on the belief that investment in people is ever more important for executing our strategies and creating a culture. This is the goal set forth in the Mid-term Management Plan 2025. As you can note, our major goal is to achieve an engagement score of 50% as a KGI for FY 2026. If we can achieve this goal, we will be at the same level as the top 25% of global companies, and this is our target. Although it is impossible to compare engagement scores with other companies because different research firms use different standards. We believe that by properly tracing annual progress, we will be able to realize significant growth for the company. In particular, the engagement score we use is based on a very strict set of conditions. This 50% means that those who are highly engaged or engaged account for the majority. Currently, if we also include those who are somewhat engaged, 75% can be accounted to be engaged. However, we have set this goal with the hope of creating a company that consists of extremely engaged people. We also want to become a company where the company and individuals are on equal footing, where individuals are not under the company, but we neutral choose each other and where people can demonstrate their own value and grow at NEC. With that intent to create an attractive company, we have [ stated ] in the Mid-term Management Plan, the phrase employer of choice, and we have been promoting human capital management to become such a company. Allow me to introduce some of these measures. The first thing we have been working on is top management communication. Based on the challenges identified at the time of the previous management, led by CEO Niino related to distance between the management and the employees, we have been conducting interactive events between the management and the employees with an ultimate objective of transforming people and the culture. Since Mr. Morita took over as CEO, the company has taken full advantage of digital technology to hold monthly dialogue sessions of the present with employees at town hall meetings. This has been very important for employee engagement and alignment between the management and the employees. President Morita has been speaking frankly, to the employees, both about good news as well as bad news. And from that fact, we believe that each and every employee is seeing that the company is gradually changing. The second is career ownership. Today, employees must be able to work on an equal footing with the company rather than just listening to and following what the management has to say. In other words, it's important that they change their mindsets so that they can think and act on their own about their careers. That's why we have been offering career design workshops for the past 3 years. Initially, we offered a wide range of workshops for employees in their 50s. But we realized that it was not enough to cover only those in their 50s. So we have expanded the scope to include employees in their 40s and 30s. The workshops are attended today by 5,000 employees per year. Furthermore, if employees wish to discuss more about their careers with someone, they can meet with a career consultant, who is different from a direct supervisor on a one-on-one basis and receive advice on their career development. This closed loop process is gradually elevating the employee sense of ownership of their own careers. While promoting this mindset change of employees, we are also promoting diversity among employees. We believe that diversity and inclusion is a management strategy by itself. Diversity and inclusion is a key to NEC in becoming a true global technology-driven company, which embraces innovation. To this end, we are trying to increase the number of people with disabilities, female employees, foreign nationals and mid-career hires and reflect diverse opinions in our decision-making and business operations. As shown in this slide, our level of diversity is still at the very early stage. However, we hope to build on the current level every year going forward. To promote diversity, we have doubled the number of mid-career hires each year since 2018. Our current ratio is basically 50 to 50, with 600 new graduates and 600 mid-career hires per year. With this as the basis and by utilizing direct sourcing as well, we are creating a very efficient structure to acquire and retain diverse personnel from the working level all the way to the executive level. This mid-career talent based on their own experience they have acquired so far, can propose ideas and activities to us that NEC personnel alone would not have thought of on their own, thus revitalizing NEC personnel and others and helping them create new businesses in various fields. This is happening in various fields at the moment. As a framework to support these diverse people, we also promote work using digital technology. The smart way of working has been further accelerated during the pandemic. We are asking employees who used to think of the office just as a place to work to rethink about the fundamental function of an office. We are trying to reposition the office as a communication hub where the team can work together to show their best performance. That's what we have been communicating to our employees. We are also encouraging innovation by strengthening communication with external business partners going beyond the boundaries of companies by converting canteens into places for casual dining and meetings with outside partners as well as with employees. Those are the innovation hubs we are creating at different locations of the company. Those are the spaces for smart ways of working where we expect employees to feel not just easy to working, but also rewarding to working, Employees already working in these spaces today to bring about various innovations. As we gradually build out such environment, this year, we transitioned to job-based talent management. This represents the completion of a new HR system ecosystem that we have been working on since 2019. We plan to transition to the new compensation structure for pay for job and pay for performance to general managers within FY '24 and to employees within FY '25. The primary objective for job-based talent management is a timely execution of business strategies and the realization of HR strategies that support them. The key theme is to assign the right people to the right place at the right time. And to switch to a system that enables the most optimal job assignments regardless of whether they are internal or external resources. We have already reached an agreement with the labor union of our company during the last spring negotiations. All that remains now is to implement it in the work site towards FY 2025. In terms of human resource mobility, we have also expanded our internal talent recruitment system called NEC Growth careers. The previous system made positions available only once or twice a year, but now positions are constantly being offered and CVs are constantly being registered and uploaded by employees within NEC -- this matching place features a mechanism where possible matching is suggested by AI to both organizations and individuals. And the number of transfers based on these suggestions have increased considerably these days. Another is talent management. Until now, we have not clearly defined the top talent in the company but have broadly provided training in an impartial manner. We have changed this stance and selected about 1% of the 120,000 employees in the entire NEC Group as top talent, and they have been training the most promising among them as next-generation leaders. We are doing this in order to create a pool of strong human resources and a strong organization through a combination of tough assignment and intensive training. We believe this will enable them to effectively lead our businesses going forward. So that's what we are promoting at the moment. We have reorganized these measures from the perspectives of organizations and individuals. And in doing so, we have had a hypothesis as to how the 4 measures I have just mentioned will lead to an improvement in employee engagement scores. The human capital management initiatives we have been implementing our hypothesis and approach to enhancing management, innovation and corporate growth. To test this hypothesis, however, we analyzed the causal relationships between human capital management initiatives and employee engagement scores using our latest AI technology. The results are shown in the diagram. Thick arrows indicate a strong causal relationship. While thin arrows indicate that the causal relationship is still weak at this point in time without a strong causal relationship. That's how we can read the chart. Overall, the results indicate that our efforts to date have not been misguided. One improvement area, however, towards achieving the goal of engagement scores of 50% going forward will be dynamic talent portfolio shown at the bottom of the slide, which we believe can be addressed by accelerating the measures I have just explained in my presentation. This diagram, which I won't explain in detail is a more detailed version of the diagram that I showed to you earlier on the previous page. As you can see, we performed a causal analysis on each of the engagement survey questions. And the result is -- there is a high degree of causality between respective initiatives and engagement scores. We believe that by repeating the PDCA cycle of our human capital management initiatives based on the results of the causal analysis, we can increase employee engagement and revitalize the business operations by adding or accelerating such initiatives. Lastly, these are the actions to realize the Mid-term Management Plan 2025. First, we will continue to strengthen communication from top management to the frontline staff and focus on promoting transformation of people and the culture, then we will accelerate the development of a dynamic talent portfolio through measures such as job-based human capital management. These actions should help us improve employee engagement and realize human capital management. That concludes my presentation. Thank you very much for your kind attention.