NEC Corporation (6701) Earnings Call Transcript & Summary

Thank you for taking your time out of your very busy schedule to attend the briefing. I'm going to talk about NEC's 2030 Midterm Management Plan. First, I'd like to take a look back on the 2025 Midterm Management Plan. We released the 2025 Midterm Management Plan in fiscal year ending March 2022, under which we have been driving corporate transformation based on a 3-pronged approach of purpose, strategy and culture. The key KPIs were EBITDA growth rate at the average of 9% per year and engagement score of 50%. As we have endeavored to achieve them, we were able to grow our revenue from JPY 2,994 billion to JPY 3,582.7 billion; increased adjusted operating profit from JPY 178.2 billion to JPY 386.8 billion, pushing up adjusted operating margin from 6% to 10.8%. We have grown EBITDA from JPY 295.8 billion to JPY 530.2 billion, pushing up EBITDA margin to 14.8% at a CAGR of 12.4%, achieving the midterm plan target. ROIC reached 9.1%, exceeding the original target of 6.5%. Regarding the engagement score, while we fell slightly short of the 50% target, it grew to 48%, reaching a level equivalent to the global top tier. So we were able to come this far. In implementing this 2025 Midterm Management Plan, we have promoted initiatives aimed at maximizing corporate value in both the strategy and culture domain. First, I'd like to talk about the strategy. We announced the value creation model, BluStellar; quickly implemented our in-house generative AI, cotomi; and advanced our DX business. Furthermore, we redefined the new security domain as a priority business, incorporating telecom services and submarine system, shifting resources towards the defense business and strengthening our cybersecurity operations. Globally, we have driven PMI of 3 European IT subsidiaries, and we believe that the acquisition of CSG has laid the groundwork for really growing our U.S. operations. Furthermore, we improved profitability in our global 5G and base businesses. In our Group management, we structured our listed subsidiaries and dissolved the parent subsidiary dual listing. For DGDF business, accelerating decision-making and growth following the relocation of our headquarters to Europe remains our ongoing challenge. We also recognize that expanding our presence in North America through the steady execution of PMI at Netcracker and CSG, whose acquisition was announced in FY 2025, that remains an ongoing challenge. Next, I will talk about our culture. We promoted reforms in people and culture, including the introduction of role-based human resources management, strengthening diversity and increasing the proportion of female and foreign executives. We also transitioned to a company structure with a Nomination Committee, and promoted corporate governance reform by restructuring Board of Directors. In terms of our organization, we accelerated decision-making by consolidating and reducing layers of organizational structure while also enhancing management controls through segment changes and the introduction of non-GAAP and cash ROIC evaluations. Furthermore, we have enhanced our corporate value and market competitiveness by promoting data-driven management and the Client Zero initiative, which involves treating our own company as our zero customer and fully leveraging cutting-edge technologies. Looking ahead, we recognize that strengthening our talent portfolio in the AI era, which is now in full swing, and enhancing global group governance remain ongoing priorities. This slide outlines where we are right now. After more than 15 years of management transformation, the steady execution of our 2025 Midterm Management Plan borne fruit. Last fiscal year, our market capitalization reached an all-time high. Building on the foundation for renewed growth rate between 2010 and 2015 and the promotion of culture transformation from 2016 to 2021, we believe we have successfully ridden the wave of corporate value expansion. And now before us lies a new phase, the widespread adoption and expansion of AI that lies beyond the extension of our past trajectory. We believe that how we perceive this major shift change and how we navigate it is key to achieving success in the future. Now let me outline our current environment and explain our perspective on it. We believe that the world is currently in a state where AI innovation and arrival of new security environment are transforming the global order and where threats and opportunities are expanding simultaneously. As social transformation driven by AI, which fundamentally reshapes lifestyles, work practices, industrial structures and social systems, progresses and global fragmentation accelerates, we believe -- we view the world as being in a new security environment where Japan has the potential to become a third option. I'd like to talk about the disruptive evolution of AI. It is symbolized by the Anthropic Shock. The capital markets are currently concerned about the future prospects of tech service companies and the market caps of major tech service companies has declined by approximately JPY 80 trillion year-to-date. We are now [ exception ]. This can be interpreted as the market having priced in the potential loss of business opportunities equivalent to approximately JPY 20 trillion in sales. We understand the concern of capital markets stems from the decline in the value of system development due to automation and efficiency improvement, the reduction in business opportunities for existing players such as system integrators due to the expansion of in-house development, the decrease in vendor switching costs, and furthermore, the increased risk associated with the blurring of operating responsibilities resulting from the widespread adoption of AI. On the other hand, regarding this AI industrial revolution, we believe it is important to focus not only on the threat, but on the opportunities as well. Currently, expectation for the market centered on semiconductors and hardware components and data center and cloud infrastructure led by hyperscalers appears to be growing significantly. But based on the history of past technological innovation, we believe that applications, platforms and even new societies and industry will emerge and become major markets in the future. Through discussions with research firms and others, we recognize that a new global AI services market exceeding JPY 45 trillion is emerging. This includes modernization through AI utilization, data for AI, the evolution of AI platform services, the advancement of AI agents in core business operations. And we recognize that this will also extend into the physical realm. In this environment, we believe the survival of the fittest among the market players will become increasingly clear. To become a company that succeeds in this new era, I believe the key lies in accurately grasping the shift in the center of value. Until now, the IT industry has been divided into 3 distinctive areas: consulting, system development and operations, with the market formed as separate businesses. In the AI-native era, we believe that companies will enhance their value by leveraging their strength in understanding the entire AI implementation processes to seamlessly connect requirements design, system development and creation of customer value through AI while also using AI to drastically improve efficiently in the system development domain. NEC's value proposition has also traditionally centered on system development in the middle. NEC's value proposition too has traditionally centered on system development. But in the AI-native era, we believe these 3 areas will seamlessly integrate to create customer value. Another paradigm shift is the expansion of the economic security market against the backdrop of normalized geopolitical tensions and the evolution of AI. Even looking at the defense market alone, in Japan, the market size is expected to expand from JPY 17.2 trillion to JPY 43.5 trillion, an increase of approximately 2.5x. In the future, we anticipate the expansion of defense budget and the conversion of military technology for civilian use. In this process, we see the potential for the scope of security to broaden. Specifically, we believe this is driving the blurring of line between peacetime and times of crisis, the convergence of civilian and defense technologies and markets, and the increasing importance of digital infrastructure. Adapting to this new security environment means that business opportunity related to comprehensive security, including economic security and cybersecurity, will expand. In terms of economic security, the value of ensuring the safety and reliability of critical digital infrastructure as well as strengthening cybersecurity to protect social system by countering increasingly sophisticated cyber attacks is expected to grow, and more than ever before. To emerge as a winner amidst these structural changes, we believe it is necessary to possess domain knowledge, system architecture and solid foundation as an integrated whole and to deliver tangible outcomes. The key focus of our 2030 midterm plan will be now we acquire [ the strength and to foundation ]. Now let me walk you through the specific strategies. NEC will drive growth by leveraging 2 core strengths: the social implementation of AI and the technological implementation of next-generation security. We believe our unique advantage lies in the continuous evolution through the interaction of these 2 domains. In the social implementation of AI, our strengths include domain knowledge cultivated through co-creation with customers, deep expertise gained from supporting mission-critical operations, end-to-end implementation capabilities spanning planning, deployment and operations, and BluStellar, our AI-native value creation model. In next-generation security implementation, NEC is uniquely positioned as one of the few companies with security domain expertise spanning maritime, communications, space and cyber. Combined with our long-standing track record of delivering safety and security, our full-line services integrating defense and digital infrastructure and our cybersecurity capabilities that fuse intelligence with AI, these strengths provide a strong competitive advantage. Next, let me explain by segment. In IT services, we will expand the implementation capabilities we have built through operating mission-critical systems in production environments into consulting and operations. By integrating these 3 areas into a unified end-to-end value proposition suited for the AI-native era, we will deliver tangible outcomes. We will grow this business into a highly profitable operation, increasing the non-GAAP operating margin from 13.4% in fiscal March '26 to approximately 20% by fiscal March '31. I will discuss BluStellar in more detail on the next page. But through strategic alliances with ABeam and BearingPoint, we will strengthen our global service delivery capabilities and enhancing our operating capabilities, including BPO services. At the same time, we will further enhance our capabilities in AI operations, security and operational governance while addressing the growing demand for sovereign cloud solutions. And in addition, we will accelerate synergy creation with NESIC Holdings. All across the nation, DX and AIX (sic) [ AX ] is going to be deployed based on our capabilities. Through these initiatives, we aim to expand our market share in both the enterprise and public sectors in Japan while becoming a top player. And in overseas, we will accelerate DX expansion in targeted industries, particularly in Europe and North America, centered on DGDF and Netcracker/CSG. I will now discuss BluStellar, which we position as the core of our AI transformation strategy. BluStellar has already become a driving force within our IT services business, delivering revenue of JPY 705 billion and a non-GAAP operating margin of 14.5% in fiscal March '25. By fiscal March '31, we aim to drive revenue up to JPY 1.3 trillion and improving the non-GAAP operating margin to 25% to drive growth of IT services business. Turning to specific strategy. We will embed AI across all BluStellar scenarios and dramatically accelerate implementation speed through the use of AI. On the technology front, we will strengthen our full stack capabilities through AI platform services, access to cutting-edge AI technologies via global alliances and specialized AI models powered by our proprietary AI supercomputing infrastructure. At the same time, we will ensure robust governance and security to support the safe implementation and operation of AI. Furthermore, by leveraging NEC's unique strength, including our Client Zero initiative, AX talent development and the commercialization of our IP DX capabilities, we will help customers create new value and enhance their competitiveness. In terms of the path from 14.5% to 25% non-GAAP operating margin, we see 4 key drivers. The first driver is higher value-added services and productivity improvements through enhanced BluStellar scenarios originating from consulting. The second driver is increased contribution profit resulting from revenue growth in BluStellar scenarios centered on NEC. The third driver is expanded sales and increased contribution profit through stronger collaboration with NEC Group companies and distribution partners. The fourth driver is improvement in the SG&A ratio driven by AI transformation. In social infrastructure, we will leverage our full-line service capabilities that integrate defense and digital infrastructure in the field of economic security. By combining these strengths with our IT services technologies, we will establish a uniquely differentiated position. In the defense business, NEC will further expand its operations in priority areas such as cross-domain operational capabilities, command and control, and intelligence-related capabilities, leveraging our position as a leading defense ICT company. We will strengthen NEC's competitiveness through the global rollout of equipment transfers aligned with government policy, broader deployment of dual-use products, and the development and acquisition of innovative technologies, both in and outside Japan. In the areas where NEC has particular strength, such as maritime communications infrastructures and aerospace, we will pursue business expansion by leveraging our full-line capabilities across these domains. In cybersecurity, we will globally expand CyIOC, our proprietary platform launched in fiscal year March '26 that integrates unique intelligence capabilities with AI technologies. We will address new market opportunities created by active cyber defense legislation by differentiating ourselves through CyIOC and our Client Zero initiatives. As a result, we plan to improve the non-GAAP operating margin from 8.9% in fiscal year March '26 to the high teens level by fiscal year March '31. From a cultural perspective, this is one of the important factors. We aim to transform into an AI-native company by evolving toward a people and culture-driven organization focused on creating value during this midterm plan period. At the same time, we will further enhance and streamline our management foundation. From a global management perspective, we will optimize the balance between Group-wide discipline and the autonomy of each company by implementing appropriate delegation of authority, while enhancing and streamlining headquarter functions, leveraging AI. And furthermore, with regard to thought leadership, one of our important missions during this midterm plan period, we will establish a platform-based think tank to serve as a catalyst for social transformation. By integrating the expertise of leading thinkers and specialists across society, we will help accelerate social implementation from a broader perspective as well. Having outlined these strategies, I would now discuss the specific vision we aim to achieve on our medium to long-term management targets. As our long-term management targets, we aim to become a company capable of sustaining annual non-GAAP operating profit growth of 15%, while targeting annual non-GAAP EPS growth of 15% or higher. As a result, we aim to build a business portfolio in which overseas operations account for 50% of total profits through global expansion and to be recognized as a global top-tier company in terms of both market capitalization and employee engagement. Under the Medium-Term Management Plan for fiscal year March '31, which serve as a key milestone towards these long-term goals, we aim to achieve a non-GAAP operating margin of 15% or higher and, as a result, double non-GAAP operating profit compared with March '26 levels. We have also established EPS targets aligned with these long-term objectives. For our nonfinancial targets, we aim to achieve engagement scores at the global top-tier level, specifically within the top 25th percentile globally. For capital allocation, we will ensure that we maintain the capacity to strengthen competitiveness and execute growth investments in the AI era while continuously enhancing corporate value. Regarding shareholder returns, we will maintain our basic policy of stable dividend increases and flexible share repurchases. Following the acquisition of CSG, we plan to secure up to JPY 1.2 trillion to JPY 1.3 trillion for growth investment through the end of fiscal year March 31. We will rigorously apply cash ROIC-based evaluation in both acquisition reviews and post-merger monitoring to ensure strong financial discipline. In addition, as a general rule, when treasury shares exceed 5% of total shares outstanding, the excess portion will be retired. Thinking around M&A and portfolio management. This is the actual results. As you can see in the table, we have clearly defined the business domains where we can generate strategic value and have focused our acquisitions accordingly, while also carrying out timely restructuring and divestitures of business or businesses outside our focus areas. During the course of this midterm management plan, we will continue to rigorously pursue business portfolio management that leverages NEC's strength through the expansion of growth businesses and decisive actions regarding noncore businesses. At a time when AI-driven social transformation and a new security environment are converging, NEC will accelerate its transformation. By leveraging our combined strength in the social implementation of AI through IT services and the technological implementation of next-generation security through social infrastructure, NEC will continue to take on the challenge of realizing a sustainable society in which every individual can fully demonstrate their humanity and integrity. Empower Humanity represents the vision and the role that NEC Group aims to fulfill towards 2030. Through the social implementation of AI, we will unlock human potential and drive innovation. Through the technological implementation of next-generation security, we will create a society where people can live with safety and peace of mind. We firmly believe that by delivering both innovation and security through these businesses, we can help realize a society where everyone can maximize their humanity and potential. Thank you very much for your attention today. This concludes my presentation. [Statements in English on this transcript were spoken by an interpreter present on the live call.]