OMRON Corporation (6645) Earnings Call Transcript & Summary

Managing Executive Officer, CFO, and Senior General Manager, Global Strategy Headquarters, Seiji Takeda.

I am Takeda, thank you very much.

And I am General Manager of the IR department. My name is Okada, and I will be the moderator today. As for the proceedings, first, CEO, Tsujinaga, will explain about the structural reform program NEXT 2025, followed by a Q&A session. We scheduled to end at 7:00 p.m. Japan time. We will explain using the presentation materials displayed on the web screen. It is possible to download the presentation materials using the QR code on the screen or through the URL. As notified in advance, there will be simultaneous interpretation between Japanese and English and live streaming in 2 separate channels. Let us now start. Tsujinaga-san, please.

Ladies and gentlemen, thank you all for taking time out of your busy schedules today to attend this earnings briefing or information session. Today, I would like to explain about the structural reforms that we discussed in our last financial results meeting. In a 20-minute presentation, I will provide an over-picture of OMRON's current status and structural reforms as well as the outline of the measures we are taking. Then during the Q&A session, we would like to answer as many of your questions as possible to the extent the time allows. So I look forward to your cooperation. First of all, let me start with our awareness of the current situation. We at OMRON, in our medium-term management plan that started in April, set a company-wide policy of taking on the challenge of value creation by accelerating transformation. And over the past 2 years, we have made progress on many initiatives, expanding the solutions business in the IAB, which is our core business, turning JMDC into a consolidated subsidiary this fiscal year building the foundation for the data solutions business, also preparing for businesses such as energy management in the SSB. None of this has been easy, but we have made some progress towards the transformation and value creation outlined in our policy, and we have gained a certain degree of confidence and traction in our efforts. However, with these steps and developments alone, it has been difficult for us to overcome the severe business environment. And I believe that is manifest in the financial results for the third quarter. This slide shows the FY 2023 forecast compared to the previous year. As noted on the left-hand side, the current fiscal year is expected to see a substantial drop in performance, a reversal from last year's record high when the company achieved its highest-ever performance. This was mainly due to a significant deterioration in the performance of the IAB and DMB. In particular, the impact of declining IAB has been considerable, thus rebuilding this business must be done as soon as possible. However, we have decided to implement structural reform company-wide and not limit it to the IAB alone. The reason is the entire company is beset with common factors that hinder company's growth and revenue expansion. First, please see the graph in the upper half. This shows the amount of sales growth for each segment over the last 10 years as well as its breakdown by area and business. As you can see in the IAB, HCB and SSB, you can see that certain areas and businesses are driving growth. This is in line with our strategic approach. We target -- we targeted this. On the other hand, this also suggests that there has been growing dependence on China for growth and the fact that the company has not been able to create new growth businesses that are sizable enough. In DMB, there is an urgent need to create new value. Next, please see the bottom half. The group's SG&A expense ratio is on an upward trend due to rising global labor costs and increased IT systems expenses. In the human resource creativity indicator that shows the relationship between human resources' investment and value added, we have not seen any improvement. This indicates that the investments we are making in human resources are not yielding results successfully. In response to this current situation, I have identified 3 factors that will hinder future growth and earnings expansion. The first is an unbalanced portfolio for growth. The businesses, products and areas that have supported our growth to this point remain the foundation of OMRON. However, we recognize that delays in the creation of new growth drivers in each our businesses is a major challenge from the perspective of ensuring sustainability of growth. The second is a rigid fixed cost structure. Sales fluctuation itself cannot be avoided due to the nature of the business environment. However, the current fixed cost structure does not allow for investment in technology, products and human resources as well as stable profit generation. I have a sense of crisis that this will be a stumbling block for future growth. Finally, there are delays in the transformation of human resources and organizational skills as OMRON is now creating data services and transforming its business model, the quality of capability required is changing dramatically. We have been making progress in replenishing our human resources and making the necessary investments, but we have come only halfway in transforming our business. Although efforts are underway to resolve these issues, the speed and the impact of their implementation generally is insufficient. To overcome this situation, we have made a decision to implement structural reforms. The following chapters describe the contents or the specifics of that. First, on the positioning of the structural reform program. The medium-term management plan, which has been set to run through FY 2024 will be suspended in FY 2023. We have newly defined a period through September 2025 as a period of structure reform and will promote the company-wide reform program NEXT 2025. During this period, as shown in the Q3 results, we will work to resolve 2 management issues. The first is to quickly rebuild the IAB. It is the business that drives the group's growth and has a large impact on the company's overall business performance. To quickly rebuild this IAB, we will promptly take necessary actions. The second is to rebuild the base or foundation for earnings and growth. Each business has its own growth-related issues. And to solve issues common to the entire company, we will promote 4 management measures. First, I will explain about the prompt rebuilding of the IAB. The performance of the IAB is expected to be significantly lower than last year. There are 3 main factors for this. The first is the impact of declining sales. Profit margins declined due to lower solution sales in the highly profitable Chinese market, especially in the rechargeable battery and semiconductor industries. This decline in sales has also led to a decrease in value added due to production adjustments and the worsening of the manufacturing fixed cost ratio. The second is an increase in the SG&A ratio. In addition to a higher labor cost mix, IT and facility expenses surged causing SG&A ratio to rise sharply, which could not absorb the impact of rapid sales fluctuations. The third is the impact of excess inventory. This is due to an increase in allowances for parts with long delivery dates ordered during the supply chain disruptions and an increase in distributor inventories. The combination of these factors led to a significant decline in profit margins in the current fiscal year. I will discuss how we will recover from this on the next slide. There are 3 key points for improving profitability. The first is to optimize the fixed cost structure. By optimizing the personnel structure and improving fixed cost productivity, we will streamline the total amount of fixed costs themselves. I will elaborate on this later. The next step is to eliminate excess inventory, controls over procurement are already in place. Over time, gross profit margins will begin to recover as reserves provisioned start to decline and the inventory, reserve for which has been provisioned, is shipped out. With these 2 measures, we expect steady improvement in the profit margin but exceed last year's ROS of 17% and to go beyond that to exceed 20%, it's essential to strengthen earnings through growth. So what are we going to do for future growth once again? The following pages will be used for me to explain. First initiative for evolution that is to build an industry and area of portfolio that reduces dependence on China. Second, initiatives for reinforcement, it is to strengthen the competitiveness of key components and expand the value of our offerings. This initiative will enhance the growth potential of not solutions, but also IAB as a whole. I will explain one by one. First of all, the future direction of our industry and area portfolio. Please see the blue box in the upper left corner. We have built a track record mainly in Japan, China and Korea of providing many solutions, particularly in the digital as well as the environment and mobility industries. As indicating number 1, the company aims to expand sales by accelerating solution development in Europe and the Americas, leveraging the control applications and customer adoptions we have accumulated to date. These 2 industries have a large scale of capital investment in factory automation, require advanced mass production technology and have high growth potential for OMRON. We will leverage our strength to achieve strong growth. Next is number 2, the food and household goods, medical and logistics industries. These industries are also areas where automation is advancing against the backdrop of changes in manufacturing in line with social needs and labor shortages. In this area, in control applications, components and i-BELT by tailoring and providing solutions that are more in line with industry needs, we will strive to expand sales. Finally, number 3, i-BELT. Our services have been well received by our clients and are becoming a growth driver with 43% sales growth projected for the current fiscal year. We need -- the need for database problem solving is particularly high, and we will leverage JMDC's technology and knowledge to improve the quality, breadth and speed of our services, leading to further sales growth. Let me now talk about strengthening the competitiveness of key components. There are 3 main targets in this initiative. First, continuous enhancement of the value provided after deploying the solution. After the introduction of i-Automation!, increase the power of components of employment to increase unit price per customer. Second, expansion of values provided to all the customers. Our products are used by a global and diverse customer base. By reinforcing key components, we will increase customer satisfaction and strengthen our growth potential. Third, strengthening of business competitiveness in the Chinese market. China will remain an important market for us. In order to raise barriers to our solutions business where we excel and to be competitive with local firms, we will strengthen key components. Please see the right-hand side. I will explain about specific initiatives. There are 2 initiatives. First, optimize the product portfolio. During the structural reform period, the number of products currently 200,000 will be narrowed down to generate a source of investment in R&D. Next, we will invest these resources in components that will be the key to growth as well as in the R&D resources of the technology headquarters at the head office in order to build a competitive product lineup at an ever-faster pace. We will steadily promote the series of initiatives to expand sales in IAB. We are currently working to materialize other strategies for further future growth. I would like to share the progress with you again on separate occasion. This is the end of the explanation on IAB. Next, I will explain the company-wide effort to rebuild a base for earnings and growth. As you can see, we will implement 4 management measures throughout the company. The first is portfolio optimization. In all segments, we will transform our portfolio to one that is both resilient and -- to market fluctuations and capable of high growth. We will also converge low-profit businesses and products, shift our resources to both areas and pursue efforts to maximize our results. Furthermore, in the data solutions business division DSB which was launched this fiscal year, we will increase the intensity of our business creation activities in the areas of Healthcare, Industrial Automation and Social Solutions to strengthen the group's overall portfolio. The next step is to improve fixed cost productivity. We aim to reduce costs mainly by eliminating low-value-added operations and by consolidating offices and functions. In addition, fixed cost discipline will be introduced and operated as a mechanism to prevent another increase in cost. This initiative is not intended to only reduce fixed cost. This is because we see it as the essence of rethinking the way we do business. Each business and headquarters function must eliminate all inefficiencies and build new operations. In this regard, we recognize that OMRON still has room for improvement in this area. The following pages describe the effectiveness of this initiative. Please see the left-hand side. With respect to fixed cost reduction, we will promote reduction of over JPY 30 billion by 2025. We already expect to reduce fixed cost by approximately JPY 10 billion this fiscal year, and we will continue to steadily implement each of these measures in the next fiscal year and beyond by doing -- in total, we will implant a reduction of more than JPY 40 billion. Please note that, as shown in the graph on the right, the SG&A ratio for the current fiscal year is high at 32.7%. The aim to improve this to less than 30% in FY 2026. The third measure is workforce and capacity optimization. By reducing our workforce globally and optimizing grading, we will build a solid foundation for growth and earnings. The following page provides more details on workforce reduction. The aim of this measure is to transform the capabilities of our organization and human resources to accelerate value creation, to build a personnel and personnel cost structure that is resilient to a rapidly changing business environment, we plan to reduce our global workforce by approximately 2,000 employees. As we have already announced in a timely disclosure document, in Japan, we will solicit applicants for a voluntary retirement from April 10 to May 31, 2024. Although we'll be reducing our workforce, we will continue to invest in the human resources we need and acquire people with the capabilities we require in order to accelerate value creation in the future. Next, evolve management systems. As we have shown as specific examples, we strive to visualize on-site data through ERP renovation and advance our performance forecasting process. We will then proceed to set KPIs to improve investment efficiency. We will evolve this area of management operation to maximize the results of our business and group-wide activities. Finally, please allow me to share the goals of NEXT 2025. First is ROIC, ROIC. In the current fiscal year, ROIC is expected to decline significantly from the historical level due to the substantial drop in operating income as well as impact of gain or loss on step acquisition at the time of acquiring additional shares of JMDC. However, through structural reform, we intend to make significant improvements to a level that exceeds the cost of capital at the earliest possible time in FY26 and beyond. Regarding fixed costs, we will reduce cost by -- through -- we will reduce cost through workforce and capacity optimization and fixed cost productivity improvements to increase the resilience of earnings to changes in environment. We will reduce cost by JPY 30 billion. Operating cash flow. We aim to eliminate excess inventory, which has had a considerable impact on our performance in this fiscal year, recover earnings in IAB and implement management's measures by assuming the intent to improve to our pre-COVID level in 2025. As explained so far, I feel that OMRON is now in the midst of a transformation period. This structural reform program, NEXT 2025, re-examines the challenges that we have accumulated and will be faced in the future. It is designed to promote fundamental reform. Some may accompany pain in the short term, however, by completing the measures we have set forth and linking them to the creation of new value, OMRON can be reborn as a company that grows even stronger. We would like to ask for your continued support and cooperation. Thank you very much for your kind attention. [Statements in English on this transcript were spoken by an interpreter present on the live call.]