Q2 2019 THK Co Ltd Earnings Presentation
Tokyo Sep 19, 2019 (Thomson StreetEvents) -- Edited Transcript of THK Co Ltd earnings conference call or presentation Thursday, August 8, 2019 at 10:59:00am GMT
TEXT version of Transcript
* Akihiro Teramachi
THK Co., Ltd. - CEO, President & Director
Akihiro Teramachi, THK Co., Ltd. - CEO, President & Director 
I am Akihiro Teramachi, President and CEO of THK. Today I'll cover the overview of the financial results for the first half of fiscal '19, our major measures and financial forecast for fiscal '19.
Let me first share with you the overview of the results for the first half of fiscal year ending in December 2019.
Consolidated net sales was down by 16.9% year-on-year to JPY 149.1 billion. One factor that I should mention about the sales decline is that there was a change in the U.S. GAAP rule that impacted our Automotive & Transportation business in North America. As we had to take out the sales that was previously generated with the buy/sell transactions of raw materials, this change impacted the sales negatively by JPY 2.8 billion. If we adjusted for this one-off item, the effective sales decline would have been 15.3%.
The U.S.-China trade friction prompted companies to curb their investment worldwide, particularly in China. Amid the general trend of [robot] placement and inventory adjustments, orders remained at low level across different regions. Even under such environment, our initiative to date for a higher CapEx in the semiconductor-related business and for accelerating automation and robotization led to significant growth in order backlog, which were steadily converted to sales. However, despite that effort, the net sales went down, due mainly to the sales decline. Operating income was down by 46.7% year-on-year to JPY 13.9 billion despite our measures to control the cost to cope with the demand adjustment. In sum, although the sales was built initial plan by JPY 4.9 billion, we were able to achieve the original plan of JPY 13.8 billion in operating income.
On the next slide, let me highlight the sales breakdown by regions. The general demand was low across different markets. We endeavor to explore the new target market like medical device, aircraft and railroad. But the demand drop for the existing business fields was so significant that in all the regions, revenue was down on a year-on-year basis.
Now let's move on to the operating income. Here I will use 2 different slides to explain about the Industrial Machinery business and the Automotive & Transportation business separately.
The operating income for the 2 businesses combined was down by 46.7% year-on-year to JPY 13.9 billion. As I go through the changes in operating income, let me first explain -- focusing just on the Industrial Machinery business compared against the first half of last fiscal year. The factors that pushed down the profit included negative JPY 11.2 billion due to lower sales and volume as well as JPY 400 million stemming from currency fluctuation.
On the other hand, the following factors impacted the OP positively. JPY 400 million due to lower fixed cost, thanks to a cost-reduction measure even on the back of higher depreciation cost and JPY 900 million from the improvement on the variable cost ratio.
Next, let me explain about the Automotive & Transportation business, analyzing the change in operating income compared against the first half of last fiscal year. The profit decline was caused by the negative JPY 1.3 billion impact from lower sales and volume, and minus JPY 700 million due to change in the variable cost ratio. The profit was pushed up by JPY 100 million due to currency, and there were no changes in the fixed cost base.
In sum, the primary reasons for the operating loss were a decline in sales and impact from the variable cost ratio.
The revenue decline was triggered by the drop in the automotive sales in different markets. The impact of the variable cost was partially due to increase in the raw material prices at TRA Canada as well as higher-than-expected costs, stemming from the new product launch that is manufactured in a vertically integrated style from aluminum forging, processing and final assembly. For the second half, we will implement more rigorous cost control for improvement.
I will now go through the balance sheet items. Total assets increased by JPY 11.6 billion year-on-year to JPY 474.5 billion. In current assets, cash and cash in account increased by JPY 14.7 billion due to the following breakdown: The operating cash flow was positive JPY 11.6 billion. Investment cash flow was negative JPY 17.1 billion due to CapEx, among other factors. Financial cash flow was positive JPY 22.5 billion due to the issuance of corporate bonds, and there were also some foreign currency translation adjustments. With lower sales, accounts receivables declined by JPY 13.7 billion, but the inventories were up by JPY 3.4 billion.
Liabilities went up by JPY 9.6 billion year-on-year to JPY 177.8 billion, mainly due to the following factors. JPY 20 billion and JPY 7.8 billion increase, respectively, in corporate bonds and long-term bank loans; and JPY 7.9 billion and JPY 8.7 billion decline, respectively, for account payables and income taxes payables. Net assets increased by JPY 1.9 billion year-on-year to JPY 296.6 billion. The main factors were: net income of JPY 9.8 billion, dividend payment of JPY 4.8 billion, and negative JPY 3.3 billion in foreign currency translation adjustments.
Now let me share with you our key initiatives aimed at achieving our management targets. As we have been showing in this slide for some time now, the 3 main pillars of our growth strategy remain unchanged. They are full-scale globalization, development of new businesses, and change in business style, and all have been implemented in a three-pronged approach. We will strive to further augment this strategy.
From the onset of the year, we have anticipated fiscal '19 to be the year of market correction. Having said that, we are highly confident that the addressable market for THK will grow over the medium to long term. And therefore, we will continue our growth investment while controlling the expenses.
We have also shown this slide at the previous financial results meeting for the fiscal year ended in December 2018. Our society today is now surrounded by network technology or data technology. This implies that we must live side-by-side with new technologies, such as robotics and computers, particularly with AI.
In the last 3 years, we have been reiterating this message inside our organization that the society has changed, and that we must assume people will be living side-by-side with technologies like computers. And that is why we have added the idea of changing the business style as the third pillar of our growth strategy to address the challenge in a 3-dimensional way.
As the society further evolves in this direction filled with technology, the semiconductor industry, which is our major target market, will see their business flourish and grow. With this, demand for automation and labor-saving investment would grow, and this will offer us opportunity in the existing business field. In that context, we aim to achieve growth with the existing business fields. And as the industry shift to a more automated and autonomous operation, there is a huge possibility that our components will be used as mechanical parts for a wide range of applications across the board. With that in mind, we will work hard to expand our product offerings, fit for these applications by broadening our core technology.
In addition, I'd also like to mention THK solutions, particularly, in the area covered by the bottom part of this slide. As a wide range of processes get more automated, it will become more difficult to fix some operational failure or emergencies by human interventions like we used to do. And when system failures occur, the loss and the damage could be huge. We must offer products and components that are fit to be used under such circumstances.
Today, machinery makers are making tremendous efforts to achieve visualization, and that initiative is important. But at the same time, we must be able to have good visibility over each single key components or it will be nearly impossible to service the machines. That is why we are making an all-out effort to expand Omni edge for further visualization.
We are also improving the way we conduct business so that there will not be any gap or intermittence in the process, which used to be the case with human operation.
We are promoting Omni THK to offer an integrated, seamless business style without creating any interruptions. For instance, we want the customers to have better visibility from the time when they make some request to order placement, product delivery and postdelivery product condition. I think offering visibility throughout the whole process is critical and that is why we are actively promoting Omni THK. We also believe that our products can be used for applications that is more associated with and used to support the B2C business. Our major medium-term goal is to be ready to leverage and grow with such business opportunity.
Let me dive deeper and give you more details about the Industrial Machinery business, which caters to a very broad range of customer base.
For the first half of fiscal '19, net sales was down by 18.3% year-on-year to JPY 97.7 billion. The operating income was JPY 16 billion. And as I explained about the operating income already, there's probably nothing more to add.
I would like to just emphasize that we continue to work meticulously in implementing proactive and efficient sales activities. With the recent rise of protectionism and populism across the globe, it is becoming more important to be able to locally supply to serve the local demand in respective regions. We will also strive to further strengthen such production and supply capabilities.
This slide is about the deployment of Omni THK. Omni THK is a very core element of our key strategic pillar, namely the concept of changing the business style. As I mentioned earlier, in terms of our offering, we have Omni edge, which enables the visualization of our products. It helps with the new product launches as we target to develop new businesses. At the same time, with the existing business, we expect to see more requests for shorter lead time for which we plan to address by expanding the tailor-made products using Omni edge. We are also adding new services like [ear] catalog and forecast to create a more user-friendly environment for customers to achieve higher level of visualization.
We are also moving forward with our own internal reform to cater to these needs.
This slide illustrates the deployment of Omni edge. As I explained at the previous result meeting, the whole idea is about installing sensors onto our products. Customers naturally expect the sensors to be installed on any new equipment and components, but what they want the most is to be able to have the sensors for their current machines in the fields or any machines that may be close to the end of the usable life. Customers may also have machines that are currently operating and have an aim to connect them with IoT under the idea of Industrial Revolution 4.0.
When the customers are pursuing in that direction, it's not enough to have the sensors on just the new equipment and not on the old ones. In that sense, we place great importance on installing sensors on the existing machines to achieve visualization. Free trials are underway with more than 100 customers now, and they have agreed to pay for the service from the following year. We are working out the fee table and considering what can be added to the product and services we will be offering.
As for the upcoming plans for this year, we will participate in the European EMO in September. It is an international trade show of machine tools. And there, we will be presenting the European version of Omni edge. The trials are currently provided to the Japanese customers, so the service is scheduled to go live in Japan in January of 2020.
As part of the enhancement of the global manufacturing structure, we completed the capacity ramp-up at the Yamagata Plant, adding another 32,000 square meters of floor space. We also have a plant in Vietnam with 16,000 square meters up and running, a site positioned to serve as the main production site to the Asia market.
With the recent slowdown in demand, the installment of manufacturing equipment at the Yamagata factory is deliberately being pushed back slightly compared to the original schedule. Having said that, we have an aim to achieve a high level of automated production for which we are actively building out the necessary environment. More specifically, we are installing new automated lines at the new plants, and in the meantime, upgrading the lines in the older factories over time so that when demand picks up in the next market cycle, we will be ready. The THK group boasts a local supply or product delivery ratio of nearly 80%, except for the Asia market, which only stands at a very low percentage points of 20%. And the plan is to gradually increase the local supply ratio by capitalizing on the capacity at TMV in Vietnam and the new plant in India slated for the commencement of operation in January 2020.
In January next year, the factory building will be completed, and then we will start installing the machines. So in effect, the operation will start from April in India. However, as a means to train the factory workers, we will [hopefully] start the knockdown production earlier than the April timing.
The total size of the land is 205,000 square meters, and the plant floorage space for the first phase of the project is 34,000 square meters. In terms of investment size, the spending for the first phase will be INR 3 billion, or roughly JPY 5 billion; and INR 5 billion or JPY 8 billion for the second phase. If everything progresses as planned, we will be spending a total amount of roughly JPY 13 billion in India in the next few years. We hope to capture the new demand in this new market.
The plant site is in Sri City of Andhra Pradesh. This region offers a corporate tax regime that is very enterprise-friendly compared against different areas in India. The buildout of the infrastructure in the area is also making a steady progress. The site is roughly 80 kilometers from the city of Chennai and the construction of hi wafer, smooth access and connection is also making good progress. Considering all these factors, it is an exceptional site compared to the other regions in India. 3 new large-scale industrial parks are also being built in the vicinity, and I believe there is an opportunity for us to work together with companies in these industrial parks.
So far, I've been talking about our initiatives on the manufacturing and supply side, but development revenue business is also extremely important. Even in the current weak market environment, the medical equipment-related demand is growing very briskly. On many occasions, I talk about our opportunities in different business areas, such as the applications in the semiconductor production equipment, machine tools and robotics. I strongly believe that in the future, we will be presenting the medical device-related business as one of the major business areas that we disclose separately from the other businesses.
With the advancement of AI and digital technology, I am observing a rapid shift to automated operation in medical devices where the procedures are distantly controlled and monitored by connecting computers to the medical devices. As 5G communication network becomes readily available, there may be more patients served by remote procedures and treatments. When something has to be mobilized or moved, that is exactly the moment when THK can exert its strength.
With aging society and more elderly people, one of the challenges for the society is rehabilitating the capabilities of the seniors. There is a huge potential here for market expansion, and our products are already being used in many applications for medical equipment. We'd like to further bolster our capacity in that area.
Recently, there were some earthquakes in Tokyo with a certain level of tremor that could be physically felt. The inquiries for seismic isolation and tremor-damping system is increasing. We haven't been able to have our products adopted for a large-scale project at this point, and it's been taking some time. But products like seismic-isolation tables are enjoying a steady increase in demand. We intend to grow this business further and continue to educate and enlighten the customers for this application.
We'd also like to bolster our offering to address the needs for automation in the restaurant business and logistics business. We are now trying out something new for new products in those areas. We have developed and started to supply the robot hands for picking work in the warehouses to help customers accelerate the shift to automated warehouse operation.
As the bottom half of the slide illustrates, we have also developed autonomous motion control system for material-handling robots. Robots are not stationary, and they need to move around in order to complete their tasks with continuous motion. So the robots need parts that would serve as the feet for human body. That is one example of what's under development right now. We use a unique approach to let the robots identify its destination of where they want to move to. We offer this to our customers as a solution to adjust their needs, whilst adopting what's been developed into our own plants. We have just started the verification test in collaboration with Tokyo Construction for robots with autonomous motion control system that can be deployed at the construction site for material-handling.
Now let me touch upon the main initiatives being deployed for the Automotive & Transportation business. The revenue for the Auto and Transportation business for the first half of fiscal '19 declined by 14.1% year-on-year to JPY 51.4 billion. As I explained at the outset, this sales decline reflects a change in U.S. GAAP, which impacted THK RHYTHM's North American business. The buy/sell transactions of raw materials can no longer be booked, and that had a negative impact of JPY 2.8 billion. Adjusting for this one-off item, the sales drop would have been 9.2% year-on-year.
The weakness in the global auto market across the major regions had a substantial impact. The sales is dropping in all the major markets in U.S., China and Europe. However, the negative JPY 2.8 billion on the sales did not have any impact on the operating income line since it was simply a matter of not booking the buy/sell transactions of raw materials.
Now let's quickly look at the Automotive & Transportation business for fiscal '19. The acquisition of the business from TRW still has some lingering effect. This is because the business for automotive normally moves in a 4-year cycle. So even when we can win a business on a single-shot basis, there's always some other businesses that are being lost. So we have yet to see a strong performance delivery. However, we have started to win some big orders recently. As illustrated by the bottom half of this slide, we have been expanding the capacity at various sites. In Mexico, we have completed the capacity ramp-up, and our domestic plant in Kyushu is also complete. In North America, the plant building was completed, and we are in the midst of ramping up the capacity in China. These are all investments made to cater to the orders from multiple car OEMs for their global models.
For our businesses in Europe, we will make use of the plant in Czech Republic, which we increased the capacity 2 years ago. We will use the idle capacity to carry out the business in the European market. With all these measures in place, we expect the Linkage and Suspension business to grow after 2020.
However, the current business condition is not necessarily favorable for the auto market. As I have been explaining, the market is on the verge of marking negative volume growth. To highlight some of the trend, the auto market in China, which was more than 28 million cars last year, may be on the brink of shrinking to below 25 million cars this year. In that since, our business has been impacted by the auto sales and their initial plan has been delayed by the weakness in the auto market. However, we plan to cope with the current situation with rigorous cost control.
In summary, we will continue to bolster measures to expand the top line. However, as I mentioned earlier, short term, our business will be impacted by the situation with overall demand. And from a long-term perspective, we will have to face competition with new players coming into the market. Under such circumstances, we will continue our efforts to strengthen the product through automation and robotization needs. At the same time, we will work to reduce the COGS by enhancing the productivity and make efforts to use expenses efficiently while achieving optimal sales price.
As the industry shift to more autonomous operation, competitive prices must be offered. But more importantly, the reliability must be secured. No one can stand to see disruption in their operation. And with more visualization, we must make sure that we maintain a high level of product reliability, offsetting the appropriate price and catering to customers' demands.
We have also been making tremendous effort for more coordination amongst all of our plants for capacity sharing and joint procurement. These are basic measures that are very obvious, but we will continue to boost our efforts for these initiatives.
Lastly, I want to quickly go through the full year earnings guidance for fiscal '19. As you can see by the graphs on the demand and order trend for the Industrial Machinery business, other regions are showing declining trend. However, we are starting to see gradual recovery, mainly coming from China as the market weakness in China happened before the other markets. That may be the reason why the Chinese market is gradually recovering prior to the other markets. However, we are aware that U.S. is maintaining its tough stance towards China on the trade negotiation, and there may be a third round or fourth round of tighter trade policy on China.
We have not changed our full year guidance on the sales target of JPY 310 billion. But nevertheless, we will continue to monitor the situations very closely. However, we are also seeing some positive signs as we have had some good discussions with our clients, including a semiconductor-related industry. We will make sure that good discussion is converted into sales.
The general trend in our industry is that when the adjustment on inventory and order placement is completed, that timing tend to be the trough, and the cycle normally starts to pick up afterwards. We believe the correction phase will be nearly completed around Q3 and we'll be prepared to cater to the pickup in demand when it happens in the market.
This will be the end of my presentation. Today, I covered the outline of the financial results for the first half of fiscal '19, our major initiatives and the guidance for fiscal '19.
Thank you for your attention.
[Statements in English on this transcript were spoken by an interpreter present on the live call.]