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Edited Transcript of 6501.T earnings conference call or presentation 30-Oct-19 9:30am GMT

Q2 2020 Hitachi Ltd Earnings Presentation

Tokyo Nov 2, 2019 (Thomson StreetEvents) -- Edited Transcript of Hitachi Ltd earnings conference call or presentation Wednesday, October 30, 2019 at 9:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Mitsuaki Nishiyama

Hitachi, Ltd. - Representative Executive Officer, Senior VP, CFO & GM of Finance Group

* Tomomi Kato

Hitachi, Ltd. - Deputy General Manager of Financial Strategy Division

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Presentation

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Unidentified Company Representative, [1]

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We would now like to begin the briefing for the consolidated financial results for the second quarter ended September 30, 2019, for Hitachi, Ltd. So we'd like to introduce the presenters for today, Mitsuaki Nishiyama, Senior Vice President and Executive Officer, CFO; Tomomi Kato, General Manager, Financial Strategy Division; Yasuo Hirano, Executive General Manager, Corporate Brand & Communications Division. So Nishiyama will start with the presentation.

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Mitsuaki Nishiyama, Hitachi, Ltd. - Representative Executive Officer, Senior VP, CFO & GM of Finance Group [2]

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Thank you very much for gathering here today despite being such a late time in the evening. And some of you might have been attending for a long time today's meeting, so thank you very much for that.

Now I'd like to use the slides for my presentation. First, please turn to Slide -- Page 1-2. The second quarter sales, the middle column, JPY 4,221.3 billion, a decline of 6% year-over-year. IT segment and Industry segments had increasing revenues with -- Life segment had an impact of business divestiture in semiconductors and automotive materials. Because of worsening market situation, Hitachi Metals, Hitachi Chemical had also declining revenues.

Next, adjusted operating income, JPY 297.2 billion. Compared to the previous year, a decline of 14%. IT, Life segment, the 5 sectors businesses, in particular for IT and Life, there was increase in income. But the listed companies Hitachi High-Technologies, Construction, Metals and Hitachi Chemical all had decline in operating income.

EBIT was JPY 290.5 billion. The railway Agility Trains West shares were sold, which was a gain by Hitachi Metals. In magnetic materials business, there was impairment loss on fixed assets and goodwill impairment loss posted, which led to a decline. So net income attributable to Hitachi, Ltd. shareholders was JPY 189.2 billion, down by 2% year-over-year.

The next slide, 1-3. Revenue and the profit of our 5 sectors and the listed subsidiaries are shown. Let me start from the bottom of the table, which are the listed subsidiaries. Adjusted operating income, Hitachi Chemical had a decline of JPY 27.1 billion year-over-year, which was the impact of our market situation with total for 4 companies, JPY 52.8 billion decline year-over-year was seen. And EBIT also, in addition to the decline of adjusted operating income, Hitachi Metals, goodwill and fixed asset, JPY 61.8 billion impairment loss. So it was a decline of JPY 116.7 billion year-over-year. And net income was a decline of JPY 57.4 billion year-over-year.

The top part of the table, 5 sectors. Adjusted operating income, the momentum of first quarter was continued and the IT sector and the Life sectors were firm, a plus JPY 5.4 billion year-over-year. The first quarter -- or rather EBIT, with the improvement of operating income and Agility Trains West shares were sold and the risk-sharing type of impression was introduced, so there's increase of JPY 54.9 billion year-over-year. So net income for our 5 sectors was an increase of JPY 53.7 billion. Now the 5 sectors adjusted operating income in the first quarter total was a record high.

Next, Slide 1-4. Revenues and operating income factors affecting the changes are shown. Left-hand side are revenues. First, with business divestiture, impact of reorganization was JPY 124 billion. Hitachi Kokusai Electric was deconsolidated, and Automotive Systems business like Clarion were divested. In total, this had an impact of a decline of JPY 124 billion. And foreign exchange impact was JPY 80 billion decline; and others, JPY 66.5 billion. So decline of revenues was a major impact.

Right-hand side, adjusted operating income. The impact of reorganization was JPY 6 billion -- a negative impact of JPY 6 billion. Foreign exchange was JPY 12.5 billion, a negative impact, negative factor; and others, JPY 15.8 billion, negative factor. And also, just like revenues, declining sales was a major factor. In addition -- investments for growth of JPY 13 billion, this is as we have planned. This added JPY 297.2 billion was the result.

Next slide, 1-5, is our revenues by market. First, to the right-hand side, year-over-year figures. Japan was 100%; and outside Japan, 88%. Though not included here, foreign exchange and divestitures impact excluded, then domestic goodwill 102; and overseas, 95. So relatively speaking, Japan is doing better, and overseas is declining. In particular, China and other areas, ASEAN, India excluding China, showed large declines. In North America, automotive parts and metals declined, but Hitachi High-Technologies, Hitachi Construction increased, so this is 95%. Foreign exchange and divestitures are -- when excluded, then North America would be 101% year-over-year.

Next, 1-6 is the financial position and statements of cash flows. Total assets, JPY 9,719.5 billion. Compared to the end of the previous term, it is an increase of JPY 93 billion. However, here, lease assets, there's a change of accounting rules of lease asset/liabilities is on balance, which is an impact of JPY 220 billion. And other assets were compressed. And the cash conversion cycle, CCC, is 71.6 days. Towards the end of fiscal year, we will aim at achieving a little below 70 days. Total Hitachi, Ltd. shareholders' equity ratio was 34.4%; and D/E ratio, 0.31x. Cash flows from operating activities was JPY 205.6 billion, similar level as the previous year. And cash flows from investing activities, expenditure was JPY 27 billion (sic) [JPY 207 billion], so there is a decline of JPY 64.6 billion, which is increase of outflow from the previous year. In the previous year, there were sales of shares, but this time, there were no major divestitures. And Hyundai Engineering in Taiwan, the Taiwanese elevator company, with the TOB, this is now an equity method company. And this outflow happened during this term. So compared to previous year, there was an increase of outflow, and free cash flow is JPY 1.3 billion.

After 1-7, these are the revenues by segments. First, for IT, increase of system integration led to 102% increase in revenues year-over-year. Operating income, strategic investments were increased. So with increasing revenues, it is increase of JPY 10.8 billion year-over-year. Next, Energy mainly at nuclear power BU, there are projects related to new regulations which we had last year, but this decreased this year, so there's a decline in revenues and operating income.

The next page, Slide 1-8 industry. For industry, revenues increased by about 2%. The sales increase in air conditioning system business for industry field was seen. On the other hand, after -- in adjusted operating income, as a result, there's a slight increase of about JPY 0.2 billion. For Mobility, the impact of foreign exchange was seen. For Building Systems and Railway Systems improved -- there was a big impact on foreign exchange. And for Railway Systems BU, there was a decrease of revenues in the U.K. market. And also Building Systems in China, sales price -- average sales price went down. So revenues declined by about 9%. On the other hand, adjusted operating income, revenues declined, but buildings cost reduced, so we could maintain a similar level of operating income as the previous year.

Please move on to 1-9 for Smart Life. So for the Automotive Systems business, because of the divestiture of the business, there was JPY 97 billion of a negative impact. And that is why year-on-year, there was 88% of revenues. Now for the Automotive Systems and also for the appliances and also for Healthcare business unit, all these because of structural reforms and also for cost reduction, we were able to realize this. Therefore, there was an increase of JPY 10.3 billion of adjusted operating income. And we -- for the 4 listed subsidiaries, starting with Hitachi High Tech. So there's been an increase in the semiconductor processing equipment. However, there was a decline in the sales of liquid crystal display exposure system there and also the FX impact. That is why we are seeing JPY 4.8 billion of a decline.

And the 1-2 (sic) [1-10], it is the Hitachi Construction Machinery. The FX impact was quite large. So in North America, Japan and Europe, the sales looks quite at risk, but there was a large impact from FX. Therefore, year-over-year, there was 98% in terms of revenues. And also because of FX and increase in indirect expenses, there was a decline in profit by JPY 8.3 billion.

Now for Hitachi Metals, for auto and semiconductor and FA-related demand decreased. And the impact was quite large, ending at 88% in terms of revenue year-on-year. And accordingly, because of the revenue decline, adjusted operating income deteriorated by JPY 27.1 billion. And also revaluation loss on inventories, it's a JPY 27.1 billion of decline. EBIT, it has declined by JPY 94.4 billion year-on-year. So EBIT, it was in deficient. It is in red. And because of the magnetic materials, there was posting of the impairment loss on fixed assets and goodwill.

So for the impairment loss amount, this is Hitachi -- consolidated Hitachi Metals, the amount is different. So for Hitachi on a consolidated basis, it's JPY 61.4 billion; for Hitachi Metals, JPY 42.6 billion. So there is a difference in terms of the impairment loss. The reason being back in 2014, once we consolidate -- prior to consolidated into IFRS, the Hitachi Metals went by J-GAAP, whereas Hitachi Ltd. consolidated went by U.S. GAAP. Therefore, in terms of the -- whether it is good for amortization or non-amortization, because of that difference, there's been a historical difference in terms of the impairment loss. So JPY 61.4 billion is the consolidated amount.

Moving on to Hitachi Chemical. For semiconductor and automobiles, the demand had decreased. And because of that, the revenue has declined by 8%, and adjusted operating income came down by JPY 7.9 billion.

Moving on to 1-11 for Other segment. Operating income went down by JPY 5.9 billion because of the impact of deconsolidation of Hitachi Kokusai Electric. Also for corporate items and eliminations, that's been declined by JPY 9.4 billion in terms of earnings, adjusted operating income because of the consolidated increase in investment, a strategic investment, that is the reason for that.

And moving on to 1-2 (sic) [1-12] for the topics. So first topic is related to Lumada business, the progress so far. So on a Q2 cumulative basis, the revenue at JPY 558 billion. It increased by 12% year-on-year for the first half of the year. On a full year basis, as we have made a forecast previously, JPY 1.17 trillion is the expected amount, which is an increase by 4% year-on-year. So we have Lumada and also social innovation business-related topics are listed here. So various activities have been conducted. So with Hitachi Vantara Corporation and Hitachi Consulting Corporation has been -- there is a decision to integrate it as of January of 2020. This is -- it will serve as the core entity for the core and the front line business to drive the Lumada business.

Also, Frasers Property Limited, we have a collaborative creation to digitalize cities and buildings in the Asia-Pacific region. So agreement has been made to promote the business related to human-centered smart city.

Also, this could be perceived as one form of smart city is this topic, the fact that Hitachi Vantara Corporation announced a strategic alliance with Disney Parks. So first, as far as Disney Parks is concerned, first, we will establish the maintenance of the facilities to enhance the operational efficiency of shows and attractions in the U.S. But several tens of millions of people visit this Disney Parks. So it could be perceived as one form of smart city. So making use of Hitachi's portfolio, we would like to expand the smart city business.

And moving on to Page 13 (sic) [1-13]. This year onwards, we have adopted ROIC as one of the important management indices, so we would like to leverage this in our daily operation. So we have formulated the ROIC tree by business and established the model, as you can see here. So we have 500 items or so of action items. So those have been presented to the business units. And this ROIC tree has been formulated in accordance with the nature of the business. And also, there is a target set for each of their tasks and work, also to increase the employees' consciousness of improving ROIC in their daily work. We try to gain their understanding by introducing e-learning in Japanese, English and Chinese.

Next, the outlook for the full year fiscal 2019, so 2-1. So in terms of the number, in comparison to the previous forecast, which is on the very right-hand column, down by JPY 300 billion to JPY 8.7 trillion in terms of the forecast. And the adjusted operating income down by JPY 80 billion, downward provision from the previous forecast of JPY 685 billion; EBIT, JPY 605 million. And net income attributable to Hitachi, Ltd. stakeholders down by JPY 75 billion to JPY 360 billion. This is the forecast for the full year. This is because for the first half of the year, so for the 5 sectors, they were able to absorb the FX impact, and they were able to perform more than initial plan. But in terms of the -- there has been decline in the demand for automobiles and metals and chemicals. The FX was quite large for the construction machinery as well. And there has been a decline in the revenue and the earnings for the subsidiaries. And we believe this operating climate will continue into the second half of the year. Also, the foreign exchange, the U.S. dollar, JPY 110 to JPY 105 to the dollar. In euro, it has been changed from JPY 125 to JPY 115 in terms of euro. So that impact of the assumption of the ForEx has been incorporated into these numbers.

Please move on to 2-2, the outlook for 5 sectors and listed subsidiaries. So in comparison to the previous term, so 5 sectors, JPY 4.4 billion of increase. Of course, there was an FX impact here, but they were able to absorb it and still able to increase the earnings. And also adjusted operating income of JPY 472.5 billion, this is a record-high number. So we would like to make sure that we can exceed this number.

So 2-3 onwards, we have the revenues by business segment. I would like to skip these slides.

That is all for myself. Thank you. We'd like to move on to Q&A session.

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Questions and Answers

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Unidentified Analyst, [1]

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You have explained that in the first half, the 5 sectors results were more than the plan. So on Page 27 of the material, there's additional information for the second quarter compared to the previous year, there's information included. So if possible, for the second quarter only, the 5 sectors and the subsidiaries' results compared to the original plan, how did they perform? And is there any specific features? Could you give me additional comments?

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Mitsuaki Nishiyama, Hitachi, Ltd. - Representative Executive Officer, Senior VP, CFO & GM of Finance Group [2]

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Compared to the plan, well, in general, first, please look at Page 6, for sector -- the 5 sectors and the listed companies, I have the total of the first half only for the details. So compared to the plan, second quarter in total, compared to the plan for 5 sectors, revenues was better by about JPY 1 billion, and operating income was plus JPY 6 billion compared to the plan [and revenue of those]. Foreign exchange impact compared to the plan was minus JPY 2 billion. So organically, it is plus JPY 8 billion compared to the plan. And for the total listed subsidiaries, sales revenue compared to the plan was a decline of JPY 41 billion. And operating income compared to the plan was lower by JPY 16 billion. So compared to the plan, the foreign exchange impact was minus JPY 200 million, and organically, was a drop of JPY 13 billion.

And compared to the previous year, in the waterfall chart, I mentioned that there was an impact of foreign exchange on same basis. If we divide JPY 12.5 billion, the 5 sectors, its impact of minus JPY 5 billion; and listed subsidiaries, minus JPY 7.5 billion impact.

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Unidentified Analyst, [3]

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In the first quarter, seeing for the 5 sectors, was about -- better by about JPY 5 billion. And the others was minus JPY 5 billion. So it was in line. And for the second quarter, FX included, it is better by JPY 8 billion for second quarter. So for the second quarter only, maybe it was better by JPY 3 billion. So 5 sectors, IT was doing well?

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Mitsuaki Nishiyama, Hitachi, Ltd. - Representative Executive Officer, Senior VP, CFO & GM of Finance Group [4]

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Yes, IT. Because of the economic environment, the market environment is also increasing. CapEx in Japan, looking at the situation, there's drop overseas, but domestic CapEx, including investments to reduce manpower is taking place, in particular software investment. According to the BOJ TANKAN, compared to the previous report, the outlook is the same, is about 12% or 12.8% increase of total investment compared to the previous year. So we want to capture these going forward. And relatively speaking, the environment in Japan will continue to be better.

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Unidentified Analyst, [5]

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My second question is for the annual outlook. Also on Slide 19 or 20, I'd like to make some confirmations. This may be a little detailed, but on Page 19, 5 sectors in total is minus JPY 10.5 billion compared to the previous forecast. On Page 20, everything is almost in line. So are write-offs included, eliminations are included?

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Mitsuaki Nishiyama, Hitachi, Ltd. - Representative Executive Officer, Senior VP, CFO & GM of Finance Group [6]

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Yes. For the 5 sectors' figures and for the listed 4 subsidiaries, and the rest is subtracted, so the elimination, other eliminations come under the 5 sectors. And the impact of the corporate and elimination on Page 21, JPY 9.5 billion is the operating income. For our corporate and elimination as measured in common to other companies reduction of material costs, reduction of indirect -- material reduction of indirect cost is included. And in each sector, these were realized and reflecting that. This comes out from the whole corporate sector, so this negative part comes under the upper categories. So in substance, looking at situation by sector, operating income is revised downwards for Mobility, JPY 1 billion. This is the impact from foreign exchange.

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Unidentified Analyst, [7]

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Lastly, about IT, in the first half, there was increase in income, but it was flat for the full year. In the second half, you expect a decline in income?

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Mitsuaki Nishiyama, Hitachi, Ltd. - Representative Executive Officer, Senior VP, CFO & GM of Finance Group [8]

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So far, strategic investments for growth were planned, and we will implement those. And here, this is firm and the domestic environment, well, we will capture the deals that we can get. But it's quite busy. But -- so it is busy. If we stretch it too much, that will lead to lower profitability, so we must do proper project management to avoid this from happening. And we want to capture the demand in this sector.

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Unidentified Analyst, [9]

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I have 2 questions. The first is related to the figures by segment for Energy. So in the first half, profit and loss was not really profitable, but you haven't changed the full year forecast. So what is the operating profit for the second half? Are you expecting to see an increase in the second half if you were to have a flat number on a full year basis? So if you can share with us your input.

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Mitsuaki Nishiyama, Hitachi, Ltd. - Representative Executive Officer, Senior VP, CFO & GM of Finance Group [10]

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So these are impacted by various projects. So in terms of Energy, so in the first half, it was quite -- it was not performing well because of the decline in the sales of nuclear power. So it was worse than expected. And aside from nuclear power, so there were onetime loss and some provisioning related to the onetime loss. So because of this, the first half of the year for energy sector was not performing well. But that would no longer be the case for the second half. So we have -- so there will be no impact from specific projects. So for the second half, it would normalize.

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Tomomi Kato, Hitachi, Ltd. - Deputy General Manager of Financial Strategy Division [11]

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So just to supplement, so the absolute number may be -- sorry, this is to supplement answer. So the energy for the first half and the second half, the sales are skewed towards the second half. So the first half, the revenue is bound to be small. Also in comparison to the internal plan, there's not much change, though for the absolute number, it seems fairly worse, but in the second half, we do not believe this is a -- as a stretch target.

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Unidentified Analyst, [12]

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So you've announced today the management integration in the automotive business. So for CBI, integration has been completed. So in the automotive business, you are -- I think there's visibility for the new system going forward. So in the last year of the midterm plan, ROIC 50% and OPM of 10%, that is the target you have in mind. So I'm pretty sure you have some level of visibility. But after making this official formal announcement, this [auto syst] under a new scheme, do you believe you're approaching closer to the achievement of this medium-term management plan from the perspective of CFO? Or you may feel that could be because of some of different factors, you may seem that the target is actually further away?

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Mitsuaki Nishiyama, Hitachi, Ltd. - Representative Executive Officer, Senior VP, CFO & GM of Finance Group [13]

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So in the previous session, this is the point that has been discussed. So Hitachi's IoT business is related to products and the operational technology, OT. And we have the product and the OT and the IT. So IT needs to have both the product and the OT. So as the Vice President has mentioned, so that is the way to link the cyber physical world. So in this world, we would like to provide the products. And also, we have the OT relation to that. And we believe most of these are very important components of our business. So we would continue to strengthen on those end. So just by owning the products will not be suffice, we need to have strong products into the market. So that has been already incorporated into the original midterm plan. And based on that, we have established the target for OP margin and also for the ROIC.

So Chassis Brakes International, CBI, and also the 4 companies, the integration, so combine these factors together, of course, we need to focus and also selective and be focused on our effort. And at the same time, we will conduct the structural reforms. So as of this moment, it is very difficult to quantify the synergy because we will still need to do a number of processes such as TOB and various audit. But of course, needless to say, we need to have the synergy effects, especially cost synergy. That is important. And in order to realize that, we need to have the structural reforms.

So for 2021 medium-term management plan, we would like to get closer to the target. So these initiatives will bring us closer to the achievement of these medium-term management.

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Unidentified Analyst, [14]

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So it has been mentioned the new entity will be launched in about a year time. So in the last year mid-term plan, you mentioned about selection and focus in structural reforms. And will that give you enough time to achieve these in terms of the time line?

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Mitsuaki Nishiyama, Hitachi, Ltd. - Representative Executive Officer, Senior VP, CFO & GM of Finance Group [15]

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In terms of the time line, somewhere, some timing, so the post-merger integration needs to be conducted. And of course, we need to conduct this in a speedily manner from day 1. And of course, if there is an effort or fruits that we can have, of course, we like to have that from day 1 as much as possible.

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Unidentified Analyst, [16]

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I have 3 questions. For IT, the demand trend in the first quarter, second quarter, are there any changes? And in the second half -- towards the second half or towards the next fiscal year, I think the situation has been very good. But I think you always mentioned that you are achieving ahead of the schedule. Will that continue? Or do you think there will be a decline?

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Mitsuaki Nishiyama, Hitachi, Ltd. - Representative Executive Officer, Senior VP, CFO & GM of Finance Group [17]

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Yes. As I have mentioned, are we implementing in advance or there's increasing receiving orders? It's difficult to distinguish. But in the first half, the orders that we have received for 5 sectors, these were good. And among them, IT was 108% compared to the first half of previous year in terms of orders received. So the firm situation continues. So my impression is that IT sector is very busy, so I don't think -- in particular for systems integration business, I don't think there is a major change felt.

But one reason for concern is for hardware. New storage was announced 2 weeks ago, and high-end storage introduction to the market. And by doing so, we went to expensive, so the high end. For the third quarter, I understand the pipeline is getting full. So are we able to really start? That is one focus area.

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Unidentified Analyst, [18]

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My second question is the integration with Honda's business, which was announced today. It was explained earlier that it is noncash. And basically, this will be conducted by exchanging shares. There is no cash-out from Hitachi. Is that right? And without cash-out, on an operating income basis, I believe your adjusted operating income for the full year, there will be a consolidation of about JPY 70 billion. Is my understanding correct? And about goodwill, how much writeoffs there is going to be if JPY 70 billion is -- simple addition, how much of that will be offset? Do you have any image about it?

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Mitsuaki Nishiyama, Hitachi, Ltd. - Representative Executive Officer, Senior VP, CFO & GM of Finance Group [19]

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First, the acquisition is noncash acquisition. Mr. Kato will answer.

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Tomomi Kato, Hitachi, Ltd. - Deputy General Manager of Financial Strategy Division [20]

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Operating income. Operating income, on a performance basis, about JPY 80 billion is the amount of the 3 companies. There may be differences with the figures, but that is the level that we expect. What I have been saying is a simple addition of past figures. But there are some which will be out of scope. So before closing, each company will sell to third parties -- will sell their noncore business to third parties, so it's not a simple addition.

At the moment, based on the results that we have from the 3 companies, that is the skill of a level that we expect. And in general, as was mentioned by Dr. Koch, for operating income, in total, a simple addition would be about JPY 210 billion, but there may be some that will be out of scope from there. As for the details, we will quantify those in details later. Correction, JPY 70 billion is the addition that we expect.

And for goodwill, we are now studying the content, so at the moment, I will refrain from disclosing exact situation.

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Unidentified Analyst, [21]

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So about JPY 70 billion, half of that will be amortized?

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Unidentified Company Representative, [22]

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I don't want to be misleading, so I will avoid making any guesses. If the figures are more clear, we would like to inform you later.

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Unidentified Analyst, [23]

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And my third question related to the subject. If there is noncash on a GAAP basis, if JPY 70 billion or JPY 80 billion is added to your income, this may be a good story for you. And in judging investments, I think that may -- the company is at risk of being too lenient in making your decisions. In the current medium-term plan, by using Lumada, your plan is -- of a current phase is to give more value added. But this integration is to strengthen the front line. Automotive parts business will be strengthened and to give more value-added by using Lumada to enjoy more synergy. I think the -- in fact that the synergy could be delayed by several years. You talked about diversifying resources, but could you explain a little more about it?

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Unidentified Company Representative, [24]

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No -- if it is only conventional parts, Lumada maybe or in the world of CASE, and the addition in the ADAS and electrification related software, these are very costly areas. So because of that, we are joining our resources.

On the other hand, the products; to strengthen the products, to scale up the products. By doing so, we need a cash cow. That is one purpose. So with a noncash acquisition, we will be able to capture those so that the cash will be able to rotate. And if it's noncash, it doesn't mean that we will be -- we'll take it easy, but we will look strictly to the impact to the balance sheet of our life sector, impact to the consolidated finance. And the total risk will also be considered. And also, we will maintain fiscal discipline. We will look into those. So it doesn't mean that we will be taking this as something easy.

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Unidentified Analyst, [25]

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I also have 3 questions. The first question is related to the press. So about the elevator business for Yungtay Engineering, you will be entering into a bidding. So Higashihara-san mentioned -- JPY 2 trillion is the number he has mentioned. But in the 2021 medium-term management plan, you have JPY 2 trillion to JPY 5 trillion amount allocated for investment for growth. So we should be executing investments above this particular amount. Or what is the possibility of taking more risks than -- that is above the fiscal discipline?

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Mitsuaki Nishiyama, Hitachi, Ltd. - Representative Executive Officer, Senior VP, CFO & GM of Finance Group [26]

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So in terms of the financial fiscal discipline, we'd like to maintain it. That is our basic policy. And in terms of the ratio, 0.5x or below, that is a level we're aiming for. And also in terms of interest-bearing debt and the EBITDA, the EBITDA ratio, 2x or below. So those are the 2 metrics we use for the fiscal discipline. So in terms of the -- so this is for [thyssenkrupp].

So in terms of the asset divestiture, we need to look into the timing for the asset sales and also what is the timing we would spend the cash. And depending on the timing of the deals, of course, it may change. So it may -- the number may actually spike. But in the previous year -- in the next year, the following year, it may come down. So it is not as if we would buy everything because it is available out there. So we need to have more of a comprehensive view of our portfolio to make that decision. So we have to make sure that the overall Lumada business will be strengthened and whether it would strengthen the SI business as a whole. And of course, we look at the price tag as well. So we take more of an integrated view in making that final decision.

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Unidentified Analyst, [27]

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So I apologize to hang on to some of the words, but even if you were to go above the fiscal discipline, you were saying that in the following year, it will come down to this level?

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Mitsuaki Nishiyama, Hitachi, Ltd. - Representative Executive Officer, Senior VP, CFO & GM of Finance Group [28]

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Yes.

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Unidentified Analyst, [29]

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A similar question related to the previous one about the goodwill. So ABB, if you were to add that, JPY 1.5 trillion could be the total amount. So related to this, in comparison to shareholders' equity, how much risk are you willing to take?

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Mitsuaki Nishiyama, Hitachi, Ltd. - Representative Executive Officer, Senior VP, CFO & GM of Finance Group [30]

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As we speak, in comparison to the global competitors, the goodwill proportion to shareholders' equity is still low. So of course, we have ABB. And we would have the closing of the large products, so that proportion is bound to increase. So what percentage is viable or 1% will be the discipline we would like to have. That sort of number and that sort of metrics, we do not adopt right now. So we have projects related to system integration. And of course, there are some business risks arising from those products, so we need to have total risk management. So we need to have more of a comprehensive view overlooking the entire project.

So in terms of yes or no, so we don't have a set target for the goodwill ratio. So even if goodwill were to be large, of course, some of the businesses are stable, and some business may be large but highly volatile, so the size of the goodwill may not actually give you the entire view. So we need to have a comprehensive risk management.

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Unidentified Analyst, [31]

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Seems as if many projects are going to run simultaneously or concurrently, so in terms of the movement of balance sheet, are there any problematic areas? Or are there any ways to hedge the risks? Are there any concrete ways, for instance, the intangible and tangible assets and so forth?

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Mitsuaki Nishiyama, Hitachi, Ltd. - Representative Executive Officer, Senior VP, CFO & GM of Finance Group [32]

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So as you mentioned, that is definitely a concern for myself as well. D/E ratio, it's one area that is of concern and also the proportion of interest-bearing debt. And another point is goodwill, the goodwill proportion vis-a -vis shareholders' equity. These are definitely areas we need to keep a close eye on. So the overall portfolio needs to be looked at.

So we have individual announcements for various projects for these acquisitions or divestitures and also asset sales will continue to be conducted. So those are all part of the consideration to assess the overall risk. So within this year, this fiscal term, we will review that. And of course, we will give an update of the Mid-term Management Plan.

So the future picture we would have in mind, we need to draw those. And of course, on a consistent basis, we are doing simulation. But we are not at the level to share those with you. So we would like to have much more clarity on the overall portfolio related to the fiscal discipline and also risk management. So once it is clear, we'd like to share those ideas with you.

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Unidentified Analyst, [33]

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About the business sentiment, so China and the economy, the automobile sales and production seems to be quite weak in China. So these 2 factors, China and automotive, could you give us your take especially the outlook for the second half of the year?

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Mitsuaki Nishiyama, Hitachi, Ltd. - Representative Executive Officer, Senior VP, CFO & GM of Finance Group [34]

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So in China, within our sector, the Building Systems is the largest business in China. So it is decelerating, as you mentioned. But given the current trend in terms of the degree of the drop of the pricing by models, it is actually mitigated in terms of the dropping of the pricing. Also, in terms of the low-priced models or what we call midrange models, we are seeing increase in the number of unit sales. So the total number of unit sales has increased, but there has been change in the product mix. So there's more shift towards midrange models. And because of that, the ASP, the average selling price, has been on the decline. So we believe that trend will continue into the second half.

However, on the other hand, the cost reduction is also underway. It's actually progressing more so than initially expected. In comparison to 3 years ago and the 5 production sites in China, the material cost and also third-party purchase parts, the procurement cost was not appropriately managed. Therefore, we have conducted cost reduction on a systematic basis. And that is why this year, we are progressing better than expected. So the toughness in the environment continues, but we have been able to offset those by cost reduction. So we believe this trend will continue.

Now moving on to automotive business, we believe the tough situation will continue. In the automotive system, we have been progressing with many in cost reduction. Reap project is the name we have given. So we've conducted extensive range of cost reduction in 2018. In Q1, the operating income was 2.2%; in Q2, 1.9% was OP margin; in Q3, 3.6%; Q4, 7.9%. There has been a gradual increase in the OP margin. In Q1, it's 2.7%. Q2, it's actually close to 5% or so. So that's for the 3 months. So from 1.9% from last year, now it's up to 5% or so, and this is because of the cost reduction, which is progressing as planned. So of course, we do -- we are concerned about the automotive market. Especially in China, we are definitely seeing a slowdown. So we need to make due preparation, and we do so in the elevator business as well. So cost reduction is the key. We need to accelerate the effort.

So we are progressing better than planned, but we'd like to further accelerate the initiatives. We believe this is the best countermeasures.

I think, yes, there's a question related to market position. I think in the previous session, there was a question related to market position. And I don't think there was a clear answer to that. So just simple calculation, simple addition. So for the major core products, if you were to combine those together, suspension -- so for the 4 companies combined together for suspension in terms of the position in the market, suspension will be #1 in terms of our ranking; braking system, #2; ECU will be #4 or so; and xEV, so inverters motors, so that is -- this is on a plan basis for 2025 for the automotive system, #1 is the expectation.

So overall, we'd like to have within the top 3 on a global basis. So depending on the products, we have been #1, #2 or #3, but we would eventually like to be one of the top suppliers in the global market. That is the kind of position we like to aim towards.

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Unidentified Analyst, [35]

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In terms of the sales breakdown about powertrain and chassis and ADAS, so what is the contribution to the overall sales? Or what is the target? Do you have those numbers?

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Unidentified Company Representative, [36]

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Sorry, we don't have that number. Just to add on, so the Keihin, Showa, Nissin and also Chassis Brakes International and Hitachi Automotive System combined together. So brake system also has the chassis brake as well, CBI inclusive as well, so it's a simple addition.

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Unidentified Analyst, [37]

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As a follow-up to the previous question, I would like to ask 2 questions. Number one, the total for automotive parts [vary in rating], these automotive parts related companies. And what's the percentage out of your revenue for the top 3 items? And by 2025, how much percentage do you aim for? Do you have any specific image about that? That's my first question.

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Unidentified Company Representative, [38]

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Currently, there is not so many items which are in the top. In the previous categories, as I have mentioned, well, the data I have right now for the categories I mentioned before, suspension, currently, market share -- estimated market share for suspension is 11.1%, ranking #4. And the 3 companies added, then it would be 19.2%, ranking #1 in brake systems; currently, 4.7%, ranking #8. And with Nissin Kogyo and Chassis Brakes International added, this would be 17%, the second rank. And ECU, at the moment, is 6.7%, in sixth rank. This will be 12.6%, ranking #4. And xEV inverter motor, if we are our own, then it is 14%, ranking #3. And with Keihin together, this would be 17.3%, ranking the top. A simple addition, and this also includes estimates, that is our overall image.

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Unidentified Analyst, [39]

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About the major items like brake, suspension, ECU, inverter, these items together, how much percentage would that be out of the revenue of integrated company?

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Mitsuaki Nishiyama, Hitachi, Ltd. - Representative Executive Officer, Senior VP, CFO & GM of Finance Group [40]

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Excuse me, that is difficult to answer.

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Unidentified Analyst, [41]

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My second question, with M&A and fiscal discipline, you mentioned that -- you talked about D/E ratio and interest-bearing debt-EBITDA ratio are very important indicators and also goodwill. As capital allocation, you have invested JPY 2 trillion to JPY 2.5 trillion strategic investment. And the original indicator, if that is cleared, then if there are good candidates, you would not -- you would be there?

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Mitsuaki Nishiyama, Hitachi, Ltd. - Representative Executive Officer, Senior VP, CFO & GM of Finance Group [42]

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Yes. To maintain fiscal discipline of JPY 2 trillion to JPY 2.5 trillion, yes, I think it is consistent with that. So then, JPY 5 trillion, JPY 6 trillion, JPY 10 trillion, are we going to acquire such an amount and maintain the ratio? No, that's not possible. The current cash allocation, as we had indicated on the 4th of June, it is up to about 2021, ensuring the financial framework and investments for growth. And I think it is generally consistent with that.

However, we may buy if there's any good potential, but it's not that we will sacrifice our fiscal discipline. We may exchange with something and sell something else instead.

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Unidentified Analyst, [43]

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There are many other briefings, and I could not attend your automotive session, the integration announcement. So one question. So xEV, motor inverter business, this is a question related to that. So Honda, I think before, there was a plan to exclusively supply to Honda. But recently, in the Nidec recently, they have already constructed plants to make major investments. And likewise, Mitsubishi Electric, they're building their sites and Himeji and Meiden. Also, Meiden, they are also building quite a large capacity. But this time around, it is not as if you're investing in a lot of capacity or plants. We do not receive that impression. So in terms of xEV, motor inverter, if you can give us an update of this particular business.

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Unidentified Company Representative, [44]

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So Honda is part of the picture. So if Honda is not able to do it then, of course, it doesn't make sense to produce it, so we think as if the other companies are making investments and increasing their capacity. We have the visibility of other company, but we cannot see that for Hitachi. So you are striving to become #1 in 2025, but we cannot see that clear picture. So I think the key point here is electrification, so what is the current state now. So with Keihin, now it's up to 17% in terms of the market. But there are different types of motor inverters.

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Unidentified Analyst, [45]

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So what is the exact state right now? And what is your future initiative? So if you can give us an update, that would be helpful.

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Unidentified Company Representative, [46]

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I don't have all the information in my head right now. So JV, we have a JV business, motor business with motor. So on a phased basis, we will launch the business. So it is not as if we would launch a large amount at once. That is not the case. So we have Japan, China. So on a phased basis, we would like to progress with the business. So it is not as if that we would launch something large on a lump sum basis.

So Japan, we will do it within fiscal year 2019; and China, within the year -- fiscal year 2020; and U.S., 2022 or beyond. And that is the time frame we have in mind.

So normally, I think this is a time frame that is required. So in China, we need to acquire the land and of course -- and also construct the buildings and tests and so forth. So we'd like to establish the company at the earliest phase possible. So start with Japan first and then move on to China, and then eventually to U.S. And that is the plan we have in mind.

So in terms of the EV motors, this is the xEV drive application and also for power generation application motors, these are what we have in mind. So we would like to progress with this on a phased basis. So this involves not just Honda but also other OEMs as well. The new company will supply to -- or will aim to supply to other OEMs as well.

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Unidentified Analyst, [47]

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So in terms of Nidec, so about JPY 500 billion to JPY 1 trillion investment in 5 years, that's quite phenomenal. But -- so that Nidec number is quite extraordinary. But if you can have an update.

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Mitsuaki Nishiyama, Hitachi, Ltd. - Representative Executive Officer, Senior VP, CFO & GM of Finance Group [48]

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Sorry, I don't have an update. So in the next briefing session, I'd like to compile the numbers and share those with you.

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Unidentified Analyst, [49]

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If it's not in the CFO's head, then probably it's not that substantial.

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Mitsuaki Nishiyama, Hitachi, Ltd. - Representative Executive Officer, Senior VP, CFO & GM of Finance Group [50]

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It is not JPY 500 billion or large.

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Unidentified Company Representative, [51]

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With that, we would like to conclude today's briefing session on the results for the first half of the year. Thank you very much.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]