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Edited Transcript of 6502.T earnings conference call or presentation 14-Feb-20 4:30am GMT

Q3 2020 Toshiba Corp Earnings Presentation

Tokyo Feb 17, 2020 (Thomson StreetEvents) -- Edited Transcript of Toshiba Corp earnings conference call or presentation Friday, February 14, 2020 at 4:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Masayoshi Hirata

Toshiba Corporation - Representative Executive Officer, Corporate Executive VP & CFO

* Midori Hara

Toshiba Corporation - Public Relations and IR

* Masayasu Toyohara

Toshiba Corporation - Corporate EVP

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Conference Call Participants

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* Yuichiro Kanematsu

Nikkei - Media

* Mikio Hirakawa

Merrill Lynch Bank of America - Analyst

* Hisashi Moriyama

JPMorgan Chase & Co. - Analyst

* Kenji Yasui

UBS Investment Bank - Analyst

* Toshihiro Yamada

Toyo Keizai Inc. - Media

* Kota Ezawa

Citigroup Inc. - Analyst

* Kazutaka Yoshizumi

SMBC Nikko Securities Inc. - Analyst

* Shintaro Shimada

Mitsui Sumitomo DS Asset Management - Analyst

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Presentation

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Midori Hara, Toshiba Corporation - Public Relations and IR [1]

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Before we start, ladies and gentlemen, starting at 1:30 to around 2:15, we are going to have a presentation about the fictitious or suspicious transactions related to Toshiba IT Services, as announced on January 18, which will be followed by the earnings briefing for the third quarter of fiscal 2019. We will then take questions. But for the Q&A, regarding the third quarter results, we will accept questions only from the media representatives of the media. For the analysts, we have a separate session, where we can take your questions about the earnings results. Your understanding and cooperation is appreciated.

Ladies and gentlemen, thank you very much for attending despite your busy schedule. This is earnings briefing for the third quarter of fiscal 2019. But prior to the earnings briefing, we would like to explain the suspicious transactions, the actual existence of which had not been confirmed of Toshiba IT Services, a subsidiary of Toshiba Digital Solutions, which was announced on January 18. The participants of this session are Masayasu Toyohara, Corporate Executive Vice President of Toshiba Corporation, who is in charge of internal control promotion. Masayoshi Hirata, Representative Executive Officer, Corporate Executive Vice President of CFO -- and CFO of Toshiba Corporation; and Masashi Yuzawa, Director of Toshiba Digital Solutions Corporation. My name is Hara from the Public Relations and Investor Relations office.

I now give the floor to Masayasu Toyohara.

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [2]

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My name is Toyohara. On January 18, we made a press release about the transactions of Toshiba IT Solutions, the actual existence of which could not be confirmed. Investigations that in truth revealed that the transactions were fictitious and instances of around tripping. We apologize to shareholders, investors and all other stakeholders for the inconvenience and concerns regarding this matter.

Allow me to continue while seated. As a result of the investigation, it is considered that the transactions were initiated by a specific sales representative of a certain external business partner. We're going to call it Company A hereafter, and that no evidence was found that indicated that there was active involvement of Toshiba IT Service, hereinafter called TSC, or any organizational involvement of the company. In addition, no evidence was found directly indicating that the officers and employees, including certain TSC sales representative who was directly responsible for the transactions were aware that the transactions were factitious or instances of round tripping. However, the company takes it seriously that the fact that the transactions are fictitious, round trips was not identified until external information was made available. We take the matter seriously, and we will develop preventive measures and execute them rigorously so that going forward, these transactions will never happen again, regardless of whether an employee willingly intends it or not.

The discovery of the transactions, we conducted a comprehensive investigation to confirm that there was no other similar transactions within our group. Specifically, the Toshiba Digital Solutions group, including TSC, we looked into 3,966,812 transactions, for which sales were recorded that way in April 1, 2015, and September 30, 2019, that meet certain criteria and checked the end users' various proofs, and in the case of maintenance and support contracts, checked for the actual implementation, execution of such contracts. In addition, within the Toshiba Group, we targeted 28 companies among the top consolidated companies that account for 95% of Toshiba's consolidated net sales and reviewed transactions since sales were recorded that way in April 1, 2018 and September 30, 2019, to see whether there were any similar cases where the end customers were kept confidential, not disclosed and whether there were any cases in which the goods were sent directly from the vendor to the customer without being checked for physical deliveries. As a result, it's been confirmed that there was no other fictitious or round-trip transaction similar to this in our group.

Next, I will focus on the outline of the case, the involvement of the persons in charge, the reasons why the fictitious or round-trip transactions were not found and measures to prevent -- measures for prevention. The summary of the investigation is described in the investigation report, the summary version attached to determine disclosure materials disclosed and released today.

First, the outline of the case. This case was discovered in relation to a tax audit of another company by the Tokyo Regional Taxation Bureau, in which the bureau made inquiries to TSC, which then carried out initial investigation starting last November. In order to ensure the objectivity and expertise of the investigation, external experts were asked to be part of the team, including experts from Moriyama, Matsumoto firm and Tigran Fortin Advisers who have extensive experience in investigating irregularities. The investigation revealed that fictitious round-trip transactions without reality were repeated in good sales deals referred to TSC by a specific sales representative of the certain business partner between 2015 and 2019. Total transactions were confirmed to be 24 deals, JPY 42.5 billion on a sales basis, and JPY 1.8 billion on an operating income basis. Of the sales of JPY 43.5 billion, JPY 21.5 billion was recorded in the first half of fiscal '19.

To help your understanding, we have prepared this slide projected on the screen. The sales amount was particularly large in fiscal 2019, but this is due to the difference between the timing of receiving the order and the timing of recording the orders and sales. As for the orders received, shown on the left-hand side, the split orders received during the 3 quarters from the first half of fiscal '13 -- or in the first half of fiscal '18, second half of fiscal '18 and the first half of fiscal 2019 were all recorded as sales in the first half of fiscal 2019. So that is one reason why we were linked in identifying the case, and explain the flow of the transactions. Again, please refer to this screen, this slide.

The distribution flow that TSC understood is shown on the upper half of the slide. The way TSC understood it, the purchase was to be made from the vendor specified by the specific person in charge at the business partner, Company A, and we sell it to customers such as system integrator. The end users were identified by the business partner in some cases. While for other cases, the end users are categorized as confidential and refer only as certain government agencies. In the latter case, the end users' identities were not disclosed to the persons in charge at TSC. As a matter of convenience here and after, I will refer to the vendor as Company A and the customer, the system integrator, as Company B. Since they are and were no legitimate transactions with Company A, the transactions that constitute this particular case will be referred to as the actual distribution flow as a range by Company A, shown on the bottom half of this slide.

Also, there were other transactions involving multiple partners. But for the sake of simplicity, in my presentation, I'm going to just use this pattern as shown on this slide.

The actual distribution flow was referred to TSC in such a way that the main transaction conditions such as the vendor, seller, price terms and payment terms were all specified by the certain sales representative of Company A. But as you can see on the bottom half, the end user did not exist. And in fact, most of the transactions simply circulated from Company B to Company A. According to the contract of goods were sent directly from Company A to Company B and TSC did not check the actual goods physically. Sales were booked based on the delivery note from Company A or the inspection receipt or delivery receipt from Company B.

Next, let me talk about whether TSC employees were involved or not. Here, a specific salesperson of the Company A, we would like to call him X, Mr. X the main person who dealt with this person was the person in charge of sales at the TSC. Here, we would like to call him the Manager. And we conducted investigation with this Manager and he clearly denied that the lack of the -- denies that there was no recognition as to the existence of the fictitious round-trip transactions. And as for the lack of suspicion on the part of that Manager, we consider this as a lack of order due professional care. And in this investigation, including the Manager, we have conducted the digital forensic investigation for 6 managers working in the sales Department of TSC. And we have conducted the interviews as well as forensic investigation for the corporate PCs. In total, we looked at 604,355 e-mail data in this investigation. And based on the results of the search, we reviewed 74,720 e-mail data. And we found no proof that all of those people concerned, had any recognition of these fictitious round-trip transactions.

Now as for this Manager, we checked his corporate PC and the corporate cellphone and also the personal cellphones, and we looked into the total of 6,643 mails, including e-mail, short message, Line Talk and others. And we also conducted investigation on his bank account. And here, again, we did not find the proof to show that there is a recognition about the fictitious round-trip transaction or any personal benefit on his part.

Now let's now look into why those transactions were not found out, and also talk about how the partnership with this Company A started. As a background, the transaction between the TSC and Company A started in 2014. This was the renewal project of the network equipment for one of the government agencies. And since that time, the business partnership expanded. Until that time, the transactions were legitimate and normal and also this project for the government agency in 2014 was also normal. The strength of the TSC is that the TSC has a 24/7 service capability at more than 100 sites in Japan and also has the capability to provide multi-vendor maintenance as well as high skill in the area of the security. Also, from the perspective of the TSC, as the security measures are being enhanced in the network market, this was the opportunity for TSC to expand the business and by strengthening the business relationship with Company A, TSC believe that its businesses can be expanded. That's for the reason why those transactions were not found out.

First, all the information necessary, including the information on goods, vendor, customer, payment condition and collection -- conditions, all of those informations were available. And secondly, the order as well as delivery statements and collection of the receivables were done as planned. Number three, both Company A and B, those are listed companies. And in the industry of the system integrators, many major companies were involved in those transactions. So TSC believed that those transactions are legitimate. As for the internal reason in the TSC, there was a lack of sufficient check function, including setting up internal rules and implementing them as well as effective supervision.

Also, there was overly reliance on the certain individuals who conducted those operations. It was common knowledge that in the industry. That those government agencies, which were considered to be end users are increasing the IT investments to enhance their securities, especially the Company B had very high market share in the public sector. So the increase of the business transactions arranged by Company A and customer -- Company B were not considered suspicious. And there is also an understanding that this could be a business opportunity for TSC because it takes advantage of its multivendor maintenance capability. And there are also other normal transactions going on with Company A. So this made it difficult to suspect those transactions are fictitious or round tripping.

Lastly, I'd like to talk about the recurrence prevention measures. From now on, regardless of the employee intentions, we would like to make sure that we take measures so that we can prevent the recurrence of similar transactions. And part of those measures are already being implemented. First of all, the preventing measures on the part of TSC and TDSL Group. Let me explain what they are. In order to prevent fictitious or round-tripping transactions, basically, the direct delivery transactions without added value will be prohibited. From now on, we would promote high value-added businesses, so the projects involving external companies' products and other -- if there are no TDSL Group's added value, those businesses will not be conducted. However, there will be some exceptions. For example, public bidding projects or transactions with clear added value or clear end user and projects in which products can be confirmed. So further process improvement and enhanced control. We will make sure that there is a good internal rules and that they are implemented. (inaudible) checking of the quotations and work completion reports will be done. Also, there'll be an internal guideline for the product sales and services and also enhancement of the supervisory function, as well as the use of the whistleblower function. In addition, we will enhance the check function among the different departments inside the company and have a regular rotation of the personnel so that we can avoid or by reliance on certain individuals. And we'd also continue to improve the education for employees. And we're also look into the internal evaluation system so that we would evaluate the aspect of the efforts made for the compliance as well as the capability of the supervision so that we can evaluate the salespeople from the diverse perspectives.

Next is the prevention of the recurrence at the Toshiba Group. As Toshiba Group, in 2015, we found a fraudulent accounting issue and since that time, we have been trying to enhance the internal control and we have looked into the revenue and expense recognitions, loss control, inventory valuation and others. But we were not fully prepared for those frauds, which are initiated by outside the company. In Toshiba Group in April 2019, we introduced the risk management system, which is a system to improve the compliance risk internal control on a continuous basis. And we have our own unique risk evaluation method. Based on the lessons that we learned this time, we would incorporate the evaluation of the fraud risk into the system and implement the analysis of the transaction data anomaly. And from now on, we would also study to evaluate the fraud risks and how the investigation needs to be conducted.

As for the future, with the introduction of the next-generation core system, we will be able to analyze the transaction data in real-time so that it can be utilized for the reporting purposes, and we'll make sure that we have an environment where we can investigate the fraud in a very quick manner. Based on the Toshiba Next Plan announced in November 2018, we would also try to reduce the number of the subsidiaries in order to enhance the governance of the subsidiaries.

To conclude, as I mentioned before, we will make sure that the internal management will be enhanced and will take root inside the company, and we take this matter very seriously. And we will do our utmost efforts in order not to repeat those issues in the future. And with, Toshiba Group, we'll work as one team to prevent those issues to happen again. Thank you.

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Questions and Answers

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Unidentified Company Representative [1]

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(Operator Instructions) Any questions, anyone? Yes, I see a hand in the back.

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Unidentified Audience Member [2]

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[Soyji] from Asahi Newspaper. I'd like to ask about Toshiba's role in this distribution flow. I think you were involved in the maintenance and installation in the previous term. Was it the same for this year as well? And was that the actual transaction that took place?

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [3]

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Regarding this actual distribution, this involved only the sale of goods. So as far as this case is concerned, there was no maintenance services involved. But as TSC's business, once goods are sold, when the vendor maintenance service warranty period expires, sometimes, we do receive the maintenance contract. So there was a recognition that there were such possibilities, which would mean that they will Toshiba IT Solutions.

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Unidentified Audience Member [4]

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What was the actual role?

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [5]

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As far as this particular case is concerned, between Companies A and B, it was positioned in between and sales were recorded based on PO, the purchase order. It would mean that the actual actions did not take place.

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Unidentified Audience Member [6]

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So Toshiba IT Service. What business, what work actually took place?

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [7]

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As far as this case is concerned, the orders received and sales recording of the goods.

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Unidentified Audience Member [8]

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I see. I'm looking at Page 8 of the investigation report, in the Japanese version, that is, the sales representatives of Toshiba IT Service, he was -- this person was not aware of this, and the company was not aware. But based on the request from Company A, documents were prepared and the due diligence was not being fulfilled as mentioned there. What do you mean by that?

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [9]

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I'm not going to go into the details, but on the part of Company A, from Mr. X., internally, as documents required for internal process, some of the document preparations were requested. And because this request came from the customer, the TSC personnel agreed to do so because it was a request from a customer.

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Unidentified Audience Member [10]

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So from Mr. X, this request was made and so the documents were made that do not reflect the actual transaction, am I correct? So is it the falsification of the -- fabrication of the documents, what do you mean by preparing the document?

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [11]

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Part of what you said did take place. The process did not reflect the actual process, which was contained in the document because that was the request made from Mr. X. So the actual process was not the same. But this person was not aware of the big picture of the fictitious transactions. It was only Mr. X who was aware of the big picture of the fictitious transactions. And part of the distribution flow were shared with this person at TSC.

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Yuichiro Kanematsu, Nikkei - Media [12]

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Yuichiro from Nikkei. 2 major questions. First, this fictitious transaction. You're trying to move back to the TSC per section. Would that be impacted? And also from the shareholder, what kind of reactions have you received?

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [13]

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First, your first question, this month, we understand that the rules were changed and as soon as we are ready, we would like to apply for that as soon as possible. Secondly, about the inquiries from shareholders, we are not aware of any reaction.

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Yuichiro Kanematsu, Nikkei - Media [14]

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About the TSC's reaction, may I understand there will be no impact?

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [15]

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Whether there is an impact or not, we are not in the position to make any comments. So from our perspective, as soon as we are ready, we would like to quickly apply for the transfer to the first section of TSC.

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Unidentified Company Representative [16]

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The person in front.

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Unidentified Audience Member [17]

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[Tamuyoka]. I think you made the initial announcement in January, but [NSOO and Net1] made the announcements in December. Why a delay?

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [18]

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Well, I'm not in a position to comment on other companies. But the 2 companies that you referred to, they made the announcement to establish the investigation committees, respectively, whereas in our case, we were engaged in internal investigation and felt that we should make the announcement after we have a better understanding of what happened. And that so happened to be at the same time as the announcement of new Presidents. It was just a coincidence at the BOD meeting, or changes in the members of the Board presented at BOD, just happened to be on the same day.

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Unidentified Audience Member [19]

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I have another question. You said that it was only Mr. X who was aware of the big picture. But this one-trip transactions, Company B was not aware. Only Mr. X awareness was sufficient to continue this transaction, is that correct?

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [20]

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Well, it's about what's spending inside someone else's company. So I'm going to refrain from making any further comments. But our investigation revealed that -- or we could not find any active involvement on our part.

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Unidentified Company Representative [21]

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I see. And about the -- this transaction -- fictitious transaction case, we can take questions from the analysts as well.

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Unidentified Audience Member [22]

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[Namato] from NHK. 2 questions. First, a bit of detail. Those people who are involved, the employee or the Manager, just one person? And in order to prevent the recurrence, you mentioned that the personnel rotation. And that person was in charge for about 5 years for this kind of transactions to go on. That's one point. The second point is that after this incident, are there any kind of punishment for -- to clarify the responsibility for this matter?

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [23]

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For your first question, organizational changes have been done multiple times. But basically, the same operation or same job, this person was in charge of it for about 10 years or so. So he's a very experienced person. So about what he understands that the work in its industry.

As for the punishment, based upon the internal rules, we would like to take the appropriate measures calmly.

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Unidentified Company Representative [24]

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Next question?

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Mikio Hirakawa, Merrill Lynch Bank of America - Analyst [25]

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Hirakawa from Merrill Lynch, Bank of America. I have a follow-up question. Currently, in light of your internal rules, would there be a punishment or not -- disciplinary actions taken or not?

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [26]

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Within the group, the disciplinary actions, we do have internal rules to implement and execute -- apply the disciplinary actions. So we are going to go through that process. So today, we disclosed the investigation report, the summary version, and since we know more, we are thinking of starting that process.

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Unidentified Audience Member [27]

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[Tajima] from Kyoto News Services. This Company A, which led or arranged those transactions, do you plan to sue them for any damages? Any potential litigation against this Company A?

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [28]

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As I mentioned earlier, there were legitimate transactions going on as well. So of course, we need to probably check the internal situation of the Company A. But as of now, the litigation against this Company A, we have not yet come to that stage.

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Unidentified Company Representative [29]

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Next question, yes?

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Hisashi Moriyama, JPMorgan Chase & Co. - Analyst [30]

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Moriyama from JPMorgan. Just in case, let me ask this question. The Toshiba Digital Solutions segment business, I wonder is your business is feeling the impact of this case over a medium to long term, do you have a narrow platform projects that you're working on. I'm wondering whether your clients, that customers are thinking of suspending some of their business with you over a certain period of time, is that taking place?

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [31]

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Well, at the current juncture, we don't see that happening.

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Kenji Yasui, UBS Investment Bank - Analyst [32]

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Yasui from UBS Securities. So this matter of -- with the subsidiary, the auditors of the Toshiba parent company, how much impact would it have on the parent company audit. I think there are different standards of the level of the appropriateness of the audit and so forth. I don't think there's a major impact. But through the exchange of views with the auditors, have you come to any conclusion?

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [33]

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Yes, you are correctly right, the impact on the consolidated Toshiba results is relatively very small. And with the auditors, there have been no discussion as to the limitation of the report and so forth.

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Unidentified Company Representative [34]

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Next question. Yes? I see your hand in the center, in the middle of the room.

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Unidentified Audience Member [35]

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[Tasai] from Asashi Bank. A follow-up question. From your business partners, I think it's really irregular for making the documents as per requested by your customer. So I'm wondering what that particular person was thinking as he was preparing that document. If he was aware that this was not reflecting the reality. But it's hard to believe that he was not aware of the fictitious transactions.

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [36]

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Well, as it was mentioned earlier, he just had to comply with the request from the customer.

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Unidentified Audience Member [37]

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Yes. So he was not careful enough? The fiduciary duty was not -- what do you mean carelessly? Preparing the false documents is not something that one would do casually or carelessly.

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [38]

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Well, the amount of transaction with Company A was large enough and therefore, in his mind, this Company A was very important customer. So he could not say no.

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Unidentified Audience Member [39]

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Looking at the investigation reports of other parties find that some of the sales had been transferred elsewhere. Where you not involved in that?

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [40]

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Our investigation team did not find such cases. We did not find the evidence of that.

And there was a question about the damages, the legal action? In the case of round-trip transactions, there could be the criminal charge that could be filed.

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Unidentified Audience Member [41]

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So are you not thinking of taking a legal action because I suppose that this had a major impact on your business, some delays and some of extra work that had to be looked into. And I'm wondering why you are not thinking of any -- were not thinking of taking any actions?

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [42]

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Well, we're not thinking of referring this to the criminal investigation authorities. And regarding the damages, we have yet to get to the very bottom of the amount involved. We don't know the exact amount, so we're not thinking of taking any legal actions. But going forward, should that become necessary, we'll consider that.

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Unidentified Audience Member [43]

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Okay. My last question. So within Toshiba, the fictitious or round-trip transactions, your conclusion is that there was no one within Toshiba, who had that awareness. Am I correct?

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [44]

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As was mentioned earlier, our investigation shows that there was no evidence to indicate that.

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Unidentified Audience Member [45]

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[Susiki] from Nikkei BP. 2 questions. First of all, the number of the companies which were involved, I'd like to clarify the number. Including TSC, how many companies were involved?

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [46]

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Based upon our understanding, 9 companies, including TSC.

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Unidentified Audience Member [47]

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And the final user or end user was not disclosed because of the confidentiality. That kind of transaction, there were no questions on your part? Or does that mean that you have had those transactions without clearly disclosed end user?

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [48]

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We don't have many of them, but the national agencies, if there are end users. In some cases, some of the projects are very confidential. So it is rare, but it happens, and this was exactly that type of case that in our understanding.

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Unidentified Company Representative [49]

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Next question.

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Toshihiro Yamada, Toyo Keizai Inc. - Media [50]

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Yamada from Toyo Keizai. I have 3 questions. First, if I could go back, not playing any rules, but allowing other parties to use your name, I think that's not uncommon. But I'm wondering what the expectations are in allowing that to happen, and for JPY 43.5 billion and JPY 1.8 billion was the operating income involved for sales, no actual reality. But when it comes to profit, the operating income did not materialize either. That was not clear. So can you explain that? And if -- well, regardless of whether it realized or not, JPY 43.5 billion and no services, no actual work that was involved and still operating income of JPY 1.8 billion, I think, is a good deal, very profitable transaction. Now given the size of TSC, I think this is a pretty good amount. I know that round-trip transactions are hard to identify, but it's slightly hard to believe that regardless of this amount, people did not really suspect. I find that to be really hard to believe.

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [51]

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Your first question now. What are the benefits of being in the [win]. TSC, as was mentioned earlier, is involved in maintenance and services. So once the products goods are delivered, then the vendors warranty period expires. In certain instances, TSC is asked to provide the maintenance service. So to be part of the big picture, that could lead to future business was what they had in mind.

And your second question. In a nutshell, in the third quarter, everything has been eliminated, especially sales, in particular, the profit, they were recorded, they were realized in these specific periods.

And regarding your question about the operating margin, the way I understood it, JPY 43.5 billion, JPY 1.8 billion, operating income, about 4% operating margin, that is in the IT business. This is not a profitable business. The operating margin is fairly low.

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Toshihiro Yamada, Toyo Keizai Inc. - Media [52]

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So you indicated that we consider this to be a very significant business. But this gross profit actually did not strike us as a very profitable one. If there is a service, 4% may not be high, but you were just putting your name on the sales slip. And if that could lead to future maintenance service business, I think this is a very good deal, isn't it? And that JPY 1.8 billion in operating income, if this was never revealed, if Company A succeeded in getting away with it without having this been revealed, then the profits would be retained, in other words, the cash will be retained, am I correct?

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [53]

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Well, this is a hypothetical, general answer. You get the product supplies, you pay to the supplier and you add profit sale to the customer to collect income, that's the flow of distribution. So even if this case had not been revealed then, the profit would be retained and cash associated with this would be retained as well that might have happened. But generally speaking, this was the case.

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Toshihiro Yamada, Toyo Keizai Inc. - Media [54]

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I haven't looked at the report yet. But am I correct to understand that the cash was not collected from the orders received to sales being recorded. The actual cash was not delivered?

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Masayasu Toyohara, Toshiba Corporation - Corporate EVP [55]

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No, that is not the case. We paid, and the money was collected from the customer.

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Midori Hara, Toshiba Corporation - Public Relations and IR [56]

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We take one more question. No other questions? So that concludes the session for the TSC. Mr. Toyohara and Yuzawa will leave the room. Thank you.

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Presentation

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Unidentified Company Representative [1]

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So we'll now move on to the earnings briefing for the third quarter of fiscal 2019. The participants, Representative Executive Officer and Corporate Executive Vice President, Masayoshi Hirata; and (inaudible) from the accounting (inaudible). And (inaudible) will give the presentation based on the slides, the hard copies of which have been distributed to you.

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Masayoshi Hirata, Toshiba Corporation - Representative Executive Officer, Corporate Executive VP & CFO [2]

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Thank you for attending our earnings briefing despite your busy schedule. Let me go over the business results for the third quarter of fiscal 2019 during this 9-month period. As was the case in the second quarter, we saw the benefit of the results from the structural reform in fiscal 2018 as well as the procurement reform that started in the second half of fiscal 2018. And in addition, we enhanced the cost control on large projects based on the lessons learned from the past. So as a result, the basic earning power made a steady improvement. And we were able to see the benefit of that reflected in our business results.

And for fiscal 2019, overall, the market conditions in China are becoming sluggish, triggered by the trade frictions between the U.S. and China, and that is lingering. And partly due to that, especially in semiconductor, Toshiba TEC, printing, retail solutions, these segments are currently struggling. And as a result, already, we have been working on the rigorous cost control. And starting in January of this year, we have further enhanced that management of cost control.

As a result of such efforts, by segment, on a full year basis, there is some downside but we believe that the actual results would be within the risk buffer that we had (inaudible). And therefore, we are not making any revisions to the full year guidance.

Please turn to Page 5. The 9 months results. Net sales, JPY 2,458.6 billion. Year-on-year, down JPY 188.6 or JPY 6 billion or 7% by segment, infrastructure systems, building solutions, retail and printing solutions posted higher sales while Energy Systems, Electronic Devices and Storage and Digital Solutions posted lower sales.

As you are aware, PC business was deconsolidated in the second half of fiscal 2018, and that had an impact of JPY 79.4 billion, which was the amount of sales recorded in the third quarter of 2018. And after Kioxia, the resale of memory products were made earlier last year, but Kioxia as they are establishing their -- distribution outlets overseas, we saw a decrease in the resale of memory products by about JPY 80 billion year-on-year. And also due to the appreciation of the yen, we see the effect of foreign exchange amounting to JPY 28.5 billion. When we exclude those factors, these sales were actually about the same as in the previous year.

Well, the sales were on par with the previous year with the steady improvement in our basic earning power. For the operating income, we saw a year-on-year increase of JPY 54.3 billion at JPY 62.5 billion for the 9-month period. Details will be explained later. And as for income before tax, a loss of JPY 106 billion, which is JPY 116.4 billion worse than the previous year. The net loss amounted to JPY 145.6 billion.

As you're aware, this was partly due to the LNG business, the business transfer, which was recorded in the first half, JPY 89.2 billion. And also, the equity loss from Kioxia. Because of the problem in the first half, we recorded a loss of about JPY 70.9 billion.

As for the free cash flow, net cash outflow of JPY 251.8 billion, as shown at the very bottom of the slide, this is in relation to the payment -- in relation to the transfer of LNG business. And also, we do have large sales in the fourth quarter. And therefore, in the third quarter, in preparation for that, the payment usually precedes the collection, which is what happens every year. So on a cumulative basis, we do have a negative figure for the free cash flow.

And the TOB is a 3 listed companies. The payments for this would be recorded in the fourth quarter or later. And therefore, this is not reflected in our third quarter results.

Page 6. The shareholders' equity as of the end of December, JPY 1 trillion and the -- almost. And the equity ratio was 28%. Compared to 9 months ago, this shareholders' equity is JPY 431.8 billion less. This is due to the net loss as well as the share buyback of about JPY 300 billion.

And so the net loss was JPY 145.6 billion, and share buyback amounted to about JPY 300 billion. And therefore, our shareholders' equity was reduced somewhat, but still at the JPY 1 trillion level.

As for the share buyback. As far as the third quarter is concerned, the amount was approximately JPY 60 billion. Altogether, starting from last fiscal year, JPY 700 billion worth of treasury stock has been repurchased.

As for the net interest-bearing debt, JPY 154.7 billion cash position as of the end of 2019 and JPY 746.1 billion less than the beginning of the fiscal year. And as for the exchange rate, about the same as the beginning of the year at JPY 110 to the dollar. And I'm going to skip Page 7 and move to Page 8. This is the operating income comparison, the usual graph.

The third quarter 2018 operating income, JPY 8.2 billion, and there were the one-time factors and when exclude that, that's JPY 31.3 billion. Compared to that, as a result of the procurement reform and structural reform continuing on from the first half, we had incremental effect contributing to the results. At the same time, there was an impact of the lower selling prices, JPY 10.3 billion. Centering on electronic devices in Storage, we felt the impact of lower selling prices.

And with the lingering effect of the U.S.-China trade conflicts, we are seeing the sluggish market conditions in China, especially in the electronic Devices & Storage, JPY 10.2 billion. Now a year ago, excluding the one-time factor, JPY 31.3 billion, but we saw an increase in operating income by JPY 30 billion, resulting in JPY 62.5 billion for the 9-month period.

Nonoperating income. I'm also going to skip that page and look at the free cash flow statements. As explained at the last earnings briefing, at the very top, you can see the total of the operating and investing cash flows in relation to the memory and long-term factors, at the very end -- at the very bottom, you can see the free cash flow of cash -- net cash out of JPY 56.3 billion. The main reason is, as was mentioned earlier, in preparation for the collection in the fourth quarter, the expenses appreciated. The operating cash flow JPY 89.5 billion -- cash outflow, but this is within the Toshiba Next Plan. We have been controlling the investment because the economic outlook is somewhat uncertain, but about JPY 150 billion minus overall.

Page 11, balance sheet. On the capital side, cash and cash equivalents. If I could repeat myself in relation to the share buyback, which is the main factor, and the subordinate balance in the first quarter, we made a repayment, which resulted in a reduction in cash and cash equivalents. As for the total assets, no major change.

On the liability side, the interest-bearing debt on the top line, almost no change, but if I could focus on some of the differences, as we repaid the subordinated loans, the amount should have been reduced. But as you know, because of a liability increase resulting from the change of the lease accounting standards, this was canceled out. We are controlling the risk assets based on the lessons learned. We are seriously reviewing that, but we do not find an accumulation of a particular risk asset.

Page 13. The details by business segments. On a 9-month basis, altogether, we are seeing year-on-year improvement.

Let me look at different segments. Energy. Net sales, JPY 408.9 billion, operating income, JPY 10.9 billion. For sales, down JPY 42.2 billion year-on-year, especially in thermal and hydro power, we saw a decrease in deals. And also in nuclear, we are conducting various safety-related projects, and there is a difference in the progress.

As for the operating income, during the first half, we saw an improvement of JPY 14.5 billion, and we are seeing further improvement, JPY 32.6 billion increase year-on-year. Structural reform effect, JPY 7.1 billion, approximately. Especially in the transmission and distribution, there was a one-time cost incurred in the previous year. And in the absence of this year, we saw improvement in operating income, JPY 90 billion loss recorded in the previous year. And this time, JPY 10 billion profit.

Page 15, the Infrastructure System & Solutions, continue to enjoy good business. Net sales, JPY 476.5 billion, operating income, JPY 16.2 billion.

In the public infrastructure, with the increase in the size of social systems project, JPY 16.7 billion increase in sales year-on-year. Operating income, JPY 16.4 billion increase year-on-year, partly due to the effect of the structural reform efforts.

And then Building Solutions. Net sales, JPY 423.6 billion; operating income, JPY 19.5 billion. About 5% ROS.

Net sales, we saw a decrease in sales in the lighting equipment, but for elevators and air conditioners, we saw very good business, both at home and abroad. Altogether, increase in sales of JPY 21 billion. As for operating income, we saw profit increase due to sales increase, and we saw the effect of structural reform of about JPY 3 billion. So our Building Solutions altogether, JPY 4.3 billion increase in profit year-on-year.

Page 16 shows electronic devices and storage solutions results breakdown. Net sales were JPY 573.4 billion, operating income, JPY 12.7 billion.

As for sales numbers, due to the slower market conditions in China and others and lower memory products we sell, which has not had a much impact, but it pushes down the sales number. The decline of the sales expanded in Q3. Despite the lower profit due to the lower sales. And as you might remember, there was a NuFlare Technology impairment loss booked in Q3 last year, that was JPY 9.8 billion for the restructuring costs, which incurred also last year. And combining all of those, yes, this year, again, about JPY 5 billion restructuring cost spend in the first half. So combining all of those, the operating income was about the same as the year before. That was the end of 9 months.

Page 17 is Retail & Printing solutions. Net sales, JPY 371.1 billion; operating income, JPY 14.3 billion. Toshiba TEC, there was an announcement from them. Retail business in Japan has been strong with the higher consumption tax, but the printing business, especially towards the end of the Q3, there was an impact of U.S.-China trade friction, restrained purchasing and led to lower sales. Overall, sales grew about JPY 9.5 billion, but we are struggling in printing.

As for the operating income, especially printing, we have lower sales. POS in Japan increased its profit, but compared to the first 3 quarters of last year, the operating income decreased slightly. The bottom half of this page shows that Digital Solutions net sales were JPY 175.1 billion, operating income JPY 7.6 billion.

Now let me explain the impact of TSE's fictitious round-trip transactions on consolidated financial statements. As it was mentioned, we revised the Q3 sales, down by JPY 21.5 billion and operating income by JPY 1.8 billion. Now JPY 21.5 billion in sales represent the elimination of Q1 and Q2 sales of fiscal 2019. JPY 1.8 billion in operating income represent JPY 0.9 billion elimination of Q1 and Q2 profit because it was already booked, and we eliminated that.

And in addition, as for the past, there was a JPY 0.9 billion profit. So in Q3, we eliminated JPY 0.9 billion for -- before fiscal 2018. We do not restate the past financial statements. There might be some questions on this, but as it was mentioned earlier, our consolidated numbers, we believe that there is a low materiality concerning this restatement and [WWC] auditor also approved this treatment. So as for sales, for this fiscal year, and as for the profit, the cumulative profit from the past are eliminated that one time. And that's how we accounted for the impact.

So Q3, the JPY 21.5 billion elimination -- sorry, the JPY 21.5 billion in sales, and JPY 23.32 billion was the Digital Solutions sales increase until first half. So that one was offset. And for the 9-month period, the operating income was about the same as the year before. Rather, the sales were about the same as the year before.

As for the profit numbers, JPY 7.6 billion, and JPY 0.9 billion was eliminated for the past. So in reality, including JPY 0.9 billion, the overall operating income increase was by about JPY 6 billion year-on-year. So we have started the restructuring efforts for some years, and we see the improvements of the profitability happening.

Page 18 shows the amount of orders received and order backlog. There are no major changes from the first half trend. The Q1 to Q3 orders of the fiscal 2019 increased 19% year-on-year. And also the order backlog also stays about the same. Although it is not written on this page, but the gross profit of the order backlog is improving compared with previous year. So we have been selective in taking orders. So the order backlog itself is not increasing, but the profitability is improving.

Next, I'd like to turn to Page 20. This shows the equity earnings from Kioxia. Top left shows the quarterly equity earnings actual. Q3 actual was equity loss of JPY 9.6 billion. In terms of trend compared to Q1, the deficit is much smaller. And excluding the impact of the PPA, equity losses of JPY 1.5 billion. So it's almost breakeven. Top right shows the big growth as well as ASP decline actuals. The Bit growth is in higher single digit, but it's on the right, ASP started to increase. So gradually, we believe that we have bottomed out. And how can we recover and when is something that we are watching closely.

Now from Page 21, we are showing the full year forecast. As for net sales forecast, JPY 3.430 trillion, revised down by about JPY 10 billion. There are different factors, but the major one is the TSC-related revisions. Also, operating income of JPY 140 billion remains unchanged. And pretax loss forecast remain the same as before.

Free cash flows, minus JPY 340 billion, JPY 30 billion improvement from the previous forecast. This is the result of the review of investment schedule and the amount in each segment in view of the sluggish market conditions in China and others. We are holding some of the investments and the change in the amount. So JPY 30 billion improvement of the cash flow is expected. And maybe we will be making some of those investments in the following year.

Page 23 shows the operating income improvement comparing fiscal '18 actual and '19 forecast. From the left, fiscal 2018 actual operating income was JPY 35.4 billion, one-time factors. When you exclude that, it was about JPY 80 billion in the previous year.

Comparing that to this year, if you look at the table below, from Q1 to Q3, those are actuals. And if you look at the Q4 numbers, red boxes are the effect of the procurement reform, sales reform and restructuring.

If you compare the first 9 months with the Q4, you -- we can say that we are likely to make steady progress. Blue box, JPY 30.6 billion improvement year-on-year. This is especially for the Energy System and the electronic device and storage solutions. In Energy in Q4, there was a loss control being added. And right now, we don't expect that to happen. So probably, there is no provision for the loss control for this Q4.

As for the semiconductors in the System LSI, low profitable ones are being reduced. So we are starting to see the effect of that. So combining all of those factors, in Q4, operating income is forecast to reach JPY 77.5 billion and full year forecast of JPY 140 billion remains unchanged.

At the very bottom, we are showing the comparison from the previous forecast. Electronic device and Storage Solutions, especially the lower sales pushed down the forecast. We see the bigger impact from China. Toshiba TEC and Building Solutions, we are seeing the worsening of the sales mix. So JPY 13.5 billion lower than the previous forecast. And we plan to offset this with the improved fixed costs and also lower restructuring costs. And also risk buffer that we have will be utilized, and we believe that we are likely to achieve the JPY 140 billion operating income.

So JPY 140 billion, we have 1.5 month to go. So all the employees are working hard to achieve that. So in fiscal '19, semiconductor, about JPY 10 billion, restructuring costs are included, especially in semiconductors. So excluding that, the operating income is expected to be almost JPY 150 billion.

So with your understanding, we spend the major amount for the restructuring and many reform -- the procurement reform and sales reform are being conducted, and we are starting to see the effects of that. So based on them, the business plan for fiscal 2020 is being formulated and we will respect those factors into that new plan.

Page 24. This is the breakdown by segment. There are some overlaps, especially the operating income comparison vis-à-vis the previous forecast. The lower profit is expected for the retail and printing, but in other segments, we expect the operating income to grow. So JPY 35.4 billion in fiscal '18 and JPY 100 billion improvement. So JPY 140 billion is the operating income that we would like to achieve. And the ROS, about 4% improvement of about 3 percentage point.

So Building Solutions, JPY 4 billion lower than before. So this is due to the lower sales of the Lighting business and one-time increase of expenses of the air conditioners.

In Retail & Printing solutions, the printing is struggling and therefore JPY 3 billion lower. And Electronic Devices and storage solutions impacted the China market condition. So JPY 7 billion lower, and Digital Solutions forecast sales is JPY 30 billion lower. And there are some impact from the TSEs.

Now lastly, I'd like to mention the spread of the new coronavirus. First, I'd like to take this opportunity to express condolences to those people who lost their lives and also express our sympathies to patients suffering from this virus.

Now as for the impact on our business results, I'm sure that you have seen the comments made by the different companies about their business results and the impact from the virus. And we are exactly the same as other companies. That is to say that what would be the impact in February and March? We are sorry to say that as of now it's not possible for us to make a good forecast. We are getting information from different sources, but we are unable to mention any specific numbers at this moment. The situation is changing every day. My personal impression is that the situation is becoming worse. So we are unable to grasp the impact of this.

As for February, March, planned sales to China is about JPY 100 billion. This number is included in our assumptions as a fact. So that's something that we would like to communicate to you.

So based on the current situation, this JPY 100 billion sales, whether we can book this number in February or March, it's difficult to say or it might be difficult to achieve. We do not think that sales would be 0, but maybe there will be a shift or delay of booking of the sales to the early 2020 or fiscal 2020, especially semiconductor TDSC weight is high. Maybe close to 60% is the TDSC related and also air conditioner, elevators, infrastructure are also included.

So those are the sales that we plan at our plants. Not all of them are closed, and some of them are operating, but Chinese employees are not coming back easily. So we are not really operating at the high level. So that is as of today. So based on that, from the end of January, we are watching the situation on a daily basis, and we will continue to do so.

We would like to create the situation so that we can book the sales but there could be some downside risk because of this virus at this moment. So -- especially the Q4, there could be some negative effect from the coronavirus and also the Chinese market condition has been sluggish to the U.S.-China trade friction. So we continue to see those uncertainties, but we established the Next Plan, and we have been implementing the measures together with all the employees and the direction and targets of the Next Plan are unchanged, and we are making a good progress, we believe. So that is something that we'd like you to understand.

Sorry to make a long presentation. That concludes my presentation. Thank you.

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Questions and Answers

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Unidentified Company Representative [1]

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That concludes the company's presentation, we'll take questions from the media. Please raise your hand if you have any questions.

Thank you. Over to you from Nikkei.

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Unidentified Audience Member [2]

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Some clarification. JPY 100 billion sales that you mentioned towards the end of your presentation, that's for China, February and March, correct?

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Unidentified Company Representative [3]

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Yes. That is correct.

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Unidentified Audience Member [4]

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Sales for the Chinese market?

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Unidentified Company Representative [5]

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Yes.

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Unidentified Audience Member [6]

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Thank you. I have two further questions. First, on electronic devices and storage. At the time of developing the Next Plan, JPY 58 billion operating income, and now that's been reduced to about half. JPY 30 billion risk buffer I think is consumed almost entirely by TDSC. So I do understand that the worsening market conditions and restructuring costs, but can you talk about the qualitative factors that are resulting in this? What's happening?

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Unidentified Company Representative [7]

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Well, nothing really serious actually. The restructuring, when we put together the Next Plan, when we made the operating income vision, the restructuring cost was not included because of the U.S.-China issue, with sluggish Chinese market. As TDSC flexibly implemented restructuring measures, over JPY 6 billion cost incurred on a full-time -- full year basis, which is pushing down the operating income somewhat. That's one factor.

And also the market conditions overall not good. I think that explains it all. It's not that there's any particular factor.

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Unidentified Audience Member [8]

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About the outlook. You have -- without the risk buffer, you said that JPY 140 billion could be achieved, but there is a delta downside risk in relation to the coronavirus outbreak. So how certain is this JPY 140 billion?

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Unidentified Company Representative [9]

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Well, as I mentioned, JPY 140 billion does not reflect the outbreak of coronavirus, JPY 140 billion itself. JPY 30 billion risk buffer had been set out initially. We have 1 month remaining. Of course, we can be optimistic, but I think JPY 140 billion is within the reach.

But looking at more recent developments, the impact of this outbreak, we don't expect the entire sales projection to be canceled out, but we don't know to what extent our sales projection would be affected. That is as of today, it's still uncertain.

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Unidentified Audience Member [10]

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So JPY 140 billion, how confident are you?

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Unidentified Company Representative [11]

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We are very confident. As I briefly mentioned in my presentation, as basis for next year's plan, the restructuring costs, about JPY 10 billion included in JPY 140 billion. So when we exclude that, JPY 150 billion, we believe, is the reflection of our actual earning power. And that is the basis of our budgeting for next fiscal year.

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Unidentified Audience Member [12]

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So that outlook, looking at the third quarter results, it's still 40%, 50%. I know that, that's your business model. But by segment, what would be the optimistic factors? What are more concerned areas in achieving JPY 140 billion?

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Unidentified Company Representative [13]

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Well, which area? All I can say is that we're going to be very serious in all business segments. But in terms of sales, infrastructure, energy solutions, they (inaudible) for a large proportion. So systematic manufacturing and relationship being built with our customers are being done. So deliveries to our customers, I think, would be very important. As for our mass-produced products, we just have to make sure that we sell what we manufacture.

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Unidentified Audience Member [14]

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So which particular segment or business?

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Unidentified Company Representative [15]

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I can't really say. It's overall.

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Unidentified Audience Member [16]

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And coronavirus outbreak?

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Unidentified Company Representative [17]

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This is really an emergency. So as company, with chairman and the presidents at the top, we are enhancing the spend management or the expense management and control by setting up the special project. I am in charge of the spend management initiative as well. So the entire company under the management, it's not really reducing the expenses, but the efficient use of expenses. That's the perspective with which we are working on this. We have to make sure that we will see results from those efforts.

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Unidentified Audience Member [18]

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(inaudible) from Toyo Keizai. Follow-up question. You're working on the budget for the next fiscal year. It may be too early, but what would be your expectation? Which segment would be the driver or also the cost reduction, where would you be focused on, especially -- also the dividend policy, I'd like to know your thoughts on the dividend?

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Unidentified Company Representative [19]

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As for the next fiscal year, we are currently finalizing our plans, so I cannot really mention the specifics, but fiscal '21 target I already shared with you. So we want to be able to achieve that. So that is the -- for fiscal 2020, so we'd like to increase that to a certain level. And currently, we are finalizing that at the corporate level.

As for the dividend, based -- not based on the single year, but we'd like to have a longer-term view, 30% payout ratio is our basic policy, which we announced already. So we are trying to have a longer view, a longer-term view. How can I explain this? When we have a lot of equity capital, then we would also consider the shareholder return, aside from the dividend payment.

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Unidentified Company Representative [20]

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Next person?

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Unidentified Audience Member [21]

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Yamada from NHK. Two questions. First, the U.S.-China trade frictions. The tariff reduction was realized based on the first round of agreement. What impact would that have on your business or on Japanese economy overall? Second, the impact of the coronavirus outbreak said that your plants are not really restarting smoothly. Is it your plants that is being affected or the supply chain that is most seriously affected?

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Unidentified Company Representative [22]

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First, about the tariffs, specifically the printing business of Toshiba TEC is affected. But with reduced tariffs, I don't know if printing, which is part -- is on that list or not, I apologize, but I don't -- I haven't looked at it carefully yet. Printing has been affected by the tariff issue so far.

Now the plant operation at our plants, factories, there are about 20 manufacturing sites that we have. And the 1 quarter, about 5 factories have restarted, but they don't have the entire workforce back at work yet.

As of today, I don't know how best to put it, it's far from seeing the normal operation. And supply chain, we have relationship with our suppliers. And locally, I'm sure there are various arrangements, coordination being made. But looking at what is being reported by the news media, looks like other players are, I wouldn't say struggling, but of course, human life protection is the top priority. And I think that is the key point. I hope that answers your question.

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Unidentified Audience Member [23]

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Thank you. About the U.S.-China trade friction, do you expect positive impact on the Japanese economy going forward? Your personal view?

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Unidentified Company Representative [24]

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Japanese economy overall, I'm afraid, I'm not in a position to make that kind of comment.

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Unidentified Audience Member [25]

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(inaudible) from Nikkei. Two questions. First, you mentioned the cost reduction, the project spend reduction. To what extent do you plan to reduce the expenses? The second is the impact from coronavirus. Some of the plans have stopped. Your Next Plan, the CapEx plan, any change to the direction of the CapEx?

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Unidentified Company Representative [26]

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First, about the spending. We have 9 items that we want to control. So those were not fixed, but rather there is some flexibility in terms of the selection. I cannot mention the percentage numbers, but spend management is being -- from -- we make a proposal. And so we are very -- asking all the companies to review the expenses very closely so that they will inform the result to the corporate side. So that is the kind of routine that we established. So it's a very focused on the details of the expenses and spending. We are trying to manage the spending very closely.

About the CapEx direction, well, I'm sure you're referring to the impact from China business. Well -- especially the production plants and also the sales sites. Due to the current situation, any specific measures or positive actions, we have not yet taken those.

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Unidentified Company Representative [27]

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Next person?

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Unidentified Audience Member [28]

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(inaudible) from Kyodo News Agency. I have a question related to coronavirus outbreak. Some of the automakers, not because of what's happening in China, but because of the supply chain, they are forced to suspend the operations in Japan as well. Is that -- what's happening to you as well? And what plans do you have regarding your expats?

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Unidentified Company Representative [29]

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The automakers are largely affected is what we are being informed. Especially on semiconductor, we are supplying many different products and components. So based on the request from the automakers, we are thinking of taking necessary actions.

And the workers in China, the expats, Japanese expats, we have a little over 100 of them. It's not all of them, but after the Chinese New Year, the managers did return to China, after returning to Japan during the holidays. But sales, service and manufacturing sites to be reopened that's the purpose. But the Chinese local workers are not really returning to work and therefore our operations haven't been back to the normal level.

Of course, the top priority is the human life. We don't want to make situations worse. So we are telling them to remain safe and where they are and business trips to China are currently being banned, prohibited. If there is the need, absolute need, the business trips will be allowed based on the management decision. But as a general rule, the business trips to China are currently being banned.

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Unidentified Company Representative [30]

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Maybe one last question? Thank you very much. That concludes the briefing session on the Q3 business results in fiscal 2019. From 3:30, we have Q&A with analysts only. So media people can stay, but you cannot ask any questions. Thank you very much for coming.

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Presentation

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Unidentified Company Representative [1]

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It's time. I can now take questions from the analysts and the institutional investors on the Q3 business results of fiscal 2019. Let me introduce the representatives, Mr. Masayoshi Hirata, CFO; and Yasuhiro Matsunaga, the Head of Accounting; Kimura from Public Communications and IR. Now we would like to take questions.

If you have any questions, please raise your hand and wait for the microphone and give us for your name and affiliation before asking questions.

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Questions and Answers

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Hisashi Moriyama, JPMorgan Chase & Co. - Analyst [1]

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Moriyama from JPMorgan Securities. On Page 8 of (spoken in Japanese) and also on Page 24 of the presentation material, it's the same pattern that I usually ask. On Page 8 of (spoken in Japanese) you mentioned the 3-month sales and operating income actuals. And the presentation on Page 24 shows the full year forecast by segment. And also, you're showing the previous year. So looking at the previous forecast, I think you can see the strengths and weaknesses of different segments. But as much as you can, on the 9-month operating income, JPY 10.4 billion compared to the previous forecast, I think that there was some weakness and the buffer is included for the full year. So I can speculate, but could you talk about that? And also, the strengths and weaknesses of the different segments, if you can talk about some of the numbers?

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Unidentified Company Representative [2]

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Yes. Q3 -- or you mean the 3-month only Q3?

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Hisashi Moriyama, JPMorgan Chase & Co. - Analyst [3]

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Yes.

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Unidentified Company Representative [4]

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Well, Next Plan fiscal '19 was formulated and there were quarterly numbers, but in comparison to them as for the strengths and weaknesses as a whole compared to the original Next Plan, it's worst or worse, semiconductor, TDSC was worse than our plan. But others are basically on track. Building Solutions, Lighting is slightly slower or lower. And as I touched upon earlier, the air conditioners, the quality-related provision of about JPY 3 billion. So this was unexpected. But semiconductor was the main reason.

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Hisashi Moriyama, JPMorgan Chase & Co. - Analyst [5]

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How bad is it? For the full year, JPY 7 billion operating income. That is the Device & Storage lowered by that. So is that something that you would achieve in Q3 and Q4?

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Unidentified Company Representative [6]

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Excuse me, JPY 7 billion.

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Hisashi Moriyama, JPMorgan Chase & Co. - Analyst [7]

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Sorry, I might be wrong. But on Page 24 of your presentation material, Electronic Device & Storage operating income compared with the previous forecast is JPY 7 billion lower, I think. So is this due to the Q3 number or in combination of the Q3 and Q4? In other words, is it lower in second half?

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Unidentified Company Representative [8]

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Well, in the fourth quarter compared to the Next Plan, it is worse. But the situation in Q3 is incorporated into the full year forecast. And I expect some worsening in Q4 as well.

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Hisashi Moriyama, JPMorgan Chase & Co. - Analyst [9]

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So lower than -- sorry, the JPY 7 billion lower in Q3, the -- that is 70-30, if you compare Q3 versus Q4?

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Unidentified Company Representative [10]

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Yes. That is the ratio.

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Unidentified Company Representative [11]

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Next question, please.

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Kota Ezawa, Citigroup Inc. - Analyst [12]

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Ezawa from Citigroup Global Markets Japan. About the Electronic Device & Storage. Full year operating income plan and the actual for 9 months, when you do the subtraction, you find that 10 -- JPY 16 billion, I think, will be the fourth quarter figure, semiconductor versus hard disk drive. Can you talk about the breakdown? Because for semiconductor, for Q3, I think the loss was rather substantial. So for the fourth quarter, I think your plan expects a big improvement. Is that the case is what I like to confirm?

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Unidentified Company Representative [13]

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How should I put it? When you do the subtraction, JPY 16 billion operating income for the fourth quarter, that is true, math-wise, calculation-wise. Discrete, from Q3 to Q4, excluding the impact of coronavirus outbreak, we felt that impact being factored in. We expect market to recover somewhat. And therefore, Q4 should do better than Q3. That is our assumption.

And for System LSI, restructuring in the first half and also in the early part of Q3, various measures were implemented. And we expect the effect of that to be felt in the Q4, which means that during Q4, fourth quarter. I don't know if I should really go that far, but we are expecting turning to profit, is at least what we assume.

Hard disk, Q3 flat. I'm just talking about the operating income.

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Kota Ezawa, Citigroup Inc. - Analyst [14]

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Thank you for continuing. And NuFlare Technology?

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Unidentified Company Representative [15]

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In the fourth quarter, they will be delivering lots of things to the customers. So the profit during the 9-month period, the equivalent amount is expected in the fourth quarter profit wise. So JPY 16 billion operating income, I wouldn't say half, but quite a bit of that comes from NuFlare. And remaining part, Discrete, LSI, hard disk, evenly sharing that share.

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Kota Ezawa, Citigroup Inc. - Analyst [16]

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I see. I have 3 questions altogether. My second question. And looking at the various analysis, operating Page 8 for the 9-month period. And looking at those figures and substract what you were presenting at the second quarter earnings results to get the third quarter results. Minus 19.4 in sales difference and the sales mix of JPY 10.6 billion. So during the first half, those were the growth drivers, but they had negative impact in the third quarter. And I think you did talk about that a little bit, the Devices, for example, but can you elaborate on what were the negative factors during the third quarter? And also, you do show us the full year forecast. But for the fourth quarter, for the differences in the sales mix, Hirata-san, you did highlight that you expect that to be a big positive factor. So I'm wondering why such differences on a quarter-on-quarter basis?

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Masayoshi Hirata, Toshiba Corporation - Representative Executive Officer, Corporate Executive VP & CFO [17]

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Okay. Page 8, the third quarter, increased division sales. Year-on-year, again semiconductor related accounting for a majority of this difference. And differences in sales mix, what is going to hurt would be ESS-related. How should I put it? The affiliated companies are expecting a cost increase and that had a negative impact in terms of the differences in sales mix. That's one factor. That's all I can say.

Yes. And TEC Printer compared to the previous year, the gross profit is declining year-on-year. It's not just about reduced amount of volume, but the -- it's not really the sales price differences, lower sales price, but it's more to do with the differences in the sales mix in the case of Toshiba TEC.

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Kota Ezawa, Citigroup Inc. - Analyst [18]

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I see. Slide 23, the fourth quarter and JPY 30.6 billion positive impact of the differences in sales mix and Devices, Energy Solutions, breakdown-wise. And now Toshiba TEC, I think, will have a negative impact. Am I correct?

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Masayoshi Hirata, Toshiba Corporation - Representative Executive Officer, Corporate Executive VP & CFO [19]

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True. That would be a negative impact, but a major factor would be in the same period, in the previous year, in Energy Solutions, that's the provision particularly for the Thermal Power Systems and the absence of that this year is a big factor. And also for Electronic Devices & Storage with System LSI, the low profit margin products not to be promoted strongly. As was mentioned earlier, that should account for this difference.

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Kota Ezawa, Citigroup Inc. - Analyst [20]

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I see. Final question, free cash flow, full year and the third quarter. When I did a subtraction, minus JPY 90 billion for the fourth quarter, at least according to my calculation, minus JPY 90 billion in just 3 months. Can you explain the reason why?

Full year, you're showing the full year, JPY 340 billion minus, that's what shown on Slide 22. And then minus JPY 20 billion or JPY 25 billion shown in earlier slides, slides 8 and 7. And when I do the subtraction, I think the fourth quarter figure would be minus JPY 90 billion. And I'm wondering if there's any special factors, special reason for that? Or is it that the working capital is going to increase or not?

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Masayoshi Hirata, Toshiba Corporation - Representative Executive Officer, Corporate Executive VP & CFO [21]

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One factor that does not exist in other years is for the small- and medium-sized suppliers. The payment condition have been changed. And that impact is particularly felt strongly in the fourth quarter. So that's one factor for this negative figure. And another is -- this was true in the third quarter as well, but especially in the fourth quarter. To book sales, many efforts are being made, and an associated payment will be made in the fourth quarter, which is the usual pattern. The actual collection will be made in the first quarter.

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Kenji Yasui, UBS Investment Bank - Analyst [22]

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Yasui from UBS Securities. I also have 3 questions. First, Kioxia impact. The media reported that there will be an IPO. If there is an IPO, 10.9% of the equity, no change, and if it goes public, in terms of the PL or balance sheet, what would be the impact? Or would there be an impact?

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Unidentified Company Representative [23]

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Well, if there is a market value, then the JPY 300 billion investment is what we have. And if the market value or the market cap goes below that, then we need to book some loss. I think that they are doing IPO. So JPY 2 trillion or higher is the level of the IPO. And if that is the case, it will be positive. But the valuation, there is no increase of the valuation, but if we sell, then when it's realized, we would book the gain. But at the time of the IPO, our investment usually or based on the common sense, it is higher than JPY 2 trillion, then at that time, at that particular time, there is no impact.

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Kenji Yasui, UBS Investment Bank - Analyst [24]

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Second question is you'll be going back to the Section 1 of the TSE, and you said that you want to smoothly proceed to that. In terms of timing, when and through what kind of procedures do you think that you can return to the Section 1 of the TSE? Is there something that you can control, for example, applying certain documents? Or you need a financial statements and so forth? What will be the path or the timing for that?

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Unidentified Company Representative [25]

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The other day, the rules were modified. And from our perspective, at the corporate level, we are making preparations to get all the documents ready. So as soon as we are ready, we will bring it to the authority to make application. So that is going to be the procedure.

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Kenji Yasui, UBS Investment Bank - Analyst [26]

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So within the end of the fiscal year, you've been able to make that preparation?

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Unidentified Company Representative [27]

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So as for the specific timing, I cannot mention that. But even before the rules were modified, there were discussion about that, and we have been accelerating the preparation. But I cannot really specifically say when. Of course, we need to make a very good preparations. We have to make sure we have all the documents. There could be some variable factors. So I really -- I think it's not appropriate for me to mention the specific timing.

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Kenji Yasui, UBS Investment Bank - Analyst [28]

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Final point or third point. Fiscal 2020, before the media presentation, you mentioned the operating income target is JPY 240 billion for '21 and it's JPY 140 billion for this year. And you have to fill in the gap. So I think it's quite a high hurdle. So fiscal '19, you mentioned that, actually, it's JPY 150 billion, say, and you need to increase net profit in fiscal 2020. So for example, are there any major ones that we should expect, like at the level of the JPY 10 billion, the JPY 20 billion?

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Unidentified Company Representative [29]

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Well, actually, the corporate side and different companies are working on that and try to finalize it. Generally speaking, for the time being, we are not likely to increase the sales significantly. That is not our strategy. So we would like to focus on the high-quality orders, and we have been trying to do so. So as for the factors that push up the operating income, the improved gross margin, especially -- or it's not really increasing the ASPs or selling prices, but higher profitable deals we want to make sure that we secure those deals.

And as for the procurement reform, we will continue to enhance this, and employees are working on this cost reduction. So it's not something quite spectacular a difference, but rather increasing the gross margin, improving the selling prices or maintaining it and reducing costs. And also, I mentioned as one of the measures for February, March, especially the expenses and payment, spending, we're currently reviewing the potential waste for February, March. So we want to further reduce that. And by doing so, we want to maintain to push up or increase the profitability or higher profit.

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Unidentified Company Representative [30]

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Next question. I see a hand over there.

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Kazutaka Yoshizumi, SMBC Nikko Securities Inc. - Analyst [31]

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Thank you for the presentation. Yoshizumi from SMBC Nikko. I have 3 questions, by segment, Infrastructure Systems & Solutions. In one of your slides, the restructuring effect and the foreign exchange effect. When you exclude this, during the first half, about JPY 14 billion improvement was recorded. But when you just look at the third quarter, looks like some decline -- looks like the profit increase trend has stopped. Any particular change in the trend? That's my first question.

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Unidentified Company Representative [32]

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You're asking on a year-on-year basis, right? Any particular changes? No. In the third quarter, Energy overall has been on the upward trend year-on-year, operating income-wise. And for the fourth quarter, in the Thermal Power, big provisions...

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Kazutaka Yoshizumi, SMBC Nikko Securities Inc. - Analyst [33]

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No. I'm asking about Infrastructure & Solutions.

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Unidentified Company Representative [34]

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Sorry. Infrastructure Systems & Solutions, is the profit increase trend weakening? Well, more so than in average years. In the first half of the year, this is based on the request from our customers, their sales are shifting more towards the first half of the fiscal year. And therefore, on a year-on-year basis, the profit was increasing as a trend. For the third quarter, on a sales level, during the 3 months of the third quarter, about the same level as in the previous year, slightly lower, but almost the same. And profit was about the same level in the previous year. Now it is reflected in our projection in the fourth quarter because there is more sales shifting to the first half of the fiscal year. For this coming fourth quarter, we are expecting a slight decrease year-on-year. So there is a profit decline due to the sales decline. But as a result of the procurement reform and restructuring reform, we feel that the operating income itself will be about the same.

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Kazutaka Yoshizumi, SMBC Nikko Securities Inc. - Analyst [35]

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My next question. For the 3 months, one-time factors, expenses. Air conditioning quality related, did you say JPY 1.3 billion? Are there any other items?

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Unidentified Company Representative [36]

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Air conditioning, JPY 3 billion. For the third quarter, any particular item, I think that's just about it.

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Kazutaka Yoshizumi, SMBC Nikko Securities Inc. - Analyst [37]

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Got it. My third question. The order backlog is included in the presentation slides and improvement in gross margin on a year-on-year basis. As of the end of the third quarter, what was the actual improvement?

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Unidentified Company Representative [38]

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I can't really give you the gross profit margin on that orders. I can't really give you the specifics for you. But how should I put it? Certain improvement was realized. So I think JPY 2 trillion was a backorder amount altogether and 1% improvement would be JPY 20 billion. So the backorder balance itself, the amount hasn't changed much, but the breakdown hasn't been changed. And that is making a difference. And you are seeing a 1% improvement, yes, at least 1%.

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Unidentified Company Representative [39]

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Maybe we can take 1 more question.

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Shintaro Shimada, Mitsui Sumitomo DS Asset Management - Analyst [40]

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Shimada from Mitsui Sumitomo DS Asset. Just 1 question. Semiconductor, JPY 3.8 billion in red and in Q3. Now JPY 3.8 billion number in Q3. System LSI, restructuring is going on, you mentioned. So could you give us a breakdown? How much is the margin? It seems that in first half, it was down by 9%, and it's 79% -- 27% down. So the decline of the sales and discrete OP from Q3 to Q4, and in Q1, System LSI, there was a deficit of JPY 3 billion. So could you talk about those? You mentioned that only the JPY 3 billion special factor in air conditioning. But LSI, for example, probably, there was a onetime cost also in Q3? That was my first question.

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Unidentified Company Representative [41]

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Q3 and Q4 comparison or special factors or onetime factor, the breakdown, the JPY 3.8 billion.

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Shintaro Shimada, Mitsui Sumitomo DS Asset Management - Analyst [42]

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Discrete is profitable, right? Sorry, not JPY 3.8 billion, the operating -- I calculated and it seems that you have a operating loss.

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Unidentified Company Representative [43]

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You mean the semiconductor loss?

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Shintaro Shimada, Mitsui Sumitomo DS Asset Management - Analyst [44]

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Looking only at Q3, semiconductor profit and loss, I think you are in red.

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Unidentified Company Representative [45]

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Well, yes, if you do the deduction, well, in Q3, as I said, NuFlare Technology is included in semiconductor. And in Q4, there are -- will be several sales, but none in Q3. So that's the negative factor.

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Shintaro Shimada, Mitsui Sumitomo DS Asset Management - Analyst [46]

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Are you in red?

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Unidentified Company Representative [47]

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Yes.

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Shintaro Shimada, Mitsui Sumitomo DS Asset Management - Analyst [48]

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So as for Discrete, as usual, you have some OP margin, a certain percentage of sales, although sales are down, only looking at Q3?

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Unidentified Company Representative [49]

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Yes, it is positive. The Discrete is positive.

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Shintaro Shimada, Mitsui Sumitomo DS Asset Management - Analyst [50]

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Is it about 5%?

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Unidentified Company Representative [51]

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It is profitable.

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Shintaro Shimada, Mitsui Sumitomo DS Asset Management - Analyst [52]

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What about LSI. LSI, not profitable? LSI is not profitable? System LSI?

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Unidentified Company Representative [53]

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Yes, slightly in red.

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Shintaro Shimada, Mitsui Sumitomo DS Asset Management - Analyst [54]

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Another point. Kioxia, excluding PPA, the deficit is almost gone. So if you look at single month in December, probably, it was already profitable. Do you have any information on that? Single month -- was there any month which was profitable?

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Unidentified Company Representative [55]

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We keep certain distance. That is our position. So we do get the quarterly number, but not the monthly numbers.

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Unidentified Company Representative [56]

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I'm afraid it is now time to end the Q&A session. Thank you very much for your participation.

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