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Canon Inc. (NYSE:CAJ)

Q2 2011 Earnings Call

July 25, 2011 8:00 AM ET

Executives

Toshizo Tanaka – CFO and EVP

Analysts

Benjamin Lu – Seligman

Shannon Cross – Cross Research

Keith Bachman – Bank of Montreal

Operator

Good day, everyone and welcome to Canon, Inc.’s Fiscal Year 2011 Second Quarter Results Conference Call. Canon’s presentation is for 40 minutes and the Q&A session for another 20 minutes after the presentation. Just a reminder, today’s conference is being recorded.

At this time, for opening remarks, I would like to turn the conference over to your moderator for today, Mr. Toshizo Tanaka, Executive Vice President and CFO of Canon, Inc. Please go ahead.

Toshizo Tanaka

Okay, thank you. Good morning or good afternoon, ladies and gentlemen and welcome to Canon’s conference call. Please refer to today’s slide and note that all financial comparison made during my presentation will be on a year-on-year basis unless otherwise stated.

Please refer to slide two. This slide outlines today’s agenda. Please turn to slide three. I will now discuss our second quarter results. Despite problems in the United States and Europe and downward pressures on manufacturing activity in Japan due to the earthquake, the global economies remained on a path of gradual recovery thanks to continued strong growth in key emerging markets such as China and India.

Our market also remained strong. As for foreign exchange rates, we saw a substantial appreciation of the yen, particularly against the U.S. dollar. Under these conditions, due to lower production linked to supply chain disturbances caused by the earthquake, our abilities to derive products was limited for all businesses.

During the quarter, however, we made a steady progress in returning to normal levels of production. We now feel that our supply chain issues will be resolved earlier than originally predicted.

In addition to continuous support by our vendors, this was made possible by the individual effort of each business group and each production base, as they took quick action to grasp the circumstances surrounding every part and component, and implemented major, to promptly gauge with each situation.

On a group-wide basis, we also put priorities on certain products, facilitating the sharing of common paths among the business groups. Our supply chain management activities, which we have continued to improve through our own production systems also played a significant role in the face of this emergency.

Although we posted lower sales and the profit due to the strong yen and the effects of the (inaudible), the profit we secured exceeded our own expectation. Please refer to slide four.

This slide summarized our second quarter performance. Our gross net sales decreased 13.8%. We achieved the gross profit ratio of 60%. This reflects our cost reduction effort amidst severe production conditions. It’s also representing our layers of profitabilities not seen since the third quarter 2007 when the yen was significantly weaker.

As we couldn’t clearly observe the effects of the strong yen and the impact of the disaster, operating profit decreased 30.9%. However, thanks to the rapid recoveries in production that exceeded our expectation and cost reduction efforts, we secured the profit levels close to that which we achieved in the first quarter. Please turn to slide five.

This slide shows the impact of the earthquakes on our second quarter. If we exclude the earthquake’s impact, net sales and operating profit actually increased, with the latter growing by nearly 30%. This is an indication that actual business condition remains strong.

Please refer to slide six. Next, I will compare our second quarter results with our results for the same period last year. Changes in exchange rates have a major negative impact on both the sales and the operating profit.

As for changes in sales volumes, amid favorable market conditions and increasing office and consumer orders, the total impact from both the sales and the operating profit was positive. However, when effects of the earthquakes are included, all business units would show a negative impact due to production delays and subsequent unfilled orders.

In the others categories, the negative figures under net sales represent price declines for cameras and other products. The positive figures under operating profit represent effort to absorb the impacts of price decline through cost reduction and marketing and other expense savings.

In summary, when the earthquake’s impact is excluded, net sales and operating profit increases ¥12.1 billion and ¥33.3 billion respectively. Because the impact of the disaster was concentrated in our second quarter, however, net sales decreased ¥133.8 billion to ¥836.6 billion and operating profit decreased ¥35 billion to ¥78.4 billion.

Please refer to slide seven, I will now discuss our projection for 2011. This slide shows our exchange rate and ¥1 current impact assumptions. Please turn to slide eight, this slide highlights some key points regarding our 2011 projections. As for the economic situation where there are concerns regarding the weak economic activity in the United States and the financial problems in Europe, we continues to see strong growth in the emerging market.

As a whole, we feel the global economy is on the recovery path.

In our market, although uncertainties remains regarding Japan, we expect global demand to continue to be strong. Under these conditions through our swift recovery in production, we’ll accelerate the enhancements of our products supply system.

We will realize the quick recovery in the second half of this year, minimizing the earthquake’s impact and work towards our target of realizing the net sales growth and then operating profit ratio of over 10%.

Please refer to slide nine, as you can see we revised our full year projection for 2011 based on latest reviews of each business and new exchange rate assumptions. Amidst the yen’s appreciation that exceeded our previous projection, we work towards achieving or exceeding these figures.

Please turn to slide 10, I will now discuss the earthquake’s impact including in our full year projections. Despite the dynamic – dramatic improvement over our previous projections, delays in production and shipment for such products as cameras and the copiers projected negatively impact net sales by ¥197.4 billion.

Although we are seeing a smooth recovery in production from our sales perspective, we expect the effects of past production decline mainly on copiers to remain until the beginning of the third quarter. As for profits, due to decreased sales and the effects of unrecovered fixed costs from lower production levels, we expect the gross profit and operating profit to be negatively impacted by ¥122.2 billion and ¥122.5 billion, respectively.

For reference, full year’s projections excluding the earthquake’s effects are shown on this slide. Please refer to slide 11.

Next, I will discuss our current full year projection with our previous quarters. As for changes in exchange rates, the overall impact is negative on both projected net sales and operating profit. Regarding the changes in sales volumes, the overall impact is positive on both projected net sales and operating profit.

We expect to exceed our previous projections for all the business unit amidst strong demand. In addition, through concerted effort to recover from the earthquake, we’ll normalize our production system earlier than expected which will have the effects of boosting net sales and the profit by ¥117 billion and ¥75.1 billion respectively.

In the others categories, the negative figures and the net sales and operating profit represents further price decline for mainly copiers. As a result when the impact of foreign exchange rate is excluded, the net sales and operating profit increase ¥133.8 billion and ¥96.3 billion respectively indicating a steady improvement in profitability.

Through these various measures amidst the yen’s appreciation, we expect a significant improvement in both net sales and operating profit from our previous projections. From a profitability perspective as well, we expect the improvement for all business units from our previous projections.

Please turn to slide 12. I will now discuss each business units starting with Office. In the second quarter, our main forecast was steadying consumable price to existing copiers and with the printer customers. We also worked to maximize sales of both hardwares and consumables by closely cooperating with sales companies and suppliers of raw materials soon after the earthquakes to avoid the lost sales opportunities amid the restrictive productions levels due to supply shortage.

As for copiers, despite weakness in Japan, we continue to see a gradual recovery in global demand, thanks to economic recoveries in the United States, Europe and Asia. Under these conditions and amid the continued strong demand for our imageRUNNER ADVANCE series, despite effort to expand the sales, we posted a 21% decline in unit sales due to supply shortage.

Although we saw strong non-hardware sales in the United States, Europe and Asia, global non-hardware sales declined 6% due to lower sales in Japan and the yen’s appreciation. As a result, copier net sales decreased 8.2% on a local currency basis and decline 11.4% in yen terms.

As for laser printers, imagine the market such as China, continue to drive ongoing market expansions. Within this market, we achieved the unit sales in line with the same period last year, thanks to a quick recovery in production.

We also realized a slight increase in consumable sales in the local currency basis. Net sales of other printing devices however, decreased 14.8%, reflecting in the yen’s appreciation.

In total, Office Business unit, second quarter net sales decreased 10.8%. Operating net profit decreased

28.6% and the operating profit ratio decreased 3.3 points due to the yen’s appreciation and low productivity.

Please refer to slide 13. I will now discuss our three years productions for this business unit. For the copier market in 2011, although we expect the earthquake’s impacts on the Japanese market through linger, we also anticipate global market to continue to gradually recover.

As the part procurement situation has significantly improved since timing of our previous projections in the second half, we will accelerate the pace of recovery. Through this, we now expect a significant improvement in unit sales from our previous production of a 2% decline to our current projection of 10% growth.

And for non-hardwares, thanks to a strong demand and the steady recoveries and productions on local currency basis, we expect the sales to increase 1%. In yen terms, however, we expect a significant decrease for the full year.

Overall, full year’s net sales of copiers is projected to increase 0.4%, as for laser printers, despite the sense of uncertainty about the U.S. and Europe, we expect the emerging market to continue to be the main drivers of market growth.

In unit terms, market research firms are projecting the market to grow at a rate of around 5% to 10% in 2011. In response to the industry’s demand for both hardware and consumables, we’ll work for the swift recovery in production and continuous effort to expand our market shares and to improve profitability.

On a local currency basis, full year net sales of other printing devices are projected to increase 4.3%. In yen terms however, we are projecting a slight decline.

In summary, full year’s net sales of our Office Business unit are projected to increase 2.1% and operating profit is projected to decline 12.4% reflecting the yen’s appreciation and the earthquake’s impact.

Please turn to slide 14. I will now discuss our Consumer Business unit starting with our second quarter result. For cameras, in addition to efforts by parts manufacturers, by flexibly responding to the changes in our own production, we achieved better than expected progress in production recoveries. And in June, camera production was nearly back to normal.

Despite this, due to parts shortage soon after the earthquake, we couldn’t avoid a decrease in unit sales. In addition to this, due to the yen’s appreciation, net sales for cameras decreased 20.2%.

As for inkjet printers, despite the sluggishness in Europe due to aggressive competitor pricing, we posted a 2% increase in unit sales, thanks to efforts to expand sales mainly in emerging markets where we continue to see strong demand.

Although consumable sales were also strong, net sales of inkjet printers decreased 5.7% due to the yen’s appreciation. In total, Consumer Business unit’s second quarter net sales decreased 17%. Operating profit decreased 32.3% due to the yen’s appreciation and lower productivity.

Please refer to slide 15. I will now discuss our full year projections for this business unit. Regarding the camera market in 2011, although we are concerned about weak consumer demand in Japan due to the earthquake, we also expected sales to continue to be strong for such products as SLR cameras, and interchangeable lenses particularly in Asia.

As for SLR cameras, amid strong demand and prospects for production recoveries, we raised our unit sales projection from 7 million units to 7.3 million. We also expect strong sales for interchangeable lenses. As for compact cameras, we expect the competition to be severe in the year end selling season as competitors also try to recover.

We work to accelerate the production, we target 20 million unit sales through the timely launch of differentiated new products. In total, we expect three-year net sales in camera to increase 2.7%. As for inkjet, we’re continuing to expand sales particularly in emerging market which continues to drive overall market recovery.

Production conditions are in line with our trends and demand is recovering in Japan. With the further enhanced lineup of new products which we launched in autumn. We expect to maintain our original full years’ projection of 8% unit sales growth.

As for consumables, we expect the continued strong sales, thanks to steady growth in our installed base. In total, we expect a three-year net sales of inkjet printers to increase 1.4%. In total, Consumer Business unit sales are projected to increase 1.8% for the three years.

Operating profit is projected to decrease from 1.4% due to the significant appreciation of the yen and the earthquake’s impact.

Please turn to slide 16. Next I will discuss Industry and Other Business unit. In the second quarter, although, some impact from the earthquake remained, we increased sales of IC Stepper. This was due to the strong demand for high-range and carrier equipment driven by strength in such market, as the smartphones and tablet PCs.

On the other hand, sales of LCD aligners decreased significantly as we were impacted by deteriorating market condition that reflects the actions from investment made in 2010 for large panel equipment an area of strength for Canon.

Overall, although Industry and Other Business unit net sales decreased to 16.2% due to lower sales of the LCD aligners. Operating profit was ¥4.8 billion in the projects, thanks to further cost reduction and effort to reduce expenses.

Please refer to slide 17. I will now discuss of our three years projection for business unit. (Inaudible) Utsunomiya factory – facilities, we suffered the most significant damage from the earthquake. Restoration had proceeded first as originally planned. Within this, we expect the unit sales of IC Steppers to exceed our previous projection of 41 unit to 46 unit, thanks to growing demand for iodine equipment due to the popularity of smartphones.

For LCD lineups, due to the impact of deteriorating market conditions, that reflects the actions from business made in 2010 for (inaudible) equipment. Our unit sales projection is significant with below the 56 units we sold last year.

For group companies, although, production systems have returned to normal, we grow our sales projection to reflect the delay in delivering product to customers. In total, industry and other business unit in the sales projected to decrease 6.8% for the three years. Operating profit is projected to be in the black, thanks to improved efficiency and increases in unit sales due to favorable market condition.

Please turn to slide 18. Finally, I’d like to discuss our financial situation. At the end of June, inventories turnover in days were 52 days, due to increases in work input in process as we target production recoveries in the second half. Going forward we’ll promote optimal inventory levels, particularly for sales companies to prevent loss sales opportunities.

Please refer to slide 19.This slide shows capital expenditures under free cash flow. Going forward, we’ll continue efforts to further strengthen our cash flow management and maintain our financial strength.

Please turn to slide 20. As a result, we expect the cash on hand to be ¥800 billion at the end of 2011, which is equivalent to 2.3 months of the net sales.

As for this year’s dividend, we decided to distribute an interim dividend of ¥60 shares, which is half the amount for the whole of 2010. As for our year-end dividend, our forecast remains undetermined due to future uncertainties. We will amend our year-end dividend forecast after better ascertaining the business environment for this and the following years.

The second half we will make up concerted efforts to implement some measures ensuring the increased (inaudible) net sales accelerating the enhancement of our product to supply systems through an early recovery in productions.

In doing so, we overcome our (inaudible) challenges posted by the earthquakes, returning through path of (inaudible) growth over the second half of this year. We also want to achieve our revised targets of record-high financial results in 2013 as a part of our new five-year plan Phase 4. This concluded my presentation. Thank very much for your kind patience.

Now, I’m very pleased to answer any question you may have as long as time permits. Thank you again.

Question-and-Answer Session

Operator

Thank you, Mr. Tanaka. (Operator Instructions) Our first question comes from Mr. Ben Lu from Seligman. Please go ahead.

Benjamin Lu – Seligman

Hi, thank you for doing this call. I have two questions. My first question is you raised your fiscal OP to 380 billion from the original guidance of 335 and at the same time you lowered the impact of the quake from 198 billion to 122 billion, but the OP excluding the quake was actually reduced from 533 billion to 502. Can you tell me why you actually reduced your OP excluding the quake and which segments are seeing the downside? And then I have a follow-up. Thank you.

Toshizo Tanaka

Answering your question about difference in the operating profit, we divide the impact of this earthquake and also we divide the exchange rate. We appreciate both U.S. dollars and euro by ¥5 each, so it’s reflecting ¥51.3 billion. So this means that the difference that you are mentioning. Do you understand?

Benjamin Lu – Seligman

Got it. Okay, thank you for clarifying. And then in Q2, your digital camera units were down 22% year-over-year. Can you tell me how compact and SLRs did in the quarter and if you can also comment on the monthly linearity in terms of how SLR and compact units did in the months of April, May, June and how July is tracking so far to help us understand the monthly improvement since the quake? Thank you.

Toshizo Tanaka

Breakdown of the decrease of the 22% in the digital camera, single compact is minus 28% and single reflects camera is 3 points decrease. So total is 22%. Unfortunately, I don’t have any breakdown of the monthly, but roughly speaking, the month-by-month, the figures is improving. So maybe month of June is almost the same as last year’s. So, biggest damage is in month of April and getting better in May and June almost return to the same level of Russia. That is the situation, that completed my answer.

Benjamin Lu – Seligman

Okay, thank you. And then my last question is on the LCD Steppers, you sold seven LCD Steppers in the first half but you raised the fiscal LCD units from 27 units to 31 units. Where is the upside coming from, is it from the large-sized or the small-sized LCD Steppers? The reason I’m asking is Nikon would leave one to believe that they have almost 100% share of the small to midsized LCD Steppers being used for LTPS and smartphones and tablets. Thank you.

Toshizo Tanaka

As you know, LCD (inaudible) concerned we are just concentrated on our large chip panel itself. So the reason why we have full unit increase in our forecast is mainly the additional orders from China. So we are not – at this moment, we are not (inaudible) size of R&R yet, that completed my answer.

Benjamin Lu – Seligman

Great. Thank you so much.

Operator

We will now move to our next question from Ms. Shannon Cross from Cross Research. Please go ahead.

Shannon Cross – Cross Research

Thank you very much for taking my questions. My first question has to do with inventory levels in the channel. Given the issues with the earthquake and getting production back on track and the fact that you’re raising or at least holding in expectations for many of your units, can you talk a bit about where you see for cameras and inkjet laser printers and copiers, the inventory levels out there within your channel partners? And then I have a follow-up, thank you.

Toshizo Tanaka

Generally speaking, after the earthquake we have a downward pressure to our production. So – most of our product lines, including cameras, inkjet, laser printers and copiers, is in shortage in our inventories. So, I don’t have any details, but generally speaking, every market, every product line has a shortage in their inventories. That’s complete an answer?

Shannon Cross – Cross Research

Okay, thank you. And I’m curious, do you expect to be on a supply-demand balance by early in fourth quarter, or by yearend? Is there some ideas of when you think you’ll be sort of back to normal? Again, from an inventory standpoint with your partners?

Toshizo Tanaka

As I mentioned in my presentation, the production levels back to the normal by end of June already. But to recover all the shortage of the inventory, as you mentioned, it takes until sometime in the second half and it varies by the product line. Maybe the digital cameras need until almost end of the year because, as you know, the end of the year is the business time for the Christmas time so it takes time.

Also the copier, copier have lots of backorder still, so maybe it takes until the last minute of the second half to gear up the orders. Is that a complete answer?

Shannon Cross – Cross Research

Okay, thank you. And then I have a question with regard to printing trends, because you’ve heard – it’s a big discussion among investors and even within some of the companies clearly of what type off end use people are seeing on the devices.

Again, if you can kind of net out the impact from the earthquake especially domestically, just are you seeing pressure from tablets? Are you seeing pressure from more and more documents just being viewed on screen? I think any color you can provide us would be very helpful because again it’s a question that comes up often. Thank you.

Toshizo Tanaka

Okay, answering your question, the print volume is concerned, it’s usually sales volume itself will be decreasing. But even in Japan, after the earthquake, the total print volumes stopped increasing. So generally speaking, the worldwide, the order – print volumes with – keep increasing. Usually, the risks print volumes is but the total, the information, the volumes of the information keep increasing. So still the total print volumes never decreased, still keep increasing that is worldwide. Is that a complete answer?

Shannon Cross – Cross Research

Okay. Thank you. And my final question, I’m just curious, as you’re seeing more and more growth coming from China and India, is there any change to sort of the margin profile of the sale in those countries versus the sale in either domestic or Europe or the U.S.? And are you seeing sort of – it typically was in India and China where much lower type sales and smaller devices and that.

But it seems as people are moving up more into color and more into high end devices in those region, so I’m curious as to how you think about the sale with – again this is more on the printing and copying side – do you think of the sale within India and China versus – from a margin perspective – versus one of the more developed countries? Thank you very much.

Toshizo Tanaka

Answering your question, as far as the business mass is concerned, China or India prefer the very low end models. So, we are looking for some models which meet their request. So automatically, the profitability is comparatively low compared with other regions. But we tried to make our best effort to make these products more profitable through our activities of improving the product by increasing the volumes, because at the end the day, market is very huge.

So, once we succeeded to introduce very attractive models in the market, I think it’s very possible that we can reduce the cost by introducing the products. That completed my answer.

Shannon Cross – Cross Research

Thank you, very much for taking my questions. That completes my question.

Operator

We will now move to our next question from Mr. Keith Bachman from Bank of Montreal.

Keith Bachman – Bank of Montreal

Hi, thank you. I also had two questions. If I look at these, excuse me, the sale of printers, you’re increasing your forecast on a unit basis from last quarter from 16% to 17% unit growth in FY ‘11. You’re forecasting revenue growth to decline from – actually let me try it a different way. Can you talk a little bit about what you’re assuming in prices for printers particularly the laser beam segment and I have a follow-up.

Toshizo Tanaka

Answering your question that the area that we have a very strong sales in laser printers, as I said, the emerging market. So, generally, they prefer the lower product, so automatically, the unit price is low compared with the market. So that is why – so compared with the – our forecast for the last time, the –

Keith Bachman – Bank of Montreal

Okay. Great.

Toshizo Tanaka

Okay.

Keith Bachman – Bank of Montreal

Could you talk a little bit about your assumptions for supplies growth for both the printer market as well as the inkjet market – the laser beam, as well as the inkjet market? What your assumptions are for supplies as you look at the second half of the calendar year? And then what was supplies growth within the June quarter? Thank you.

Toshizo Tanaka

Answering your question for the laser beam printers consumables for the first half, it’s flat in local currency basis. But in the second half, 9% growth and the annual basis is 8% growth in local currency basis.

Inkjet printers; first half is (inaudible) second quarter 1% to growth on local currency basis and second half is 8% growth, annual basis is 5%. So same tendency on both laser beam and the inkjet printers. Second quarter – second half, we are expecting the jump from the first – second quarter. So that’s the reason why the production itself come back to the normal, then we can expect that his kind of sales growth in the second half. That completed my answer.

Keith Bachman – Bank of Montreal

Okay. And then just a quick follow, when Shannon was asking about inventory levels, will you have some catch up in inventory levels in supplies market for both inkjets and laser jets as you look at second half. In other words, is the strong growth in supplies that you’re talking about for second half, is that being helped by some inventory replenishment as you look at the very end of the calendar year? Thank you.

Toshizo Tanaka

Even after the earthquake, we put the past priority to drive the consumers to the customers, because that is our duty to so. So, even the – as good as inventory situation of supply is not bad compared with the hardware itself, so after we increased in the second half, maybe, we can catch up the inventory situation by the end of this year easily, I think. That’s completed the answer?

Keith Bachman – Bank of Montreal

That completes my question. Many thanks.

Operator

As we passed the schedule in time, we would like to close the Q&A session. And I will now hand the call over to Mr. Tanaka for any additional or closing remarks.

Toshizo Tanaka

Okay, thank you very much everybody. Canon management, we try our best to meet your expectations and that a very difficult circumstances we have. Your kind of cooperation and understanding through Canon is highly appreciated. Thank you again.

Operator

This concludes today’s conference. If you have further questions please send them to Canon’s email address crj-ircall@list.canon.co.jp. Canon will respond as soon as possible. Thank you everyone for your participation.

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