Hitachi Ltd. ADR (OTCPK:HTHIY) Q1 2018 Earnings Conference Call July 28, 2017 4:00 AM ET
Executives
Mitsuaki Nishiyama - Senior Vice President, Executive Officer and CFO
Tomomi Kato - Deputy General Manager of the Financial Strategy Division
Ken Mizoguchi - Executive General Manager of the Brand and Communications Division
Analysts
Operator
The time has come to start the meeting to announce the Consolidated Financial Results for the First Quarter Ended June 30, 2017 for Hitachi Limited. I would now like to introduce the speakers for today, Mitsuaki Nishiyama, Senior Vice President, Executive Officer and CFO; Tomomi Kato, Deputy General Manager of the Financial Strategy Division, Ken Mizoguchi, Executive General Manager of the Brand and Communications Division. Mr. Nishiyama, please.
Now please refer to the PowerPoint presentation in listening to my presentation. First of all, I would like you to turn to Page 5, 1-2. This is the consolidated statement of profit or loss. Now the center is the first quarter results. The revenue was 2088.6 billion yen, compared to previous year, a decline of 41.7 million or a 2% decline.
The reason is, because we had the portfolio reorganization, Hitachi Transport Systems, Hitachi Capital Corporation and Hitachi Koki have been subject to portfolio reorganization. But if we subtract the portfolio impact and foreign exchange impact it has grown by 6% organically.
And the adjusted operating income is 131.8% and the operating income ratio is 6.3%. This is 40.3 billion yen increase. As for the portfolio, it’s 68% without the portfolio reorganization impact. EBIT was 143.2 billion yen and the net income attributable to Hitachi Limited’s stockholders was 75 billion yen or increased by 18.60 million yen or 33% increase year-over-year.
Next is 1-3 and this is the – these are the factors affecting changes in revenues and adjusted operating income macro analysis is presented here. In terms of revenues portfolio reorganization impact was 170 billion yen. As I mentioned earlier, this is for Hitachi Transport Systems, Hitachi Capital and Hitachi Koki have been subject to reorganization.
The foreign exchange impact was positive 13 billion. This is scale expansion, the impact was positive 115.3 billion yen.
Now regarding the content of 115.3 billion, Bradken H-E Parts acquisition has been included and energy chemicals acquisition of FIAMM is also included in the business scale expansion. So, M&A, acquisition impact was 37 billion and 70.3 billion is the organic growth.
To the right, we have the adjusted operating income and with the portfolio of the organization minus 15 billion yen. Foreign exchange impact was positive 2 billion yen. Profitability improvement, 53.3 billion yen positive as being recorded in the 53.3 billion yen, Hitachi Construction too as well as Hitachi Chemicals impact is also included and overall, it improved by 53.3 billion yen.
Next is 1-4. Revenues by markets. To the right, please refer to the year-over-year percentage. Japan was at 93%, outside Japan, 103%. Total is 98%. In terms of outside Japan, 53% increased by two points. Foreign exchange as well as portfolio impact is included. Although it is not given here let me give you the numbers specifically.
For Japan, it’s 101%, outside Japan, it’s 110% instead of 113%. In Asia, inclusive of China, this is 112% but it will be 116% and in China, it’s 113%, it will be 119% ASEAN India other areas is 113% and North America is 13% and Europe 12% and then 1.5% for other areas and 106% overall.
So, for the overseas increase, so organic increase was 10%. In particular, we saw strong growth in China. Our Hitachi Construction Materials – Construction Machinery, as well as Automotive Systems business grew significantly. And for ASEAN India and other areas, Hitachi High-Tech, Hitachi Kokusai Electric, semiconductor production equipment improved significantly.
For North America, increased by 3%, 2% in Europe and other areas, a strong growth was seen for the acquisition of Bradken and it contributed significantly.
Next is 1-5. The balance sheet summary and cash flow statement is presented at the break-up. For total assets, compared to the previous term there has been no significant change 9694.1 billion yen. Third line on the bottom you see cash conversion cycle it came in at 67.9 days.
Now, compared to the end of previous term end was a 72.2 billion yen that was a reduction of 4.3 days, but in the first quarter, it was 61 days. Year-on-year, this is because the IEP cash increase. But the plan was 73 days for the first quarter and therefore, compared to that, in terms of operation, there was an improvement of five days.
The stockholders equity ratio was 31.1%, 0.4 point increase. The ratio, 0.3 times flat. At the very bottom, we have the cash flow and this is 22.3 billion yen and cash from operating activities are 126.9 billion. For cash flows from investing activities, it is a decline of 104.6 billion or an increase in expenditures.
And in the first quarter last year, Hitachi Transport Systems was subject of the organization. There was revenue and in first quarter there was the Bradken to the expenditure and it means that expenditure increased. And however, we have been able to have positive cash flow of 22.3 billion yen.
Slides 1-6 and 1-7, I would like to discuss the sales and operating income by business segments. Over the nine segments, others because of reorganization by a subsidiary and for financial services impact of reorganization of Hitachi Capital it was first, so there were declines in others and financial services or the other segments increased.
Now, Information and Telecommunications Systems, year-on-year sales were flat to storage and ATM sales in Japan were down. System Integration business in Japan continued to be robust and there was increase. So on a net basis, our sales were flat year-on-year and in terms of the operating income, there was effect from structural reform, especially for IT products.
The effect of structural reform is enjoyed and System Integration business in Japan, especially, SI business, profitability was up and so, 14.9 billion yen increase year-on-year in the adjusted operating income. For Information and Telecommunication Systems EBIT, well, on top of 14.9 billion yen increase in operating income EBIT also increased essentially by 25.1 billion year-on-year.
Now next Social Infrastructure and Industrial Systems, revenues were down slightly. The railway system in the UK was up, it increased. But low-profitable business in industry and distribution field was withdrawn. So there was a decline there and Industrial Products business especially in oil and gas sector. There was a slight decline there.
So in total, revenues were 99% to the previous year and down 1% year-on-year. And adjusted operating income increase by 9 billion year-on-year. There are three factors behind this, one, withdraw from low-profitable business in industry and distribution field, there was positive impact from that and another effect of profitability improvement in the Industrial Products business, as well as profit increase in railways systems business because of these three positive factors and increase of operating income by 9 billion year-on-year.
Now in terms of EBIT, there was impact from FOREX fluctuation, as well as equity method in total. It increased by 22.6 billion year-on-year.
Moving on to 1-7, Electronic Systems and Equipment, in this business segment, Hitachi High-Technologies and Hitachi Kokusai Electric, in these subsidiaries, there were sales increase in semiconductor production equipment. But there was deconsolidation of Hitachi Koki. So, down 4% year-on-year.
Now, because of the positive factor of profit increase at Hitachi Kokusai Electric, operating income increased by 5.8 billion year-on-year and Construction Machinery was affected by two factors. One, sales increase in China and another – the other, acquisition of Bradken and H-E Parts because of the positive impacts, 31% increase in Construction Machinery in revenues and because of increase in revenues, adjusted operating income was up 14.3 billion.
Next, High Functional Materials and Components, sales increase in Electronics and Automotive-related products was posted and there was acquisition of FIAMM, Energy Technology by Hitachi Chemical. So because of the effect of M&A, up by 12% year-on-year in revenues and because of that 3.7 billion increase in adjusted operating income. Next on Automotive Systems, both in Japan and China, sales increased, so up 5% year-on-year. In line with that, adjusted operating income increased by 3.1 billion year-on-year.
Moving on to the next Slide 1-9, Smart Life & Ecofriendly Systems. Demand in Southeast Asia was sluggish. Therefore, it was 94% of the previous year, down 6%. But on the other hand, we were able to proceed with cost reduction efforts. Therefore, operating income was up by 1.4 billion year-on-year.
As I said, in the others and Financial Services segments, there was reorganization of Hitachi Transport and Hitachi Capital, because of these reorganizations, operating income was down for the others and Financial Services.
Now moving on to 1-10, I would like to highlight some topics. First is about the progress of Lumada business. In the middle column, the Q1 sales and performance in FY 2017, it’s down into core business and outside business. So with the two combined, revenues from Lumada business in the first quarter was 204 billion and our forecast annually is 950 billion. We will continue to drive the business to achieve the annual forecast that is the plan.
To look at the progress rate, according to our initial plan, in the first quarter, we were to have little under 20% progress rate in terms of revenues. But the actual was 21.5% at 204 billion. So, it was on plan or actually better than plan.
Now, another topic I would like to mention is the acquisition of Sullair. As of July 12, we completed the acquisition of Sullair in the second quarter and we will incorporating Sullair’s sales and income into our consolidated performance and on a dollar basis, 138 billion yen of expenditure in the second quarter, $124.5 million and in terms of sales, 30 billion, operating income, 0.5 billion.
So these will be reflected in our performance and 0.5 billion there is amortization of intangibles as well as one-off expenses, 2.9 billion for amortization of intangibles and 2.1 billion for one-off expenses. So 2.1 billion of one-off expenses, excluding that, operating income 2.6 billion, that’s 8.7% margin.
In terms of the operating income margin, on a full year basis, for fiscal year 2018, our sales are projected to be roughly 50 billion, operating income margin because there is going to be no more one-off expenses. Even after amortization of intangibles, we will have a margin of 10% in terms of operating income margin.
Now moving on to the next page, Slide 2-1. Now, at the center, foreign exchange rates for the second quarter and onward for the yen/dollar rate, 110 yen to the dollar, which is unchanged from our initial assumption and euro 120 yen to the euro. As of May, our assumption was 115 yen to the euro, now yen is depreciating against 120 yen to the euro.
Second quarter onward FOREX exposure in terms of operating income, 2 billion, if there is change in one yen and 1 billion in euro. So these will be the FOREX exposures for both the dollar and the euro. Now, for the annual outlook, for every business, so our understanding is that we were off to a very good start in terms of performance.
By segment, for all the segments, we have kept the forecast unchanged. Until the end of the second quarter, we believe that the environment will continue to be favorable, but in the second half uncertainties still remains. So we have kept the forecast as it is.
Now, we changed the euro assumption and so there is a reduction about 5 billion in terms of operating income 30 billion, in the EBIT, 75 billion. So, risk on reproduction has been increased by 5 billion because of the change in the FOREX assumption for euro.
In the first quarter, we were able to have the record high operating income and operating income margin was 6.3% a record high, a very good start in the first quarter. But uncertainties still linger in the global economy, they are still there.
Even under those two consensuses however, we would like to stick to the mid-term business plan centering around Lumada, we would like to drive solutions business and continuing to improve profitability. So that we can have continued profitability improvement as well as capital efficiency.
So that concludes my presentation. Thank you for your attention.
We would now like to open the floor for questions. Please wait for the microphone to be brought to you and state your name and affiliation before asking your question.
Question-and-Answer Session
Q - Unidentified Analyst
Thank you for your explanation. I have three questions. So first of all, from MHI, MHI you have a litigation, please give us your business update. Second point is the following. On Page 9 and onward, so what is the deviation from the internal plan by segments?
So please give us this information. The third question is as follows. In terms of Social Infrastructure and Industrial Systems, on Page 24, the revenues and the details are presented. Now, in terms of Building Systems as well as Railway, as well as Industrial Distribution, please elaborate further comparing year-on-year where there is a larger deviation? Please elaborate.
Unidentified Company Representative
Regarding the South African project, we are still continuing to engaging consultation. We have submitted to MHPS. This is a important joint venture for us and for MHI have been in the past and will continue to be a very important partner for Hitachi going forward. Therefore, we would like to engage in consultation in good faith on a continuous basis.
Now you are asking about the update. There has been no significant changes. In terms of the consultations that are taking place at the time of integration, for the South African project, there was process outlined for adjustment and we have received the pass for that to qualify to willing to and we have also received further detailed data to further clarify.
So, through the evaluation of data, we are engaged in consultation. Now in terms of internal plan, the deviation against the internal plan, the first quarter, the revenues, 60 billion, operating income basis 20 billion, improvement that we made respectively. In terms of the breakdown, for information telecommunication systems, in terms of revenues, 10 billion increase, operating income increased by 5 billion.
Now the 5 billion increase is increase in revenues, storage and product mix, high-end was better than the original plan. That is driven at this improvement. In terms of Social Infrastructure and Industrial Systems, a 15 billion increase of revenues, operating income increased by 5 billion. Now the improvement in operating income, this is driven by the revenue increase from the second quarter, or front-loading of the revenues from – has been achieved.
For Building Systems, Elevator business, the cost reduction has been achieved in this area making a contribution. In terms of Electronic Systems and Equipment revenue increased by 15 billion than planned and operating income exceeded plan by 5 billion.
In Semiconductor and Professional Equipment, in Hitachi High-Tech, Kokusai Electric, Semiconductor production equipment have been strong driving this improvement. For our Construction Machinery, 15 billion increase in revenues and operating income increased by 5 billion driven by China and India a revenue increase, capacity utilization has increased making contribution to these profits.
For our High Functional Materials and Components, in terms of profits no change from plan but the revenue upside was 15 billion. This is, the Materials corresponding to the product has increased driving this improvement in revenues. So in total, 60 billion in terms of revenues, and 20 billion improvement in operating income improvement has been made against our original plan.
Now, to your third question regarding Page 24, the profit increase will be further elaborated. Now in terms of Industrial Systems, it is increasing across the board. The Industrial BU is also improving in terms of business it is improving as well. And in terms of Building Systems, compared to previous year, the revenues are increasing, but in China, the number of units are increasing. But the unit price is subject to fierce competition and when we look at the mix, the average price has gone down at year-on-year. Therefore, there is a decline in profit for Building Systems.
Now, regarding the – you said litigation with MHI, but that is a correction. That is required. There is no litigation yet. That has not occurred.
Unidentified Analyst
Thank you very much.
Unidentified Company Representative
Any other questions?
Unidentified Analyst
Thank you for the presentation. My first question is this. Increase in revenue 106% of last year, it was very easy to follow, but Page 9 and onward, by segment, actually what was the case? If you could give a segmental breakdown, so that’s my first question. And my second question is as follows. The Building business in China, what is the market trend and the forecast for the market, what is the potential growth in the future?
According to your competitors’ comments, they seem to view the market rather pessimistically. So, for the Elevator business how do you see the future in China? And my third point, you said that it’s still uncertain in the second half, but what is the market forecast for each business if there is anything noteworthy that you can share with us by segment? That’s my third question.
Unidentified Company Representative
So, I would like to address your second and third questions, following that, for the first question, Kato will give you the segmental information first about the building-related business in China. Demand - in terms of demand and the number of units sold, it underlies.
But as I said, competition is very intense and it’s turning into a price war and so prices are down because of the highest competition. And as an initiative to counter that, we would like to expand repair service, and export from China to Southeast Asia. Those are the initiatives we have.
And because those are robust demand for investment, we are offering mid-range priced products to cover greater product to market but high end products with the higher margin should also be increased and we would like to capture more of that demand and by so doing, we would like to secure enough profitability. That’s another initiative that we are pursuing. In terms of demand, as I said, demand continues to be brisk.
And the volume of sales, so we will continue to rise, so for the time being as we see it and if I am going to move to the third question that you raised, investment in the second half in China, well, it’s still uncertain, uncertainty still lingers. And the second half of year 2017, for one thing, what is going to be the forecast for the building-related business in the second half, that is still unclear and uncertain, that’s one factor.
And overall, Hitachi Construction Machinery, up until the second quarter, we believe the performance will continue to be quite good. But in the second half, especially in the Chinese market, well, the favorable performance that continue – we will have to continue to carefully monitor how the performance is going to evolve.
So, until the end of the first half, I’d say that the performance will be pretty good. But second half of FY 2017, there are going to be geopolitical risks perhaps affecting our business especially Machinery, Elevators, Automotive markets. There are a lot of big businesses that we have in China. So, in the second half, we need to carefully watch how the demand is going to evolve.
So to address your first question, the information by segment. The operating income increased and the breakdown by segment, not necessarily operating income, revenue I think was the question. Excluding reorganization and FOREX, 106% we said, but to give you the number by segment.
For Information and Telecom, 99%, Social Infrastructure & Industrial Systems, 100% over the previous year, Electronic Systems and Equipment, 114% of the previous year, Construction Machinery 128%, High Functional Materials and Components, 110%, Automotive Systems, 104%, Smart Life & Ecofriendly Systems 93%, others, 100%. So that is the rate there.
Unidentified Analyst
If I ask for supplemental information, what is the volume increase in China? What is your forecast for the next few years? So, how much growth in terms of percentage are you expecting in the China market?
Unidentified Company Representative
We don’t have the number based on volume that we can share with you at the moment.
Unidentified Analyst
Well, in terms of new construction?
Unidentified Company Representative
Last fiscal year, 490,000 units and for the newly constructed equipment, I think similar growth or similar number will be achieved this fiscal year.
Unidentified Analyst
Does that mean that the business is going to be flat in terms of volume? So there will be no increase in volume?
Unidentified Company Representative
That is correct. As far as newly constructed is concerned, that is the case. Next question please?
Unidentified Analyst
I have three questions. My first question is related to the previous question. In the United States currently, the automotive sales slowdown is becoming very significantly and toward the second half automotive parts, automotive system business, what is your outlook? That’s my first question. Shall I give you all the questions first?
Unidentified Company Representative
And so let me respond one-by-one. Regarding the Automotive Systems business, it remains very strong for the time being. For Japan and China, the business is strong, but for the U.S. demand growth is not growing as much as expected. As I mentioned earlier, by region, data has been presented and I said that U.S. is not growing and this is one reason why the U.S. market is not growing for us. China has room for growth.
And in the second half, there is demand and then we feel that in China, Automotive System business will continue to grow. In the United States, I don’t have the volume number, but in the U.S. it’s basically flat I believe. In terms of profits, the performance is according to plan.
Revenues on an annual basis, for Automotive System overall, China is strong in growing revenues and we were trying achieve the outlook of 1 trillion yen. That’s our plan. So, for the U.S. we don’t have plans for significant growth. I would just like to add, that is the case of North America and demand is slow in the United States that is the reason why the forecast is flat.
Unidentified Analyst
Regarding the information and telecommunication system, the 6% growth in the first quarter is very strong. Now in your explanation, it says that revenue has increased and also – you also emphasize high-end storage. So it seems very – seems it’s a one-off achievement, but in the area of Information and Telecommunication Systems what is your actual strength. In terms of the first quarter which is not one-off. In terms of the actual image for your profit margin, please comment.
Unidentified Company Representative
It is not really one-time. But product mix was very favorable for us. And that is the reason why we had upside about our plan. But on a continuous basis, IT products for 2014, 2015, 2016 business structure reforms have been implemented in this area because the IT hardware has been shrinking as a trend and we had to deal with this prevailing trend.
And there was a need to achieve reduced cost, various measures were implemented. We have shifted our personnel and we have narrowed down the type of products, the number of products to being developed. By so doing, compared to the previous year, in terms of hardware we were in red ink. But we have been able to recover this to the level of 6% plus.
So, in terms of structural reforms, so we have been able to implement this. So, and this is not just a one-off change. Furthermore, for the SISS which is mainly domestic, project management was implemented thoroughly.
And demand is not growing significantly but still remains quite strong and profitability has been improving for us because of better project management we have been able to realize profitability improvement, so we shall be able to do that going forward as well.
Unidentified Analyst
My last question is information regarding media reporting. It seems that Horizon, your engagement consultations such as state in Horizon, it seems like you are making progress. So, I have a two-fold question. Please elaborate on the progress made so far. And in terms of your intention, I know that you are still in initial stages. But are there companies interested in Horizon? And is that going to be reflected in the consultation toward the establishing of the strike price? Please elaborate further.
Unidentified Company Representative
For the individual strike price, we are going to be negotiating this with the UK government. Therefore, interested potential investors are not involved in this discussion. But in 2019, a final investment decision is what we are working for and then construction will begin, but prior to that we would like to reduce our equity stake and that is the reason why we are receiving some things from potential investors several power companies, utilities and other companies who have shown interest in making investment. However, the details of the discussions that are taking place cannot be shared with you at this time.
Unidentified Analyst
I have two or three questions. Point number one, question number one, just to clarify with respect to Sullair, 30 billion, 50 billion in terms of the timeline, are you going to reflect that starting in the second quarter and onward?
And if you could please elaborate once again and give us details. Well, because it’s completed, I think you can share the details with us. What is your feel or assessment of Sullair’s business and what is the performance between April and June? If you could please elaborate on Sullair’s business once again.
Unidentified Company Representative
As I said earlier, fiscal year 2017, we will be reflecting their performance into our performance in the second quarter and onward. So, nine months worth of performance equaling 30 billion will be incorporated and 23 billion in sales and profit zero that was as of May and we have a clear understanding of income in terms of operating income, 0.5 billion or 500 million.
And amortization of intangibles, PPA is still to be calculated. It’s a temporary calculation. 2.9 billion of amortization of intangibles and fiscal 2017, one-off expenses 2.1 billion. If I exclude one-off expenses, 8.7%. Well, you criticized about this business rather – but on a closer look, we disagree. I think the business is not all that bad and not that I have taken a direct look personally, but I think the management of Sullair is quite solid.
We believe people who are good still remain on the management. And as we have discussed with Sullair, eventually, IOT, Lumada can be brought to 4,000 cons of Sullair eventually. But first and foremost, the air compressor business that Hitachi operates, we will need to cross-sell.
We would like to achieve that cross-sell between Hitachi’s business and Sullair’s business and we have high expectations for achieving that. In fiscal year 2018 with air compressor business of ours included the sales on the order of 40 billion that we have at Hitachi and 50 billion yen in sales in Sullair.
With the two combined, we would now like to achieve 100 billion yen in sales and industrial or IT related Lumada business, with that we would like to generate synergies, so with the Sullair, with Hitachi’s be used and we have set up industrial equipment management division. And Mr. Oki became the head of the division.
A new division has been set and industrial BU, Ogawa and water BU head Urase, they are co-heading the division and of course, [Indiscernible] will also be joining the team. So industrial cluster, the broad industrial group synergies with the broad industrial group are to be intact. Now, this fiscal year we will be incorporating that business and following that, PMI is worked upon by the whole team.
Mr. Aoki himself is leading the effort and in early August, next month, he will be making rounds among the facilities and sites organizing townhall meetings. So, PMI efforts have begun.
Unidentified Analyst
On a full year basis, amortization is being done. Intangibles, that 3.5 billion is that correct? And the amortization period is about five years, is that correct?
Unidentified Company Representative
Well, the amortization period differs depending on the item. We have not done PTAs. So I cannot give you an accurate answer, but what we have factored in as of today is 3.5 billion on an annual basis.
Unidentified Analyst
For fiscal year 2018?
Unidentified Company Representative
3.5 billion annually for fiscal year 2018.
Unidentified Analyst
Amortization period is usually five years, how long is it?
Unidentified Company Representative
It’s over ten years. So, but then, it varies from one item to another. And so, which is price, so allocation will be done in detail, but according to the current simulation, 3.5 billion of amortization in FY 2018. And inclusive of that the operating margin of 4.6 or 8%.
Unidentified Analyst
What about the performance between April and June?
Unidentified Company Representative
We don’t have the answer for that. Next question.
Unidentified Analyst
Especially, Social Infrastructure and Industrial Systems, there was an increase in revenue quite substantially. Up until last year, you were so implementing structural reform. So, in the attribution analysis it was unclear.
So for Information and Telecommunication as well as Social Infrastructure and Industrial Systems, what was the result of the cost reduction, especially in fixed other cost? How much of that is reflected and has contributed to increased outperformance? So, if you could please elaborate on those two points?
Unidentified Company Representative
So, Social Infrastructure and Industrial Systems, year-on-year compared to the previous year, in terms of operating income, improvement of 8.9 billion was achieved. Now, 0.5 billion in Forex and review of portfolio as well. Scale increased 4 billion, expansion in business scale. And in terms of investment fixed cost 4.5 billion. And cost of production reduction, 0.5 billion. But of this number, there is a structural reform impact that’s 1.5 billion. So mainly for the Industrial Systems, that’s for the Industrial Systems mainly.
Unidentified Analyst
What is the impact from – withdrawing from low-profitable business?
Unidentified Company Representative
The impact from that is reflected in net cost reduction which is about 1 billion.
Unidentified Analyst
There is some overlaps in the numbers. And a question, what about Information and Telecommunication Systems?
Unidentified Company Representative
14.8 billion yen increase in operating income, 0.5 billion is Forex, the remainder portfolio review or restructuring and the greatest impact was brought about by cost reduction 13 billion. Of that amount, structural reform impact, 3.5 billion. Other than that, increase in business scale 1.5 billion. Development cost and other cost reduction, 1 billion.
Unidentified Analyst
Thank you. My last question. With respect to Information and Telecommunication Systems, you said that there is increase in volume and what is the business sentiment surrounding IT business in Japan. There is quite a bit of increase in the operating. What is your forecast or outlook?
You said that it’s not going to either increase or decrease too much going forward and I do understand that looking at survey, the business sentiment or the market conditions are pretty favorable and margin is improving. So, in terms of the orders received and the performance outlook, how do you see the IT market here in Japan? My last question.
Unidentified Company Representative
With respect to IT products, structural reform has been beneficial and contributed. SI business, this is something that we have forecast since before. The peak of financial services industry, we thought that the investment would peak out.
But as I said, quite a number of financial institutions who are making global investments and they are quite proactive in making investments overseas and public sector clients, social and public sector, the SI business, therefore, the SI business for that sector we thought that peaked out in terms of my number system.
But actually, we are seeing derivative business continuing and so, in that regard, SI business continues to be quite brisk. However, we don’t foresee a substantial growth at least in the Japanese market, but we do hope that such steady growth can continue. Those clients who are looking to make investments overseas and they are quite proactive as I said in making investments overseas.
So, business related to that can be expected application of AI, application of Fintech, for example. That is emerging as a business as well. So increase above that, we do hope to achieve growth.
Unidentified Analyst
So low-profitable business, non-profitable business, that’s not happening?
Unidentified Company Representative
SI business, its contribution to profitability, well, they are making contribution to profitability, that’s because unprofitable project and an unprofitable business. It’s being eliminated and we are not seeing unexpected losses from such loss running projects that being eliminated and in that regard, the trend has been improved and that has contributed to increased profitability.
Unidentified Analyst
Thank you.
Unidentified Company Representative
Next question please.
Unidentified Analyst
I have three questions. Regarding Hitachi Kokusai, I would like to clarify the assumptions, there was a 61 million in terms of revenues and a 9 billion in terms of operating income is the contribution. And you are assuming that there is going to be reduction in terms of revenues as well as operating income. Is it as of September and or December end, please clarify?
Unidentified Company Representative
Regarding the Hitachi Kokusai, look, how it is being factoring in terms of our performance. The original was through factoring nine months.
Unidentified Analyst
No, there as a TOD and in August the conditions are likely to be set, but after TOD, price is announced, it seems like the prices, stock price is still increasing. So against the 1710 yen, which is the selling price, so is there room for change or is it fixed?
Unidentified Company Representative
Regarding the details of stock price it’s something I would like to refrain from commenting on. Currently, based on the agreed contract agreement, we will be proceeding with the necessary arrangement. And it is true that in terms of the stock price, there is some deviation as you have prepared to, but I shall refrain from making any comment in that regard.
Unidentified Analyst
Question number two is regarding free cash flows. You said that the assumption for this year is zero. Is this because of the M&A plans? And in Hitachi Kokusai Electric’s sale, cash in, where is that included? And regarding the results for MHI, the cash outflow is zero. So in terms of cash outflow or free cash flow you have said that is zero. What is the breakdown of this?
Unidentified Company Representative
For Kokusai Electric – in Hitachi Kokusai Electric, in terms of reorganization of this entity, the revenue is included. Regarding Sullair, it’s being factored in. Cash outflow is factored in. In the second quarter for Sullair, the fund expenditure is factored in.
Unidentified Analyst
Is that very significant?
Unidentified Company Representative
In terms of Sullair, it’s 1.245 million and that will be expenditure out – cash outflow in the second quarter. So, there is inflow and outflow in terms of cash, with respect to reorganization, there is proceeds from reorganization and M&A expenditures.
So, there inflows as well as outflows. However, even with the expenditures I believe we can – we will aim for black ink breaking even in terms of cash flow. Regarding M&A, 1 trillion has been earmarked. I know that there are variable factors, but in terms of the financial structure, what is the maximum risk you can take in terms of net DE?
Unidentified Analyst
0.5 below – under 0.5, gross debt to equity ratio is less than 0.5. That is what we would like to preserve. You mentioned 1 trillion yen in terms of the amount that is earmarked, it is something we have to use all over the south?
Unidentified Company Representative
We don’t have to exhaust it. So depending on case-by-case, we shall make the appropriate evaluation and make sure that we can augment the investing parts of our business. So we have to make sure there is alignment in terms of the total strategy and the – each of the cases will be scrutinized accordingly on the appropriate timing on a case-by-case basis.
Unidentified Analyst
Question three. Regarding the UK, the FID in terms of Horizon, what is the time limitation? What is the deadline for FID?
Unidentified Company Representative
So if you cannot reduce your stake below the 50% you said that you could forego this. So please clarify the timing of the FID?
Unidentified Analyst
According to the current process, in 2019 we want to start the construction. Therefore prior to that, FID showed we made that we will be preceding the construction. Therefore prior to construction start, various criteria for business – will be for the decision criteria for business continuation.
So these are criterias that we have to consider and as we proceed with the business, we have to make sure that although commissions and approvals are obtained, and we have to have a strike price which will be viable in terms of business continuation inclusive of considering cost.
And finance scheme and taking the business off balance sheet, we will have to be considering this. So, that will be the criteria for business continuation decision. Therefore, against this backdrop, we will be discussing this method – as the potential investors. And we will continue with the consultations receiving some things, and by so doing, by 2019, prior to construction beginning, we would like to take this business off our balance sheet. That is our plan.
Unidentified Company Representative
So, by this time next year, you should have a good guideline?
Unidentified Analyst
Yes, that’s our plan. We would hope that that can be achieved.
Unidentified Company Representative
It’s almost time to close. So we would like to take one last question.
Unidentified Analyst
Thank you. My first question. Regarding Lumada, on Page 13, you have disclosed the performance, thank you. Last fiscal year, I don’t think you have detailed numbers that you can share with us. But in terms of change year-on-year, in the first quarter against the internal plan of less than 20% you are way about to achieve something better above 20%. But year-on-year, Lumada, so how has Lumada business evolved? Just to give us a feel.
Unidentified Company Representative
Last fiscal year, sorry, in terms of KPI, we discussed only used cases, that was how we presented the performance and in terms of core business, we did not have the details to share with you. So, quarter-on-quarter, it’s very difficult to give you a comparison.
But, up until last year, what we have accumulated over the years the used cases, Hitachi Group cases, that we have accumulated have been reflected in POC and they are entering further stages. We are seeing increasing number of such projects and the number of enquiries we are receiving from phones is also on the rise, increasing number of customers are interested.
And as we wrote in the material, there is a model that was completed high efficiency production, a model and together with one of our clients Okuma, we have started a joint demonstration experiment. And so, Lumada application the model applying Lumada is being viewed by a number of clients, clients that come to our work so to watch the model and that has translated into actual business and we are feeling quite a bit of traction there.
Unidentified Analyst
Thank you. My second question is as follows, on Page 6, increase in operating income, well, by segment you gave details Information and Telecom Systems and Social Infrastructure and Industrial Systems. And cost reduction, development investment if you can give us some more break down and details?
Unidentified Company Representative
Overall, of the 53.3 billion, the breakdown is, M&A contribution 3 billion by Construction and Koki and the remainder is organic growth. So just to give you the breakdown. Extension in business scale organically. That’s 29 billion organic growth and reduction in fixed cost, or increase in HR cost or business incubation cost, business development cost, if netted against those, plus 4.5 billion.
So, business development cost was not as large in the first quarter compared to last fiscal year in other words. And loss-making projects are eliminated and the effect of that is 1 billion. So a positive 1 billion because elimination of loss-making projects. And the remainder is cost reduction net off against a reduction in prices, that’s 16 billion. And so those are the – that is the breakdown of 53.3 billion.
Unidentified Analyst
Thank you.
Unidentified Company Representative
And so the time has come to bring this meeting to the close. Thank you very much for your attendance today.
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