I would like to ask you about the increase in Operating Income for the 1st half of the fiscal year ending March 2017. What is the reason for the great increase of 14.2 billion yen compared to the 1st half of the fiscal year ended March 2016? I would also like to ask you whether the profitability achieved in the 1st half can also be expected in the 2nd half.
The main reason for the increase in Operating Income is the decrease in unprofitable projects. In the 1st half of the fiscal year ended March 2016, unprofitable projects caused 10.7-billion-yen loss. As we have been managing them not to generate losses, we booked only 3.3-billion-yen loss for the 1st of the fiscal year ending March 2017.
In addition to earnings growth from revenue growth, the improvement in the profit rate of a range of projects and other factors are reasons for the Operating Income increase. There are other reasons, including extension of the consolidated financial term due to the unification of accounting periods of European subsidiaries, which led to the Operating Income increase.
In the 2nd half of the financial year ending March 2017, sales and profit will decrease due to the end of large-scale IT projects such as new program implementation for the utility industry owing to liberalization of the retail electricity market. As there will be other negative factors, Operating Income for the 2nd half is expected to be 105 billion yen as we planned at the beginning of this term.
We budgeted 8 billion yen as a risk buffer for unprofitable projects for this financial year, but the loss was only 3.3 billion yen for the 1st half of the fiscal year ending March 2017, so we are expecting to decrease the risk buffer by 2 billion yen to 6 billion yen. However, we will stay focused on completing ongoing projects as risks remain.
When will the financial results of Dell Services, which you have acquired, be consolidated and booked in P/L?
Dell Services makes its financial report in January. We will consolidate their results for 3 months (November, December, and January) into our results for the fiscal year ending March 2017.
The acquisition of Dell Services is reported to expect to have 7% of Operating Income to Net Sales. Is their Operating Income expected to be 20 billion yen of Operating Income?
We expect them to have 7% of Operating Income to Net Sales as some costs will not occur thanks to it joining our group.
1. The advisory cost and other costs for the acquisition of Dell Services are reported to be 2 billion yen through this fiscal year. How much impact will this have on your quarterly results?
The advisory cost and others for the 1st half of the fiscal year ending March 2017 was about 1 billion yen. We expect about 1 billion yen for the 2nd half.
2. You booked about 1 billion yen for the advisory cost and other costs for the 1st quarter of the fiscal year ending March 2017, if I remember correctly. How do you explain that?
We booked 1 billion yen for advisory cost for the 1st quarter by consolidating a range of costs. In reporting results this time, we broke it down into operating cost and extraordinary losses, which led us to report about 1 billion yen of operating cost and about 2 billion yen of extraordinary losses for the 1st half of the fiscal year ending March 2017. For the whole fiscal year ending March 2017, we expect to report about 2 billion yen of operating cost and about 14 billion yen of extraordinary losses.
1. If the cost of amortizing goodwill and PPA in acquiring Dell Services is about 5 billion yen for a period of 3 months in the fiscal year ending March 2017, is it expected to be 20 billion yen for the whole fiscal year? How much are the goodwill amortization costs and PPA amortization costs respectively? How much of the assets will remain to be amortized in and after the fiscal year ending March 2019, when you are going to apply IFRS Standards?
The values of goodwill costs and PPA costs and their proportion have the most uncertain factors in acquiring Dell Services. Reported values are forecasts and may change slightly since they need to be evaluated by a third party, which takes a very long time to process. We currently expect a total of about 5 billion yen of amortizing goodwill and PPA for the fiscal year ending March 2017, which is made up of 2 billion yen of goodwill amortization and 3 billion yen of PPA amortization.
2. How much in intangible assets will be reported in total?
This is the very item that will be fixed while fixing the PPA amortization costs. We will calculate it including the intangible assets of Dell Services and intangible assets to be fixed while preparing the first balance sheet after the acquisition.
3. There are various methods of calculating amortization of PPA, including the sum-of-the-years-digits method over five years. How do you calculate the amortization of PPA that is reported this time?
This is also what is determined during the process of fixing PPA amortization costs. Firstly, we need to allocate to goodwill and intangible assets. Then, we need to decide years of amortization for each intangible asset. That is how PPA amortization costs are fixed. I would like you to understand it will take time to calculate PPA amortization costs.
Furthermore, the details of intangible assets will vary depending on its definition: some customer bases, some backlog of orders, and some assets may be included in intangible assets. We need to decide what years of amortization are appropriate for each intangible asset. Our consolidated results of the fiscal year ending March 2017 will be affected only by their 3-month results and we assume there may be only a small gap from our forecast.
1. The summary said that the acquisition of Dell Services will cost you about 10 billion yen for internal IT system development. How much impact will this have on your P/L for the fiscal year ending March 2017 and March 2018 respectively? Is there anything to be capitalized?
There are three types of costs regarding internal IT system development following the acquisition of Dell Services. The first cost is for purchasing some IT systems from Dell, which has already been included in the acquisition cost. The second cost is the usage charge to allow NTT DATA Services to continue using systems that Dell still owns. This cost is included in the current balance of payments while having an impact on P/L. The Operating Income to Net Sales of 7% mentioned before is calculated including this cost.
The third cost is for transferring the systems that Dell still owns to our group’s systems before the period that is limited by contract will end. This is a temporary cost and will be booked as an extraordinary loss. The 10 billion yen mentioned before is included in this cost.
2. You explained that the third cost would be booked as an extraordinary cost. Does this indicate it will not impact Operating Income?
That is correct.
Regarding the target for the Operating Income in Medium-term Management Plan. If it were 105 billion yen for the fiscal year ending March 2017, it would be 150 billion yen for the fiscal year ending March 2019, increasing to 45 billion yen. Are there any factors that would lead to an increase in the Operating Income?
First of all, there would be no more amortization of goodwill more after adopting IFRS in the fiscal year ending March 2019. We cannot tell you the specific value right now, but amortization of goodwill is expected to be about 17 billion for the whole fiscal year ending March 2017 after the acquisition of Dell Services.
In addition to this, there will be positive impacts as the depreciation method has been changed from the declining-balance method to the straight-line method since the fiscal year ending March 2017. Once the depreciation burden has decreased, the positive impacts thanks to the depreciation method change will diminish. And although this is very temporary, it is expected to increase to some billions of yen for the fiscal year ending March 2019.
The Operating Income (before amortizing goodwill and PPA) is expected to be about 20 billion yen thanks to the acquisition of Dell Services while it will vary by the results of goodwill amortization costs and PPA amortization costs. The profit after deducting PPA amortization costs from the Operating Income is a positive factor. In addition to this, we will work on increasing both domestic and overseas organic growths. We believe that another M&A from 50 billion to 100 billion yen will be possible. We will discuss this comprehensively.
Additional cost of about 10 billion yen is allocated to the R&D investment, but I believe that the quantity of R&D cannot be significantly increased as the operation rate of NTT DATA for the coming three years will be high. Is it possible to execute the R&D worth 10 billion yen? Also, what kind of R&D are you going to launch?
Most of our R&D projects are classified into applied development while some are pure R&D projects like NTT’s. There are two types of R&D investment. One is investment in the development of software development methods. Japan, the U.S.A, and Europe have unique development methods. We have started developing our unique development method with a global standard.
The other is the investment in Proof of Concept (PoC) and others that allow us to realize new business models with our clients. This is the reason why the R&D investment has been allocated an additional cost of about 10 billion yen. For example, we have established alliances with pivotal, Virtustream, and other companies to reinforce cloud services, and other purposes. This of course includes pure research projects, such as deep learning of AI, with academic organizations including universities.
I personally would like to increase the R&D investment cost by 3 or 5 times from the current cost, but the additional 10 billion yen has been planned after considering the balance of cash allocation.