Q&A Session at the IR Presentation Meeting for the Third Quarter of the Fiscal Year Ending March 31, 2018
1. In the three months of the third quarter, domestic new orders received increased in all segments, especially in the Public & Social Infrastructure segment. Please show us the reason for the growth of each segment and your future prospects.
Domestic new orders received have been very positive in all segments.
The Public & Social Infrastructure segment has received orders for large-scale projects from the telecom industry and government ministries without fail, and we believe that this trend will remain unchanged.
The Financial segment has started to receive digital-related orders from insurance companies and banks, and we expect that this trend will continue.
For the Enterprise & Solutions segment, we have seen projects materialize for EC-related omni-channel, etc. and for IoT- and AI-related businesses by manufacturers. We think that this trend will remain unchanged and stable, too.
2. I suppose that domestic new orders received are more than expected. Do I suppose correctly?
The increase in new orders received is more than expected, in general.
1. The amount of loss from unprofitable projects seems somewhat large while the impact on the overall profitability was absorbed by the robust domestic businesses.
Could you explain the details of the unprofitable projects? What impacts do you expect them to have on businesses in this and subsequent fiscal years? How will you manage and control unprofitable projects in the future?
As you said, the amount of loss from unprofitable projects was large. Most of the losses was booked in the third quarter as additional reserves for unprofitable projects in the second quarter.
As I explained at the IR presentation meeting for the second quarter, challenging projects that required highly sophisticated technologies faced performance problems, etc., which forced us to take measures, for example, making additional investments in hardware and rewriting part of the software. Thus, we provided additional reserves.
Until now, as we have carried out reasonable estimates as accurately as possible, we can foresee almost all impacts on the financial results in this fiscal year. However, as I cannot say that there would be no possibility of additional costs as the process proceeds, we will keep tight control on the projects. Services of these projects will be launched one after another, and the projects are expected to be completed in or after the next fiscal year. Most of the services will be launched in the next fiscal year, but the projects will continue through the fiscal year after next.
2. Do you mean that these unprofitable projects are unusual?
The projects are very difficult.
While organizations including the Project Review Committee conducted an assessment, feasibility study, etc., performance problems became tangible as the process proceeded because we typically find various bottlenecks only after production data is migrated to the production environment.
Looking back on these projects, we think that we need to be prepared to take prior measures for very difficult projects like these in the future.
3. You booked a large amount of loss from unprofitable projects a few years ago. I understand that, unlike the previous case where unprofitable projects were caused by mismanagement, you challenged technologically difficult projects, which turned out to be unprofitable due to performance problems.
Please tell us what measures you will take in the future to entirely avoid such unprofitable projects.
We must conduct verification to establish preventive measures after the projects are completed. However, we think that there are some points where we can detect a performance problem earlier. We will examine what kind of checking is effective to identify signs of a problem for each phase.
1. If the amount of loss from the unprofitable projects had been small, new orders received, net sales and profit would have been robust.
The objectives of the Mid-Term Management Plan entering its final period next fiscal year, were set a long time ago. However, given the very robust performance in the recent years, the shift to IFRS and the impact of large-scale acquisitions, from what perspectives will you draw up a plan for the next fiscal year?
Although the objectives for the next fiscal year, the final period of the Mid-Term Management Plan, have already been set, we need to draw up a plan based on the actual performance of this fiscal year, of course.
As you said, domestic businesses have been robust, but there still were unprofitable projects, which must be controlled strictly. For overseas businesses, as we can see minor signs of concern, we will try to establish a plan for the next fiscal year from a comprehensive perspective.
2. Do you see any new signs of concern for overseas businesses?
In the North America segment, it is now in the process of PMI for the former Dell Services. PMI is going well, but the business environment is tougher than our expectation.
We need to complete PMI processes as early as possible and transform our organizations to adjust to the changing business environment.
3. Could you tell us about the business environment in North America specifically?
In North America, the trend toward digitalization has been accelerated.
While companies tended to outsource IT, some companies have shifted to in-house development to enhance IT. In addition, we can see a trend of vendor consolidation that reduces costs by consolidating outsourcing vendors.
As these trends became more visible in the second half, we recognize that our challenge is addressing them.
1. During the three months of the third quarter, domestic new orders received showed a year-on-year increase of about 30%.
Do you expect that this increase will contribute to the growth of net sales and profit for mid- and long-term, for example, five to seven years? Or do you expect that such figures will significantly increase in the fourth quarter or the next fiscal year?
It all depends on projects. In the segments including the Public & Social Infrastructure segment, some projects will contribute to the growth of net sales and profit for the coming years. In the Enterprise & Solutions segment, however, there are projects for which net sales will be booked in this and subsequent fiscal years.
2. I can see a significant increase in new orders received in the Public & Social Infrastructure segment. I suppose that this will mainly result in mid- and long-term increases in net sales and profit. Do I suppose correctly?
You suppose correctly.
1. Operating income showed a year-on-year increase of 2.7% in the three months of the third quarter. Was this somewhat low level of increase due mainly to unprofitable projects? Were there impacts from overseas businesses?
For domestic businesses, it was because of the unprofitable projects, as you pointed out.
For overseas businesses, operating income was slightly lower than our expectation in the North America and the EMEA & LATAM segments.
2. What was the reason for the lower-than-expected profit for overseas businesses?
The reason for the low operating income in the North America segment was the much fiercer competition environment. In the EMEA & LATAM segment, it was because of the costs of recruitment, etc. that have been increasing as businesses expanded.
Q3. It was reported that Amazon, Berkshire Hathaway, and JPMorgan would jointly participate in the healthcare industry. While their business model is still unclear, do you think that there will be a possibility that the three companies’ new business will compete with the outsourcing business of the former Dell Services’ healthcare unit?
As their specific business model and schedule have not been announced yet, we cannot see the short-term impact.
There are many players in the healthcare industry such as health insurance companies, companies that run hospitals, medical device-related companies, and pharmaceutical companies. We will carefully check areas that may be affected and the extent of the potential impact on our businesses.
1. Concerning unprofitable projects, I remember that you told us that there were two large-scale projects in progress as of the end of the second quarter, and one project would be completed in this fiscal year, and the other one would continue through the next fiscal year.
I suppose that you provided additional reserves for both of the two projects in the third quarter and both of them faced cutover postponement until the next fiscal year or later. Is my understanding correct?
Only a specific project turned out to be significantly unprofitable, and we could control the profitability of other projects. Concerning the cutover schedule, we will start services one after the other from the next fiscal year, as I explained before.
2. Did only one project make such a significant loss in the third quarter?
To be precise, we handle tens of thousands of projects in a year. There are unprofitable projects with small amount of loss, and this is the only one with a large amount of loss.
1. Concerning profit in the North America segment, when excluding advisory expenses related to the acquisition of the former Dell Services booked in the previous fiscal year, the real deficit became more prominent. I think that it is difficult to grasp PMI expenses quantitatively, but I would like to know how much of a year-on-year profit decrease you had due to the PMI processes.
Explaining the PMI progress, IT integration works, which account for the majority of the PMI processes, have been proceeding smoothly.
Concerning the expenses, we booked a large number of extraordinary losses, which were because of restructuring expenses at about 3 billion yen booked in addition to the PMI expenses. We booked the restructuring expenses for changing human resource allocation and optimizing the number of employees for our existing businesses to adjust to changes in the business environment such as the shift to digital businesses, vendor consolidation and clients’ moves toward in-house development in the North American market.
2. Were PMI expenses booked as extraordinary losses instead of the cost of sales or SG&A expenses?
They were booked as extraordinary losses.
1. Although some competitors in North America reported positive financial results, is the business environment tougher than the second quarter? Please show us your prospects of the timing when profit would begin to grow.
In this fiscal year, the North America segment focuses on PMI processes for the former Dell Services.
As I explained that we made proposals with multiple pipelines of large-scale projects in hand at the IR presentation meeting for the second quarter, the healthcare unit could receive orders for large-scale projects steadily as planned, which reassures us.
However, as the competition environment for businesses such as IT outsourcing and application management outsourcing has become tougher than we expected, there are concerns posed by failures to receive an order against expectations and projects that generated profit margins less than expected. We think that we must tackle the focused issue of improving the profitability of these existing businesses.
2. Do you mean that the tougher business environment facing the North America segment will persist, rather than being a transient environment that can show recovery in a short time?
We recognize that the existing businesses in the North America segment have structural issues.
However, there is also encouraging news. As movements related to digital businesses are fast in the North American market, we can see pipelines for large-scale projects such as virtual assistant-related projects utilizing AI as effects of our investments in the new areas in the region.
Q4. The EMEA & LATAM segment showed a significant year-on-year increase in new orders received in the three months of the third quarter. What projects brought such new orders?
The profit remained unchanged when the impact of everis-related extraordinary compensation paid in the previous fiscal year is not taken into account. Please tell us the reason why the growth in sales did not translate to a profit increase.
In the EMEA & LATAM segment, new orders received were robust as you recognize. For example, in the manufacturing sector in Germany, telecommunication and digital-related sectors in the U.K., our approaches have been paying off.
However, profitability has worsened due to various factors including recruitment of personnel prior to initiatives toward new areas such as the digital area, increased selling expenses to boost sales, and taking on challenging large-scale projects with business scale expansion.
Q5. Which companies among EMEA, everis and Business Solutions increased the net sales of the EMEA & LATAM segment?
The businesses of all of EMEA, everis and Business Solutions are robust.