Hitachi Earnings Call Insights: Risk Factors in Eliminations & Corporate, Balance Sheet

On Friday, Hitachi, Ltd. ADR (OTC:HTHIY.PK) reported its fourth quarter earnings and discussed the following topics in its earnings conference call. Take a look.

Risk Factors in Eliminations & Corporate

Unidentified Analyst: If there are any risk factors that you can explain, what sort of risk factors are incorporated in Eliminations & Corporate Items, if you can explain that, that will be appreciated even if it is quantitative basis?

Unidentified Company Representative: We can’t really explain in specific terms but in some group affiliates, the foreign exchange assumption is somewhat skewed to weaker yen as compared to our internal rate of 75 yen to dollar and 100 yen to euro. So, there are such factors that are incorporated, but you never know what is going to happen down the road and something unexpected could happen. So, there are things that we can specify and things that we cannot and this is as far as we can disclose for the moment.

Unidentified Analyst: The question on Page 7 of the PowerPoint have indicated major factors that change in operating income, likewise do you have any comparison between fiscal year 2012 plan and fiscal year 2011, especially how much have you incorporated through procurement cost reduction in your plan?

Unidentified Company Representative: We haven’t worked out any overall total numbers. But with regard to material procurement costs reduction including the Smart Transformation Project benefits we’re striving for 160 billion yen in fiscal year 2012. Conventionally we use to see the reduction of about 200 billion yen, but now that hard disk drive business and small and medium-size display business were gone. In those businesses, sales prices were low, but product lifecycle was short. So, there was significant benefit in terms of reduction in cost of goods sold, but this is now gone. So, 150 billion yen to 160 billion yen in reduction will be comparable to the conventional level in terms of reduction of cost.

Unidentified Analyst: In power systems there was special costs incurred in last fiscal year and this is going to be gone in this fiscal year, including the issue of the (boiler) materials in Europe. If you can elaborate on that that will be appreciated?

Unidentified Company Representative: It all started with the new material called T24. With regard to this issue, by the end of last year, we have indentified the cause and came up with the solutions. So as we negotiate with the customers, we have just started the construction work again. With regard to investigation and test expenses, we have paid for that, so those were paid for by Hitachi. Going forward, we are going to make further improvements and we would consult with our customers so that we can start operation as soon as possible. From January 2012 those negative factors have been going away and construction work has started and Hitachi Power Europe closed the book in December. So, the performance between January and December is reflected in the March 2012 earnings of Hitachi. So the performance in January through March of 2012, Hitachi Power Europe will be reflected in the first quarter of Hitachi Limited. Because of the issue of T24 being resolved, we have seen slight surplus and so we would not see the kind of losses in fiscal year 2012 that we suffered in fiscal year 2011.

Unidentified Analyst: I’m sure you have accounted for some allowances, is there any prospect for getting some provision?

Unidentified Company Representative: There maybe some but the probability is not that high therefore we believe that the numbers that we have come up with for the full test are reasonable so we do not anticipate any major change.

Unidentified Analyst: I have two questions; first is on TV business. Mr. Nakanishi said that profit is possible. How much improvement did you see in revenue and operating income in fiscal 2011 and what is your outlook for fiscal 2012? My second question is on China business which you said was difficult, what is the reason and your outlook for fiscal 2012?

Unidentified Company Representative: TV business generated loss in fiscal 2011. We closed the domestic production and started utilizing EMS. We will not discontinue our TV business, but we are pursuing business restructuring. This year we will restructure our manufacturing bases and revenue will decline due to the maintenance cost formed by us. Fixed cost cannot be reduced to zero and therefore negative figures will remain but it will not be a surprisingly large downswing like we saw in the past. Revenue in number of units will be explained later. Now, responding to your second question on elevator business in China, Eastern region in China is declining but the orders in Central and Western region is not dropping thanks to the government’s aggressive plan to build China’s affordable housing. The decline is seen in construction machinery, such as mining machineries and hydrolytic accelerators, and Hitachi Construction Machinery. In addition, PC could not be manufactured last year due to the flood in Thailand. So, although hard disk drive price rose, the price of optic disk drive is declining as a trend. Therefore, we are being impacted in China. In railways, we expected a bigger increase, but the investment is dropping due to the problems in government accidents and the increasing debt in railroad ministry. The investment should resume in the second half of the year but we see an impact in China. The market will not grow by double-digit like in the past. Let me make some supplementary comments on TV. Fiscal 2011 was 1.5 million units globally, 76% year-on-year, and fiscal 2010 was 1.97 million with an operating loss. Revenue is not disclosed.

Balance Sheet

Unidentified Analyst: My first question is around balance sheet. What is the impact of the transfer of hard disk drive business on your balance sheet? Along with gain on sales, the cash in, the liabilities may have decreased too, so please give us the figures? Second question, looking at the balance sheet excluding Financial Services net debt is dropping to 800 billion yen level, when do you think you can turn to net cash? Please explain your free cash flow plan for this year and whether this level is sustainable going forward? Third question, please give us the storage solution revenue result and plan on the local currency base? You forecasted a small growth this year, probably due to the strong yen. So, if you could give us the local currency base, please? Also what is the operating income forecast for this business, excluding the possible impact of the shortage in hard disk drive procurement?

Unidentified Company Representative: The positive impact of the transfer of Hitachi GST on our balance sheet, we received 287 billion yen in cash which was used to repay our debt. The gain on sales was 191 billion yen so debt decreased and equity capital increased. In foreign exchange adjustment the negative portion in other comprehensive loss is gone with the disappearance of Hitachi GST, another positive factor in equity capital. Stockholders equity ratio is now 18.8% and approximately three percentage points comes from the transaction this time. So debt decreased, equity capital increased, and total assets decreased. So, it was favorable for our balance sheet. Now, responding to your second question on when net debt in manufacturing will be zero. We do not plan to go for a zero debt management again, de-ratio in this field is 0.56 in fiscal 2011 and we plan to aim for 0.5 in fiscal 2012. We will pursue global growth strategy going forward and increase cash flows from operating activities, which means cash flow from investing activities will increase accordingly. Investment cash flow will increase in the manufacturing sector rather than the Financial Services sector, so we will have debt. Therefore, debt free management in the manufacturing sector is unlikely. Storage Solutions in foreign currency basis is 115% year-on-year or U.S. $444.3 billion. It is difficult to calculate the negative impact of hard disk drive price increase on Storage Solution. But our competitors are procuring hard disk drive as well, so we are in a level playing field. We are strengthening soft services and increasing revenue including the acquisition of BlueArc. Therefore despite the negative impact we are promoting reform so profit margin will not decline.

Unidentified Analyst: Is 15% increase this year’s time?

Unidentified Company Representative: No, fiscal 2011 result.

Unidentified Analyst: What about this year’s plan?

Unidentified Company Representative: We do not disclose dollar-based figures.

Unidentified Analyst: What is your this year’s free cash flow?

Unidentified Company Representative: We hope to achieve at least 100 billion yen positive.

Unidentified Analyst: I have three questions. Firstly, about profitability of the Digital Media & Consumer Products segment, if you can’t disclose specific amount of losses in TV businesses then can you explain more on the quantitative basis in the last fiscal year one major factor of losses may have been disposal of (inventories) is that correct to understand that. And what would it take to recover the level of profitability that you achieved in fiscal year 2010 in TV business and other businesses including the timing of those measures that could be taken. Are you talking about fiscal year 2011? No, we are talking about 15 billion yen profits that you have achieved in fiscal year 2010? My second question is about the Information & Telecommunication Systems segment forecast for this fiscal year. I am not sure if this is intentional, but you mentioned the word ‘project management’. So that would make people wonder if there were any losses incurred in the last fiscal year. If there is any such losses to some extent, then can you explain more about those losses? Thirdly, I have a question about the Power Systems segment. The nuclear power stations have not been restarted and this must have impact in the last fiscal year as well as in this fiscal year. So, have you assumed the resetting of nuclear power stations in this fiscal year, and if there is no restarting of the nuclear power stations, are there any cases where you haven’t been able to recognize profit because there are no acceptance tests that were performed by customers, and how have you incorporated this prospect in your forecast for this fiscal year?

Unidentified Company Representative: With regard to Digital Media & Consumer Products segment profitability, as compared to the fiscal year 2010, with regard to profits in TV business, quantitatively – or rather qualitatively, there was a sudden drop in demand and price fall in fiscal year 2011. So there was disposal of inventories. So, what is said is in that sense right. We are taking measures such as discontinuing of domestic production and reduction of headcounts. So, there will be still some negative impacts in fiscal year 2012. The revenue scale is expected to decline and losses will obviously be reduced as compared to fiscal year 2011, but there will be some that we will see in this fiscal year. What is necessary to recover the fiscal year 2010 level of profitability? In the global market the commercial packaged hair conditioners and home appliances will have to be produced in emerging countries and sold in those countries. We are already reducing exports from Japan, but we have to shift our approach from exports to local production and local consumption. In TV business we are not expecting major surplus but because of these measures we are expecting more sales in home appliances. So, without any major losses in TV business we can expect surplus in the segment as a whole. With regard to the emphasis on project management in the Information & Telecommunication Systems, people may have wondered that there were some losses. Well in the project management there are always some projects that suffer losses and how to manage this is the most important in terms of system integration business. In order to avoid those losses you have to enhance the quality of project managers and the management structure of the project should be segmented clearly and we always have to share information closely with the customers so that the project will not deviate from the original plan. So, we are working on project management currently and there is a screening process to decide whether we take a particular order and we have lower the threshold about which project will be subject to such screening from, for instance 1 billion yen, so that there won’t be any deviation from the original plan. The project team may say that there will be surplus, but the project may end up with losses in the end. So it’s not the case that the (indiscernible) certainly out of control, but in domestic market the system integration business is not the kind of business that we can expect major growth. So, we have to avoid any lost opportunities, so we are continuing to reinforce project management. With regard to restarting of nuclear power stations, in the fiscal year 2012 we are not assuming any starting of nuclear power stations. The Unit 3 and 4 of OE nuclear power stations is irrelevant because we’re not involved. But for those units that are relevant for us, we are not assuming any restarting of those plants in this fiscal year. With regard to the failure to recognize profits, it is true that Higashidori and other plants have not been restarted. So we wish we could recognize profits, but if there is no progress in work, we would not be able to do, so we are not assuming any recognition of profits.