Full-Year Guidance Raised on Strategic Procurement and Large Server/Network Deals; AI PC Expansion and Monetization of Built-Up Inventory Are the Key 2H Focus

Summary

The company had initially expected a pullback following the PC demand boom. Instead, 1H beat initial guidance, driven by large server/network deals, higher PC ASPs and demand pulled forward ahead of anticipated price hikes. Management expects price increases driven by surging memory prices to persist. It therefore plans to continue strategic procurement to stabilize earnings. Management stressed that more than half of inventory is already allocated to orders, so there is no concern about slow-moving stock. The inventory build temporarily absorbed cash. Assuming current conditions hold, however, management expects cash to return to historical levels by fiscal year-end as inventory is monetized in 2H. The key theme for the next medium-term plan is whether the company can broaden an earnings base that does not depend on PC unit volumes.

Key Points (Earnings Highlights and Growth Initiatives)

• Management Strategy and Market View
  • Price increases driven by surging memory prices are expected to continue into 2H; the company will keep securing inventory strategically on the assumption of resilient demand
  • The standard inventory policy is 0.7 months of monthly sales; higher PC ASPs have pushed up inventory as a multiple of monthly sales
  • Priority is on strengthening an earnings base independent of PC unit sales, centered on servers/networks, AI and security
  • Rebranding is under way ahead of the April 2027 corporate name change (MUSUBITE, DIS), a contributing factor to higher advertising expenses
• Current Business Progress and Drivers
  • Server ASPs roughly tripled; despite lower unit volumes, server transaction value rose +102.8%
  • Server delivery delays persist in some areas but are easing, enabling monetization of backlogged orders
  • Standalone 2Q gross profit margin was 7.2% (1Q: 6.6%), helped by lower GIGA shipments and strategic procurement
  • PC transaction value fell only -11.5% against a -31% decline in units. Management attributes this to 2H purchase plans being pulled forward into 1H
  • Education declined -16.7% on the post-GIGA Phase 2 hangover; the company is watching for purchase and delivery delays as prices rise
• Key Strategic Initiatives and Inflection Points
  • Strategic procurement was triggered by server price revisions early in the year; with prices rising every few days to every week, gross margins eroded between quotation and order
  • Management stated that more than half of inventory value is already allocated to orders, so slow-moving stock is not a concern
  • Order backlog is high even compared with the PC boom and GIGA peak, led by servers, networks, storage and cloud
  • In Industrial Machinery, some units are held as stock machines to shorten lead times; orders were won at trade shows in Australia and the US

Outlook and Strategy

• Full-year guidance raised to revenue of JPY 1,369.0B and operating income of JPY 43.0B (initial: JPY 36.5B); 1H operating income progress was 48.3%
• For IT Infrastructure Distribution in 2H, gross margin improvement is expected to be offset by higher SG&A, keeping OPM flat at 3.1%; PC units are assumed to be slightly below 1H
• Management said operating CF should recover to historical levels by year-end as allocated inventory is monetized in 2H, provided current order conditions hold
• AI PCs rose to 13.4% of the mix from 2.7% a year earlier; management expects the share to rise sharply over the next few years
• The next medium-term plan is slated for release in May 2027; the company is considering achieving ROE of 20% at an early stage and pursuing inorganic growth through M&A
• Shareholder returns target a total payout ratio of around 60%, determined holistically in light of financial soundness and share price levels; a progressive annual dividend of JPY 110 is planned

Positive Factors

• AI PC transaction value reached JPY 34,983M (+282%); rising prices of general-purpose PCs make upgrading to AI PCs more attractive
• Management noted that the backlog mix closely resembles 1H results and expects 1H earnings conditions to carry into 2H
• Network security (JPY 11.26B) overtook endpoint security (JPY 10.37B), indicating a shift in security demand toward the network layer
• Security investment, led by large enterprises, is expected to spread to SMEs on the back of the SCS assessment framework; the network of roughly 19,000 sales partners is a key strength
• Management is pursuing repeat business following large data center deployments and described the probability of winning orders as high
• Machine tool orders rose +39.5%, driven by shipbuilding and energy in addition to aerospace

Concerns and Risks

• The inventory build drove operating CF of -JPY 69.5B; cash and deposits fell to JPY 10.7B while short-term borrowings rose to JPY 56.0B
• The equity ratio of 32.1% is below the next medium-term plan's target of around 35%; balancing growth with financial discipline is a key monitoring point
• Procurement assumes continued price increases, so weaker demand or a change in price trends could hurt inventory efficiency
• Concerns over buyer hesitancy due to higher prices remain; GIGA devices may also see delivery delays as prices rise
• Full-year SG&A is planned to rise by JPY 0.89B in personnel costs and JPY 1.92B in non-personnel costs, mainly due to base pay increases and advertising
• The Automated Machinery division posted lower revenue and profit as customers remained cautious on capex amid high raw material and energy costs

Performance Highlights

1H consolidated revenue was JPY 677,352M (+3.1%), a record high for a first half. Operating income was JPY 20,785M (-7.4%), the second-highest level for a first half. Gross profit margin slipped to 6.9% (-0.3pt), and SG&A rose by JPY 1.1B, resulting in lower profit. Interim net income attributable to owners of parent company was JPY 14,572M (-7.4%).

Segment Performance

• IT Infrastructure Distribution Transaction Value: JPY 715,558M (+3.3% YoY)
• PC Shipments: 2.144M units (-31.1% YoY)
• Server Shipments: 20K units (-26.2% YoY)
• iKAZUCHI Transaction Value: JPY 34,492M (+31.9% YoY)
• Security-Related Transaction Value: JPY 30.8B (+6.8% YoY)
• Industrial Machinery Orders Received: JPY 8,312M (+26.3% YoY)
• DIS Domestic PC Share (Corporate): 39.9% (+1.2pt YoY)

Q&A List

• Q

  How much has proactive, strategic procurement improved gross margin? Could you explain in plain terms how sustainable this is?

  A

  In the near term, manufacturers announced expected price increases each quarter, so we bought ahead of them. As a result, PC unit prices are up 40–50% from last year. Our standard policy is to hold 0.7 months of monthly sales in inventory, but higher unit prices have raised that ratio. The impact on margins is not dramatic. The aim of buying ahead strategically is to secure stable profits. The YoY improvement is hard to quantify, but please understand it as an increase of a few tenths of a percentage point.

• Q

  Related to the use of working capital, operating cash flow is deeply negative. How will free cash flow return to an appropriate level? It may depend on price trends, but what is your outlook for year-end and next fiscal year?

  A

  Operating cash flow currently stands at -JPY 69.5B. This reflects higher working capital to secure inventory, not deteriorating earnings. A substantial portion of inventory is already allocated to booked orders. We fully expect to convert inventory, including these allocated items, into cash as it is monetized. We expect operating cash flow to recover to a reasonable level. We manage operating cash flow closely as a key financial metric and will continue to monitor it.

• Q

  AI PCs are driving strong revenue growth, but they still account for only 13% of transaction value. Are corporate users buying AI PCs reluctantly for lack of alternatives, or proactively? How do you see the ~13% share rising over the medium term?

  A

  The share this fiscal year is 13%, up sharply from 2.7% a year earlier. Manufacturers are expanding their AI PC lineups, and user demand has shifted significantly toward AI PCs. Broader choice is one factor. Another is that average prices of standard PCs have risen so much that AI PCs are now only a small step up. We expect the share to rise sharply over the next few years.

• Q

  You raised guidance, but the total payout ratio is just over 50% versus your 60% commitment. Within what you can share, how should we think about dividends and buybacks?

  A

  Against our target total payout ratio of around 60%, the current forecast stands at 50.6%. As we have repeatedly explained, we will continue to execute corporate actions based on a holistic assessment of capital allocation, financial soundness and share price levels. This fiscal year, we have completed the acquisition and cancellation of JPY 6.0B of treasury shares, and we plan a progressive annual dividend of JPY 110. We will continue to balance growth investment and shareholder returns while steadily improving capital efficiency.

• Q

  The inventory build seems a smart move characteristic of your company. You do not disclose orders, but could you give a sense of how much backlog has accumulated, and in which products?

  A

  We cannot provide specific amounts or effects. Early this year in particular, server prices rose every week, or even every three days. Prices were rising between the quotation/order stage and the point of actual order placement, which was the main reason we began strategic procurement. The inventory build took place roughly from May to June. We would prefer you not reverse-engineer specific figures, but more than half of inventory value is allocated to orders. As a reference point, the order backlog is JPY 30.9B higher even compared with the backlog before the PC boom and GIGA School peak. By product, PCs are lower than last year, while servers have increased sharply, along with backlog for servers, networks, storage and cloud. We expect 2H to look very similar to 1H.

• Q

  Security products appear to have lost some momentum versus 1Q, but with the SCS assessment framework, demand should remain strong in 3Q/4Q and into next fiscal year. What is your outlook? You also mentioned demand shifting from endpoint to network security. Are there any products growing particularly fast?

  A

  This category was already growing strongly last year. As shown for reference in the 1Q materials, the prior year's growth rate was +20% overall, with individual categories growing +47% and +20%. Please view the current growth against that high base. Endpoint security declined in proportion to last year's very high PC shipments.

• Q

  Security incidents in Japan have become more prominent in recent months. Are your sales teams seeing signs of a further step-up in business for 2H or next fiscal year? Has demand shifted?

  A

  Not limited to security, adoption generally starts with larger enterprises. Currently, deployment is progressing primarily at those companies. As noted in our materials, the SCS assessment framework and similar schemes will be introduced, so we expect smaller and mid-sized companies to follow, and they are now considering adoption. We believe demand will expand significantly and that security will become indispensable. Since policies on the level of protection depend on each company's judgment, we will prepare appropriate products.

• Q

  In security, what types of customers do you serve in terms of company size or industry? Are there any distinctive characteristics?

  A

  There is no particular skew. We do business through 19,000 sales partners nationwide and supply products across all segments. As mentioned, deployment tends to start with relatively large enterprises and then spread to SMEs across the country.

• Q

  Is it correct to view the large data center and network deals as one-off?

  A

  Many large deals end with the initial deployment. However, we handle large deals with an eye to follow-on business and conduct sales activities focused on post-deployment repeat orders. This approach, aimed at expanding business opportunities, is already producing results.