Thoughts on the Nikon Financial Announcements
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Let's Review What Nikon Announced
Based on the panic induced drop in stock price following Nikon's recent announcement of financials for the third quarter ending December 31st, 2016, there's an enormous amount of noise that Nikon is done, that the company is over, yadda, yadda, yadda. I don't think so.
So at the behest of some readers who know that I have spent most of my life in senior corporate roles, I wanted to go through what Nikon announced and provide an assessment of what it may mean to us as creatives. These are 100% my opinions, based on my business background. I have not spoken with anyone at Nikon, their agencies and have no proprietary knowledge about the firm. I do know the photographic industry rather well so I hope that this assessment is of some value to you.
Please note that while have experience with both American and Canadian accounting practices, I do not have expertise in Japanese accounting practices. Thus my analysis of the financial statements is limited to what I think that I know.
This is a 3rd quarter set of statements that incorporates revenues from the holiday season. The 4th quarter is typically a soft quarter for companies on this type of fiscal year end.
The statements make a year to year comparison in the same period, thus they compare Q3 2015 to Q3 2016. This is a fair approach.
In summary, net sales fell 8.2% 2015 to 2016 across all of Nikon's business units. Given the soft global economy where flat is the new increase, Nikon is feeling the pinch the same way many businesses are. Operating Income increased by 67.1%. Operating income is often referred to as EBIT or earnings before interest and taxes and is a measure of the business profitability. In the case of Nikon their EBIT is 7.45% That's not a going out of business number, but it indicates a business facing some real challenges. Not that this EBIT is an improvement over 2015's EBIT of 4.09%.
It is commonplace for businesses to provide "guidance" on coming quarters although more and more companies are declining to do so to help avoid spikes and craters following the announcement. Nikon continues to offer guidance and is estimating a net sales loss Y/Y for the fiscal year ending March 31, 2017 of 8.5% That's not good, but that they are estimating an EBIT increase of 38.8% Y/Y is a good thing.
This is good in the short term for certain, but because Nikon has been in the process of restructuring, they have been able to recognize some significant operating expense savings upfront, which will balanced by one time charges (the extraordinary event), those savings are not consistently replicable. Good financial experts can show a company as profitable right until the doors close.
Nikon has about 50% equity in their total assets. This will impact any takeover, because the equity is less than the declared asset value. A buyer would have to reconcile this.
Nikon has multiple business units. The Precision Equipment Business had a solid three quarters. The Imaging Products business, which includes digital cameras suffered, partly due to a slowdown in consumer spending, and the inability to ship products due to the destruction of Sony's sensor plant in Kumamoto resulting from the earthquake. Nikon sources a large number of sensors from Sony. The Instruments business had poor sales due to losses on Foreign Exchange and the inavailability of allocated budgets in customers for new machines. Finally while the Medical Business saw strength in Europe and Japan, US business was sluggish.
From the Financial Statements we learn that in the first three quarters of the fiscal year, assets increased by about 74 million Yen. Most of the increase came from increased cash and deposits, typically indicative advances received. This is coming, according to Nikon, from the Precision Equipment business and offsets losses in other units. The greatest increase in Liabilities comes from Long Term loans payable, an increase of just over 40M Yen in the first three quarters.
The Income statement tells the story of why the loss looks as bad as it is. In the first three quarters of the fiscal year, Nikon took a hit of 29,790,000 Yen in restructuring expenses. A large chunk of this is the acceptance by over 1,000 employees for voluntary early retirements and terminations. Nikon's gross profit was nearly the same as in the same period prior year because although the net sales were down, so was the cost of sales. It is that restructuring expense that contributes nearly all of the Extraordinary Loss. If Nikon elected to take the entire hit up front, this means that unless there is a further restructuring, we will not see this again.
So after that, let's get to the Imaging Products division which is where we as creatives are most concerned.
Imaging Products saw a loss in the same period year over year in net sales of 29% and a related loss in operating income of 18.4% Imaging Products is the largest business unit and when it fell it pulled the total down with it. Precision Equipment saw a 65% sales growth but it is just over half the size of Imaging Products so only so much loss can be offset.
So what is Nikon doing?
In November 2016, Nikon announced a voluntary retirement program with a goal of 1,000 applicants. They have received 1,143 applicants. That means a significant one time charge to the company, but will reduce future operating expenses. Nikon also announced restructuring in other areas for centralization, real estate and others, as well as an investment in what they refer to as Rewiring Management DNA. If that sounds like newspeak, it's because it's newspeak for pick it up and shake vigorously. What worked in the past, doesn't work now, time for aggressive change. This is the same thing that many businesses have and will continue to go through. Nikon is expecting their total one time restructuring estimate has been increased to 50B Yen but also maintains that they expect to achieve a 20B Yen fixed cost reduction in fiscal 2018
Since the restructuring was only announced in November 2016, not a lot of progress other than the voluntary retirement has occurred. Nikon's analyst presentation specifies a lot of planning has been started, but not much else.
For Imaging Products, the focus is to exit low profitability products while increasing focus on "high value-add products". We have seen this tangibly with the announced cancellation of the DL lineup of premium compacts. As I noted in a prior article, I think that this is a very smart move on Nikon's part because they are very late to that game and it would have been an uphill battle against multiple superior foes.
Nikon is also questioning their entry into the Action Camera market. Not only has the entire market softened, real world demand for 360 degree video has not materialized, nor is it expected to. Retailers have inventory collecting dust due to high cost of goods, marginal software and complexity for end users. Smart retailers are already treating 360 like 3D television, a fad that was dead on arrival. Dumb ones are going to take a beating. Nikon also missed their guess on how significant the worldwide market slowdown would be. The entire imaging business is off worldwide and until economies turn, luxury goods which include image products are going to be near the bottom of the buy it now pile. With increasing taxes, poor government spending controls and increased citizen distrust of government, media and business, expectations for a turnaround are based on a strategy of hope, not on fact.
In their forecast for the fiscal year end, and specific to the Imaging Products Business, Nikon is specifying a 35B Yen "downward adjustment" in net sales with a consummate negative adjustment of 8B Yen in operating income. We will also see a one-time restructuring cost in the final quarter to handle the cancellation of the DL product line. Nikon has stated a drop in digital camera interchangeable lens type products of 810,000 units in the same period, a drop of 1,080,000 units of interchangeable lenses in the same period, and a drop of 2,960,000 units in the same period. These are significant changes for Q1-Q3 2016 to Q1-Q3 2017 fiscal years. While foreign exchange and increased advertising costs contributed to the loss in net sales and operating income, a falling consumer market is the elephant in the room.
What Do I Expect? Crystal Ball Time
I do not see Nikon going away soon. I also do not see them being acquired as those with the wherewithal to pick them up are also struggling and why would you buy into a declining business unless you could milk it, chop it and dump it fast. Lots of rumours about Sony picking up Imaging Products. I don't see it. Sony has enough challenges as it is, including expensive rebuilds without adding another millstone to their necks.
I expect that as they go through their DNA rewiring, that Nikon will smarten up and get out of the already dead and stinking point and shoot business completely. The profitability sucks, and there is no buyer loyalty. Smartphones killed this market three years ago, and only delusional folks think that it has any hope of recovery. Specialized compacts is another area where Nikon will not play. This includes the superzoom space as well as the high end compacts. Nikon can save more by shutting down those operations than they could ever make by keeping them running.
Given the significant challenges facing the business, I do not expect a Nikon mirrorless camera that uses the existing Nikon mount lenses in the next year. Despite being hammered in the media for not having a mirrorless product, mirrorless is well served by the existing providers and none of them are in a boom state, because the North American market has not bought in yet, nor is it likely to in the near term. Some believe that Nikon must do a mirrorless to remain competitive, particularly if Canon does a mirrorless body that takes EF lenses. I don't see this happening anytime soon at Canon either, because they are a very conservative risk averse company and see what is happening in terms of real sell through numbers.
This leaves what Nikon calls the high value add business. This is the DSLR and lens space. Numbers tell us that while mirrorless is viable, DSLRs outsell Mirrorless about 8:1 and Nikon and Canon are the gorillas in that room. Nikon has an excellent reputation for lenses and their higher end bodies are very successful. Where they have faltered is in their recent attempts in the consumer DSLR and action camera space to link these devices to smart phones. Their execution here has been horrible and products have shipped that did not work. No one believes that Nikon can do wireless transfer easily. In a recent review lauding the Snapbridge offering, the writer admitted on multiple occasions that it didn't work, that he sought help and it didn't work and it took significant time to make it work. I do not see that as laudable. I have configured Snapbridge on multiple devices and it's horrible. The recent releases of the D3400 and D5600 consumer bodies are no different than their predecessors other than adding Snapbridge and that has done Nikon no favours.
There is expectation that Nikon will do a major body refresh in calendar 2017. I don't see it purely for financial reasons. The D7200 works well and sells well and all they could do is hang an anchor around it by making a D7300 with Snapbridge. I hope that saner heads prevail. The D7200 is still an excellent and competitive product. The D610 and D810 are aging, and while they may release a replacement for the D810 with yet again more megapixels for no tangible gain other than presence on pointless comparison charts, I do not see a replacement for the D610. My guidance would be in fact to end the D6xx line and the Df line completely and consolidate functionality and services into the D7xx lineup, with an upgrade to the D750 that consolidates the low light performance of the Df, and the overall usability of the D750 with a higher maximum shutter speed of 1/8000, often seen as a show stopper for sports and action users. Nikon needs a strong player against the Canon 5D Mark IV and can do so without driving the price through the roof and alienating prospective buyers. The D5 is still new enough not to need an upgrade, and the D500 is so new, that nothing is needed there for a couple of years. While Sony believes that they can release a minor upgrade every nine months, and I think that has caught up with them, Nikon should slow down releases, consolidate and make the upgrades real upgrades, not a bolt on of junk software.
Nikon also needs to understand that the market has changed. While younger buyers enjoy photography, there is not the same passion and brand loyalty to be found in the aging demographic. Increased costs of housing and inconsistency in employment also impact the younger buyer's ability to invest in photography. Nikon did try to go after the older enthusiast with the retro but far too expensive Df and that failed miserably.
I only wish the best for Nikon. The photographic world benefits from vendor competition and it keeps innovation happening. I am often accused of being paranoid and I do think that pricing is out of control and I smell the distinct aroma of pricing collusion too often. Those concerns shared, I don't want to walk into a camera store and find that there is no more Nikon.
