Fujitsu Ltd

TSE:6702

Earnings Call Transcript 2022-Q2

[Takeshi Isobe, executive]

This presentation will cover our financial results for the first half of fiscal 2021. Revenue for the first half of fiscal year 2021 was JPY 1,663 billion, up 2% from the prior year and operating profit was JPY 81.4 billion, up 30% from the prior year. Investments in IT and the demand for digital transformation services are on a recovery path, but the pace was still rather moderate.

In terms of profits, improvements in profitability are proceeding, resulting in an increase in operating profit compared to last year. We are also actively engaged in investments for growth, which represents a key point for this fiscal year.

The growing demand-supply imbalance for semiconductors and electronic components had both positive and negative impacts on our business. For Technology Solutions, there was a negative impact due to delays in receiving shipments of components. The performance for the Device Solutions segment was extremely positive as it was supported by strong demand.

Page 5. Please look at the column with the bold outline. Revenue was JPY 1,663 billion, up JPY 31.1 billion from the prior year. Excluding the negative impact of business restructuring, revenue rose by 3.6% to JPY 58.3 billion. Revenue rose in all subsegments of Technology Solutions and performance in Device Solutions was also very strong.

On the other hand, revenue declined in Ubiquitous Solutions compared to the prior year when there was strong demand due to a surge in remote working and revenue significantly recoiled. The negative impact of business restructuring was JPY 27.1 billion.

In addition to the restructurings of low profitability businesses in North America and Europe during last year, this would also include the impact of the sale of the mobile phone retail sales business in Japan. Operating profit was JPY 81.4 billion, up JPY 19.2 billion from the prior year. In a moment, I will break down the contributing factors behind this increase in a waterfall chart. At the very bottom, profit for the period was JPY 52.9 billion.

Page 6. I will briefly comment on the financial results for the second quarter. Please look at the column with the bold outline. Revenue in the second quarter was JPY 861 billion, up JPY 31.9 billion from the previous year. Excluding the negative impact of business restructuring, revenue rose by 5.6% to JPY 46 billion. The first quarter essentially started like the prior year, but revenue rose in the second quarter in Technology Solutions and Device Solutions.

Operating profit was JPY 47.7 billion, up JPY 7.7 billion from the prior year. Compared to the first quarter, the increase in operating profit in the second quarter appears to be relatively weak despite a strong rise in revenue. There are 2 main factors for this.

The first factor stems from the product mix in network products. Last year, profit was mainly driven by products for the Japanese market. But this year, there was a big increase in products for the North American market. The second factor was the negative impact of delays in receiving shipments of components during the second quarter. At the very bottom, profit for the second quarter was JPY 28.7 billion.

Page 7. I will now comment on the factors that caused increases or decreases in operating profit in the first half compared to the prior year. On the far left, operating profit for the first half of fiscal 2020 was JPY 62.2 billion. I will use this as a starting point for explaining increases or decreases from the prior year.

The first upward arrow shows the combined positive impact of JPY 11.4 billion from special items in business restructuring. It is comprised of 3 elements. First, there was a positive impact of JPY 4.8 billion because there was no longer a burden from business model restructuring expenses from the restructuring implemented last year.

Next, there was a gain on the sale of businesses in the first half of JPY 4.9 billion, including the sale of our remaining stake in the Aizu semiconductor facility. Lastly, there was the impact of business restructurings. On the revenue side, there was a negative impact of JPY 27.1 billion. By withdrawing from low profitability businesses, however, there was a positive impact on operating profit of JPY 1.6 billion.

The remaining arrows show increases and decreases in operating profit, excluding the impact of restructuring and special items. Within the dotted line box, the first upward arrow shows a positive impact of JPY 18.7 billion from higher revenue. This is the increase in operating profit from higher revenue in Technology Solutions and Device Solutions.

The next upward arrow shows a positive impact of JPY 17.4 billion from improvements in profitability. In addition to progress in improving profitability in the Technology Solutions segment, against a backdrop of strong demand in electronic components, the effect of operational improvements led to a sharp increase in profitability.

The next downward arrow shows a negative impact of JPY 21.2 billion from high operating expenses. Growth investments are progressing as planned and increased by JPY 22 billion. The last downward arrow shows a negative impact of JPY 7.1 billion from delays in receiving shipments of components. Sales extensions led to a decrease in revenue by JPY 14.9 billion. In addition, there was a negative impact of increased costs. Adding everything together, operating profit for the first half of the fiscal year was JPY 81.4 billion.

Page 8. I will now give some supplemental information on the arrows inside the dotted line from the waterfall chart regarding changes in revenue from the prior year, excluding the impact of restructuring and special items.

Revenue in Technology Solutions rose by JPY 30.4 billion from the prior year. Revenue from Solutions/Services increased by JPY 6.5 billion. This year, we saw only a slight increase in sales in the first half of the year due to the fact that large-scale business deals tend to be concentrated in the second half of the year.

Revenue in System Platforms rose by JPY 6.2 billion. The impact of global chip shortages reduced revenue by JPY 14.6 billion. The scale of the negative impact on network products was essentially the same as that on system products. Aside from that, revenue for system products also declined due to the falloff in the supercomputer Fugaku revenue from last year.

In network products, in addition to higher revenue from 5G base stations, there were also sales related to further build-outs of backbone networks, and revenue rose both in Japan and outside of Japan.

In international regions, excluding Japan, revenue increased by JPY 22.3 billion. Almost all of the increase is attributable to foreign exchange rate movements. Excluding the impact of foreign exchange, on an actual business basis, the level of revenue was essentially unchanged from the prior year.

In Ubiquitous Solutions, revenue declined in comparison with the prior year when there was a strong demand for remote working solutions. In Device Solutions, there was strong performance in electronic components in line with increased global demand for semiconductors. The widening of the demand-supply imbalances in semiconductors had a negative impact on Technology Solutions due to delays in receiving shipments of components, but the strong demand of semiconductors had a positive impact on Device Solutions.

Page 9. This slide shows the status of orders in Japan. Please look at the total of the main industry segments at the very bottom. There was a decline in orders of 7% in the first quarter and an increase of 2% in the second quarter. Inside the brackets, excluding orders for PCs, there was a 5% decline in the first quarter and a 5% increase in the second quarter. This is a moderate recovery in orders. I will comment on each industry segment separately according to the current business climate.

First is the private enterprise segment. Orders for the first quarter were down 9% from the previous year, while orders in the second quarter were up 1%. Many of our customers are also facing impacts from the pandemic and supply chain issues. And while circumstances differ by individual companies, there has not been a very strong recovery. For the first half of the fiscal year as a whole, manufacturing is on par with the previous year, while trends are weak in the distribution segment.

Next is finance and retail. Orders increased by 9% in the first quarter and declined by 5% in the second quarter. Major business deals have a relatively strong impact in this segment, and there can be large quarterly fluctuations. Excluding PCs, orders were up 5% in the first half, and we received orders for mission-critical system upgrades in both the finance and retail segments, resulting in an increase in orders compared to the prior year.

Next is the Japan region. Orders were up 20% in the second quarter and up 2% for the first half altogether. This segment primarily consists of orders from government ministries and agencies as well as telecom carriers. For this fiscal year, we expect revenues from government ministries and agencies to be concentrated in the fourth quarter.

Orders significantly declined in the first quarter, but in the second quarter, we won several projects that will lead to a significant increase in fourth quarter revenues. From telecom carriers, the trend in orders in both the first and second quarters was strong, primarily for network equipment.

Next is Fujitsu Japan. Orders were weak in both the first and second quarters, and orders declined by 8% overall in the first half compared to the prior year, or by 4% if PCs are excluded. Orders from educational institutions declined significantly from last year, reflecting the drop-off in orders due to last year's GIGASchool project. In addition, small- and medium-sized enterprises are still feeling the impact of the pandemic. Overall, conditions remain weak.

Page 10. This shows the improvement in our gross margin and the status of our operating expenses. First is gross margin. Excluding the impact of restructuring and special items, our gross margin was 30.2%. This is an improvement of 0.9% from the previous year. I will provide additional comments on areas with special characteristics.

First, I will comment on Solutions/Services in Technology Solutions. We are continually improving productivity, transforming systems development, including through the further expansion in the use of agile development methodologies, the delivery of services with new channels like the Japan Global Gateway, as well as support work through an expansion of remote maintenance, for example.

In System Platforms, there was a slight deterioration due to changes in the product mix and the impact of delays in receiving shipments of components. In regions outside Japan, there were improvements compared to the prior year. In addition to winning a high-margin services contract in the U.K., we have also made progress on structural reforms in North America.

In Device Solutions for electronic components, a significant increase in capacity utilization from the increase in demand sharply improved profitability.

Page 11. Next, our operating expenses. Operating expenses increased by JPY 21.2 billion from the prior year. Growth investments were JPY 36 billion. Of these, JPY 27 billion were operating expenses, an increase of JPY 22 billion from the prior year. The rest was investments in assets.

Progress has been as planned from the start of the fiscal year. There are 2 main initiatives. The first initiative is investments to strengthen our services business to create greater value. To begin with, there is the Japan Global Gateway. While pursuing standardization of development methods, we are using global delivery centers and enhancing training. As a result, there has been a steady increase in the use of offshoring again in the first half.

Next, we are investing in our global offerings to create services that resonate globally, with the aim of expanding our business. We are preparing our solutions and strengthening our delivery organization to have a full scale launch starting in the fourth quarter. Those are the 2 main areas of investments.

The second initiative is investments in Fujitsu's internal transformation. To achieve data-driven management, we are investing in Internal DX. In addition to achieve innovations in the ways we work, we have invested in our Work Life Shift initiative and have been rethinking our office environments and enhancing our network infrastructure. In July, we opened the Fujitsu Uvance Kawasaki Tower as the flagship location for our Work Life Shift initiative. The scale of investments in value creation and internal transformation is about half and half.

Page 12. Next, I would like to comment on the impact of delays in receiving shipments of components as a result of the global chip shortage. Primarily in the second quarter, there was a negative impact on revenue of JPY 14.9 billion and on operating profit of JPY 7.1 billion. Primarily in x86 servers and network equipment including 5G base stations, sales have been pushed into the third quarter and beyond.

In addition, there have been higher costs such as higher component prices, costs of switching to substitute parts due to design changes and the cost of air shipments. While pursuing a consolidation of parts such as through vendor negotiations and switching to substitute parts, we are working on recovery measures, including sales price increases, and working on measures to minimize the impact on our full year financial results.

Page 14. I will now comment on our results by segment, primarily in relation to last year's results. First is Technology Solutions. Revenue was JPY 1,412.8 billion, up 1.4% from last year. Operating profit was JPY 41.1 billion, down JPY 3.2 billion from last year. I will explain the factors behind these results in each subsegment.

Page 15, Solutions and Services. Revenue was JPY 845.4 billion, up 0.8% from the prior year. Revenue increased primarily from manufacturing industry and telecom carrier customers. Operating profit was JPY 56.6 billion, in line with the previous year. While overall profitability improved due to continued changes to system development and delivery methods, we also actively expanded growth investments. So on balance, operating profit was in line with the previous year.

Page 16, System Platforms. Revenue was JPY 286.7 billion, a 2.2% increase from the prior year. Revenue in system products declined 7.3%. In addition to component supply delays, revenue was also impacted by the falloff from nonrecurring revenue for the supercomputer Fugaku recorded last year. Revenue in network products increased by 25.4%. While it was affected by component supply delays, revenue from network products grew sharply, both inside and outside Japan, primarily owing to 5G base stations.

Operating profit was JPY 15.8 billion, up JPY 9 billion from the prior year. In addition to the effects of higher revenue from network products, operating profit increased due to greater efficiency and expenses, including the fact that business model transformation expenses recorded last year did not recur this year.

Page 17. Next is International regions excluding Japan. Revenue was JPY 346.6 billion, up 3.5% from the previous year. On an actual business basis, excluding business restructuring and foreign exchange impacts, revenue was more or less in line with the previous year. Operating profit was JPY 5.1 billion, an improvement of JPY 5.9 billion from the prior year.

In addition to securing a highly profitable large-scale service contracts in the U.K., profitability improvements continued due to the effects of structural reforms in North America. Looking at results region by region, although our level of profits is still low, we have ensured that all regions are in the black. So there has been an overall improvement from the previous year.

Page 18. This shows the common expenses of Technology Solutions. These expenses reduced operating profit by JPY 36.4 billion, an increase in expenses of JPY 18 billion compared to the prior year. Our growth investments included investments aimed at our internal transformation, including Internal DX initiatives and transformations in the way we work.

Page 19. This shows revenue results in the 2 areas of value creation in Technology Solutions, For Growth and For Stability. Revenue in the For Growth area was JPY 446.8 billion, down 3% from the previous year, impacted by the revenue from Fugaku that occurred last year but did not recur this year.

On the other hand, revenue in the For Stability area was JPY 966 billion, up 3% from the prior year, due in part to a tendency for contracts to proceed. Starting from projects that are indispensable for our customers' business continuity, the recovery in the For Stability area is preceding the recovery in For Growth. And while we are beginning to see projects related to DX, we anticipate that a full-scale recovery will happen going forward.

Page 20, Ubiquitous Solutions. Revenue was JPY 116.6 billion, down 23.9% from the prior year. In addition to the impact of business restructuring, revenue fell due to the strong demand for remote working solutions last year that did not recur this year. Operating profit was JPY 5 billion, down JPY 1.6 billion from the prior year.

Page 21, Device Solutions. Revenue was JPY 175.2 billion, up 26.4% from the prior year. Revenue increased significantly, supported by strong demand. Operating profit was JPY 35.2 billion, an increase of JPY 24.1 billion from the prior year. In addition to the effects of higher revenue, profitability also increased significantly due to operational improvements.

Page 22, this is cash flow. Cash flows from operating activities were JPY 172 billion. There was an increase in inflows of JPY 15 billion, primarily due to increased operating profit. Cash flows from investing activities were a net outflow of JPY 67.9 billion. Investments were made in electronic components and in our office environments.

Free cash flow was JPY 104 billion. Cash flows from financing activities were a net outflow of JPY 109.2 billion. Outflows increased due to bond redemptions and treasury stock purchases. Of the JPY 50 billion in treasury stock purchases planned for this fiscal year, JPY 20.7 billion of purchases were conducted in the first half.

This is not part of the slide deck, but I would like to comment on the difference between second quarter results and our internal forecasts. Our consolidated total operating profit fell short by about JPY 5 billion. In Technology Solutions, the primary factor was the impact of delays in component supplies. In Device Solutions, there was a slight improvement due to a continued weakening in foreign exchange.

With regard to the problem with delays in component supplies, we are taking countermeasures, but we expect that supply delays will continue in the third quarter. In addition, there are also concerns that the problem will expand its effects to other products, so we will enhance our countermeasures appropriately.

Page 25. These are the results forecast for fiscal 2021. Please look at the upper portion of the table with the bold outline. There has been no change to any of our forecast of revenue of JPY 3,630 billion, operating profit of JPY 275 billion and a profit for the year of JPY 205 billion.

Page 26 shows the breakdown by segment. We have revised our segment-by-segment forecast. For Technology Solutions, we forecast revenue of JPY 3,150 billion and operating profit of JPY 220 billion. We have revised revenue downwards by JPY 50 billion and operating profit downwards by JPY 20 billion from our previous forecast.

For Ubiquitous Solutions, we forecast revenue of JPY 230 billion and operating profit of JPY 5 billion, unchanged from our previous forecast. For Device Solutions. We forecast revenue of JPY 350 billion and operating profit of JPY 50 billion. We have revised revenue upwards by JPY 50 billion and operating profit upwards by JPY 20 billion from our previous forecast.

We foresee a risk that the impact of component supply delays will expand in Technology Solutions. We are currently implementing countermeasures, but there is also a strong sense of uncertainty about the future. So we are taking a conservative view of the growth of the risk. At the same time, in Device Solutions, we have increased our forecast, incorporating the fact that the strong sales of electronic components will also continue in the second half.

Page 27. This is a breakdown by subsegment for Technology Solutions. Here, I'd like to make a simple comment on the changes from the previous forecast. For both Solutions/Services and System Platforms, the revision is due to the risk of delays in component supplies. In Solutions/Services, this is primarily in our hardware unit sales business and in scanners. In System Platforms, we have incorporated the risk primarily in areas such as x86 servers and 5G base stations.

This concludes my presentation, and I'd like to thank you once again for joining us today.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]