Fujitsu Ltd

TSE:6702

Earnings Call Analysis

Service Solutions Drive Strong Revenue Growth

Service Solutions, the company's most important segment, saw a striking 13.6% increase to JPY 984.1 billion in revenue, excluding divestitures. Fueled by high demand for DX and other modernization efforts in Japan, the adjusted operating profit for this segment soared by JPY 44.4 billion year-on-year to JPY 62.4 billion. Nonetheless, consolidated revenue across all segments rose only 2.7% to JPY 1,711.8 billion after excluding restructuring costs due to weaker Device Solutions demand. Despite increased growth investments aimed at long-term gains, the overall adjusted operating profit decreased by JPY 24 billion year-on-year to JPY 50.7 billion. Orders showed mixed regional performance with a sharp 81% rise in the Americas contrasting a 27% drop in Europe, while Fujitsu Uvance's revenue surged by 63% to JPY 153.7 billion, and order status remained robust, marking a 70% increase from the previous year.

Service Solutions Steers Performance with Strong Revenue Growth

The most significant driver for the reported period was the Service Solutions segment, with robust revenue of JPY 984.1 billion, clocking an impressive rise of 13.6% from the prior year. This robust performance was fueled by strong demand for digital transformation (DX) and modernization, generating an adjusted operating profit of JPY 62.4 billion—a year-on-year increment of JPY 44.4 billion.

Challenged Device Solutions Amid Sluggish Demand

Conversely, the Device Solutions segment encountered headwinds, as continuing subdued demand since the latter half of the last fiscal year led to a mere 2.7% increase in consolidated revenue, reaching JPY 1,711.8 billion excluding restructuring impacts. This segment saw its adjusted operating profit curtailed by JPY 24 billion year-on-year to JPY 50.7 billion, reflecting the sector's challenges.

Fujitsu Uvance: A High Growth Prospect

A standout performance was noted in Fujitsu Uvance with a 63% uptick in revenue, thriving on vigorous demand for consulting services, modernization projects, and cloud migration support. Achieving JPY 63.4 billion in adjusted operating profit for the first half of fiscal 2023, an improvement of JPY 19.3 billion, the target for Fujitsu Uvance's full-year revenue is set ambitiously at JPY 300 billion.

Boost in Orders Signals Strength

Orders and pipeline strength remained prominent with domestic orders surging by 18%, and orders for Fujitsu Uvance climbing by 70% in the first half compared to the prior year. This bodes well for sustaining revenue momentum.

Margin Improvements Noteworthy

Positively, the company's profitability rose by JPY 19.3 billion and gross margin saw an incremental gain of 1.3 percentage points year-on-year, signaling the company's proficiency in bolstering its bottom-line performance.

Global Solutions and Regional Operations Paint Mixed Picture

Global Solutions experienced revenue growth of 18.2% to JPY 217.7 billion and demonstrated improvement by lowering its operating loss to JPY 2.6 billion. Meanwhile, Regions (Japan) and Regions (International) showed varied results with revenue upticks and profit gains in Japan but a decline in international profitability, largely attributed to struggles in the European market.

Some Segments Encounter Declines

Amid the overall positive narrative, specific segments such as Hardware Solutions and Device Solutions faced declines both in revenue and adjusted operating profit. These dips reflect the cyclical downturns and continued cost pressures in these markets.

Rising Investments for Future Growth

The company persists in laying down significant investments toward its medium and long-term growth trajectories. This includes advancements in AI, quantum computing, energy saving processors, and other innovations essential for staying at the competitive vanguard.

Solid Cash Flow and Reduction in Free Cash Flow

Core free cash flow, stripping one-off items, portrayed a healthy increase of JPY 27.4 billion compared to the previous year. However, there was a reduction in free cash flow, in part due to the acquisition of GK Software, indicating significant investment moments for the company.

Forecast: Optimistic on Service Solutions, Cautious on Device Solutions

For fiscal 2023, the company projects revenue of JPY 3,810 billion, with an adjusted operating profit of JPY 320 billion and an adjusted profit for the year of JPY 208 billion. Comparatively, there has been a downward revision in the forecast, reflective of the sluggish demand in Device Solutions which underperformed against anticipations.

Earnings Call Transcript 2024-Q2

[Takahito Tokita, executive]

Thank you for this opportunity. I would like to give you an FY 2023 second quarter consolidated financial results overview.

Please turn to Page 3. This is the financial highlights for the first half of fiscal 2023. The most important segment is Service Solutions, where revenue was JPY 984.1 billion. Excluding the impact of divestiture of PSU, this was a strong increase of 13.6% from the prior year.

Early for business in Japan results were driven by strong demand for DX and modernization, and there was also a strong rise in orders. Adjusted operating profit was JPY 62.4 billion, otherwise JPY 44.4 billion year-on-year. Because of the positive impact of higher revenue and progress as planned in equipment profitability, such as the transformation in the delivery of services.

On the other hand, with continued lower demand in Device Solutions since the second half of last fiscal year, revenue on a consolidated basis was JPY 1,711,800,000,000, an increase of only 2.7% excluding restructuring. Adjusted operating profit was JPY 50.7 billion, a decrease of JPY 24 billion year-on-year.

Page 4 shows an overview of the financial results for each business segment. I will discuss the results of each segment, starting with the next slide. And on this slide, you can see an overview of the segments. At the very top is Service Solutions, by growth driver, gaining further momentum from Q1, revenue in Q2 also expanded significantly. PSU was included in the consolidated results until the first half of the previous fiscal year. But excluding the impact of restructuring, total revenue in the first half increased by JPY 117.6 billion.

On the other hand, Hardware Solutions, which includes network products and device solutions, which performed well in the prior year, had lower revenue and profit. In Inter-segment Eliminations and Corporate, we are pursuing a plan of increasing investments to achieve growth over the medium to long term.

Slide 5 and on each share results for each segment. Page 6, Service Solutions. Revenue for the first half was JPY 984.1 billion, which on a continuing operations, this represents an increase of 13.6% year-on-year. The customers, both inside and outside of Japan, there was an acceleration in DX initiatives and initiatives to resolve the cycle issues such as climate change. As a result, there is a greater demand for consulting services, modernization projects and cloud migration support.

Fujitsu Uvance was able to take advantage of this robust demand with a 63% increase in revenue. Adjusted operating profit was JPY 62.4 billion, up JPY 44.4 billion year-on-year. Although we increased growth investments related to Fujitsu Uvance, because of the impact of strongly higher revenue and measures to improve profitability, operating profit grew significantly. I will explain the components of this increase in profits with the waterfall chart later on.

This is the breakdown of results by quarter. The red line graph, which is revenue growth. The blue bar is adjusted operating profit. Revenue rose by 10% in Q1 and in Q2, even higher by 17%. For adjusted operating profit as well, the scale of the increase in profit rose from Q1 to Q2 with an adjusted OP margin of 8.2% in Q2. There was also a large increase in adjusted operating profit year-on-year in the first half.

Page 8. This chart shows the fact that, of course, increases or decreases in the first half adjusted pay in Service Solutions compared to the prior year. On the far left, adjusted OP for the first half of fiscal 2022, JPY 19 billion. I will use this as the starting point to explain.

The first is positive impact of JPY 37.4 billion. In part because of a solid increase in revenue in Fujitsu Uvance, Services Solutions revenue also was 13.6%. Second, an increase of JPY 19.3 billion from improved profitability. We continue to make progress in the expanded use of global delivery centers and standardization and development work and other initiatives to improve productivity.

The impact of higher employee cost was covered by profitability improvements entirely or in home. Third is a decline of JPY 12.3 billion from higher expenses, primarily investments in growth areas. We actively made investments in areas that directly promote business growth such as development of facility offerings and investments in employee channel and development and enhanced security.

Adding this up, adjusted operating profit for Service Solutions for the first half of fiscal 2023 was JPY 63.4 billion, as you can see in the far right corner. Page 9, I will now provide supplemental information on each of factors in the previous multiple charge. This is the status of orders in the first half of fiscal 2023, which led to the increase in revenue. This page shows orders in Japan.

Domestic orders increased continuously during the first and second quarters, resulting in an 18% increase on the first half of the prior year. In [indiscernible] industry segment achieved double-digit growth in the first half. I will now comment on each industry segment.

In the Private Enterprise Business segment, orders were up 11% year-on-year. Momentum for growth in Q2 exceeded that Q1. Primarily for modernization projects, growth was driven by customers in the manufacturing and mobility sectors.

In the Finance Business segment, orders were up 23%. In relation to deals of mission-critical systems for mega bank and insurance institutions, we also won modernization project deals, resulting in a significant increase year-on-year.

In Public and Healthcare segment, orders were up 27%. We won multiple modernization deals for upgraded systems for government agencies among customers in the health care industry as well, we are seeing our vital investments in electronic medical ecosystems and healthcare information systems. Below that is mission critical orders were up 12%. Orders benefited from project, including a systems integration project in the national security field. In our business in Japan, because of strong demand that has continued from Q1, order backlog is increasing, and that will lead to higher revenue in the second half.

Page 10 shows autos in regions international. Trends in orders differed by region. Orders for Europe declined by 27%, reflecting a pullback from the large-scale public sector deals we won in the prior year. Orders in the Americas increased by 81%, as we won multiple private sector business application deals in North America. This is over the prior year.

Orders for Asia Pacific were down by 1%, despite a slight pullback from the large cap public sector deals in the prior year, overall trend was solid. Page [ 11 ] is the progress of Fujitsu Uvance, which we are positioning as the most vital area for the growth of our business and the transformation of our business portfolio. Fujitsu Uvance consists of a total of vertical areas, which are cost industry areas that solve societal issues, and horizontal areas, which are technical performance that support the vertical areas. There are a total of 7.

And overall revenue in the first half increased by 63% year-on-year to JPY 153.7 billion. This is a pace that may enable us to exceed our Fujitsu Uvance full year revenue target of JPY 300 billion. In the first half of the last fiscal year, Fujitsu Uvance accounted for 10% of Channel Services Solutions revenue, but that increased to 16% in the first half of this fiscal year.

In the supplementary materials, we include information on the status of orders, which are extremely positive, up 70% in the first half compared to the prior year. In the second half, primarily in the vertical areas, we will flow into multiple offerings that enable our customers to achieve sustainability transformation.

In addition, in the horizontal areas, in consideration from Q1 for what we call the 3 business applications consisting primarily of SAP, ServiceNow and Salesforce, there is still high demand. We are clearly acquiring our futures business, which is the key to our growth in our medium-term management plan.

Page 12, I will now comment on profitability improvements and the status of growth investments. Profitability increased by JPY 19.3 billion and gross margin improved by 1.3 percentage points year-on-year. Through the Japan Global Gateway, JGG; and the global delivery centers, we are making steady progress in the standardization of development work automation, expansion of enhanced work and use of offshoring.

The usage of a show of JGG has increased from 30% in fiscal 2022 to 34% in the first half of fiscal 2023. On the right-hand side, growth investments and expenses increased by JPY 12.3 billion increase in expense. Including development of Fujitsu Uvance offerings, investment needed to develop specialist talent and investment to strengthen our security, we continue to proactively invest in areas directly related to business growth.

This concludes my supplemental explanation of the increases and decreases in profit outlined in the chart on Page 8. On Page 13, I will briefly touch on the status of each subsegment in Solutions. First is Global Solutions.

Revenue was JPY 217.7 billion, up 18.2% from the prior year. On an adjusted basis, the subsegment posted an operating loss of JPY 2.6 billion, but it is an improvement of JPY 10.8 billion compared to the loss in the prior year. Fujitsu Uvance experienced faster than anticipated growth and large-scale sales of software supporting modernization also drove revenue growth. We are currently in a phase of making aggressive growth investments. But in addition to the impact of higher revenue, profitability is also steadily improving, which resulted in a large decline in losses.

In Regions (Japan), revenue from continuing operation was JPY 571.1 billion, up 11.9% from the previous year. The adjusted operating profit was JPY 72.2 billion, an increase of JPY 36.5 billion, roughly 2x the level of previous fiscal year. The number of DX business deals and upgrades of mission critical systems are increasing the wide range of sectors, primarily in the public and health care sectors.

In addition to the impact of higher revenue, we made steady progress in improving profitability. In Regions (International), operating profit was JPY 280.4 billion, up 9.4% against the backdrop of foreign exchange movements.

On an adjusted basis, the subsegment posted an operating loss of JPY 6.2 billion, a deterioration of JPY 3.8 billion from the previous year. In terms of profitability, the conditions continue to be difficult, primarily in Europe.

Page 14. I will first comment on Hardware Solutions on the upper portion. Revenue for the first half of fiscal 2023 was JPY 477.5 billion, a decrease of 3.7% from the prior fiscal year. The adjusted operating profit was JPY 17.4 billion, down JPY 3.5 billion from the prior year. In System Products, the impact of higher component procurement costs came from the previous fiscal year was resolved. And along with the upgrade projects for our customers' mission critical systems, there was also higher demand for server and storage systems.

On the other hand, in Network Products, there was a large pullback from the strong demand of the previous fiscal year in both Japan and North America, resulting in drop in revenue. For this fiscal year's Network Products, in the midst of a decrease in sales due to large-scale demand cycle, we are expanding our development investments for the next growth cycle, including our investments to achieve high speed, high capacity, low latency and low energy consumption networks.

On the bottom of the slide, you see Ubiquitous Solutions. Revenue was JPY 130.7 billion, down 1.8% from the prior year. The adjusted operating profit was JPY 9 billion, up JPY 4.6 billion from the previous fiscal year. With regard to the higher component costs, including the impact of the ForEx movements, we are advancing efforts to cut costs and pass onto sales prices, and we are steadily increasing our resilience to changes in the external environment.

Page 15, I will now comment on Device Solutions. Revenue was JPY 142.6 billion, which was 31.3%. There was a significant decrease from previous fiscal year. The adjusted operating profit was JPY 9.3 billion, down JPY 41.8 billion from the previous fiscal year. The demand for semiconductor packaging, which had been strong through the first half of the prior first fiscal year, significantly decreased in the second half of the prior fiscal year. There was no recovery in the first half of this fiscal year and trend has continued in the first half of this year.

In addition, factory operation also declined due to the reduction in volume. As a result, OP decreased significantly. We anticipate modest recovery at the end of this fiscal year, but the segment had a rough first half.

On the bottom of the slide, you can see Inter-segment Elimination and Corporate. This segment posted an operating loss of JPY 48.5 billion with a JPY 27.6 billion increase in expenses year-on-year. We continue to expand our investments in medium to long-term business growth, including enhancing advanced research in cutting-edge areas such as AI, quantum computing and energy saving processors and promoting the One Fujitsu program for enhancing our management of foundation.

On Page 16, you see the status of cash flows. Core free cash flow, which excludes one-off items, was JPY 91.1 billion, up JPY 27.4 billion from the previous year, primarily due to greater working capital efficiencies. At the bottom of the page, you can see the free cash flow, which was JPY 34.6 billion.

During the first half of fiscal 2023, Fujitsu purchased GK Software, a German software company for the retailing industry to enhance Fujitsu Uvance's offerings. As a result of cash-out relating to the company's acquisition, other factors. Free cash flow was down JPY 12.6 billion from the prior fiscal year.

Page 17 shows the status of our assets, liabilities and equity. I will omit an explanation of these figures. This concludes our financial results for the first half. There is not a slide for this, but I would like to share additional information about the status of our forecast for fiscal 2023.

Service Solutions is progressing in line with our forecast. Orders and pipeline of projected orders for this segment continued from the first quarter to be strong in the second quarter, primarily in Japan and the Americas, which matched our forecast. Against this fact, our analysis shows that we can expect orders to currently expand from the second half of the fiscal year onward.

By steadily releasing Fujitsu Uvance's offerings and making progress on transforming our delivery of sources through simple hard work, we believe we can expand as we planned both the volume and profitability of our business in Service Solutions, which is our growth driver.

On the other hand, in Device Solutions, although we expected demand would be sluggish, it is taking longer than we originally anticipated for customers to adjust their inventory. So our sales volume did not meet our forecast. This resulted in the segment's base operating profit took short of our forecast by several billions of yen. Starting from the next page, I will discuss our full year financial forecast.

Page 19. This is our financial forecast for fiscal 2023. As I previously mentioned when explaining our financial results for the first half, we anticipate that a full-scale recovery in demand of Device Solutions will be delayed until next fiscal year, and this change had been reflected in our financial forecast. As a result, on a consolidated basis, we are projecting revenue of JPY 3,810,000,000,000, with an adjusted operating profit of JPY 320 billion and adjusted profit for the year of JPY 208 billion.

Compared to our previous forecast, the more cash revenue has been revised downward to JPY 50 billion with the adjusted operating profit to JPY 20 billion, and adjusted profit for the year revised downward by JPY 10 billion.

Page 20 is our final forecast for fiscal year 2023 by segment. Service Solutions has experienced very strong growth during the first fiscal -- first half, and we believe that we can achieve high range target that we have set. Our projections for Hardware Solutions and Ubiquitous Solutions at the same time as our previous half. The only revision was in the Device Solutions.

On Page 21, we break down our forecast for the first and second halves of fiscal year '23 by segment. So I will touch upon Service Solutions. The segment posted an adjusted operating profit for first half of the fiscal '23 of JPY 63.4 billion, up JPY 44 billion year-on-year. For the second half of this year, we anticipate an adjusted operating profit of JPY 109.5 billion, up JPY 47.5 billion year-on-year.

Although the trend of operating profit being concentrated in the second half of the year remains unchanged, the progress made in the first half was slightly better than the previous year. Also, we anticipate that the increase of the OP for the second half will be on par with the increase in the first half. Page 22, core free cash flow. It reflects downward revision to operating profit for Device Solutions.

This concludes our financial forecast for fiscal 2023. In the first half of fiscal 2023, although we saw a delay in the recovery of demand for Device Solutions, Service Solutions, our main driver of growth made very strong progress in revenue and adjusted operating profit. There is some uncertainty in economic environment, so it is impossible to make predictions. But we will work to achieve solid results for growth as we build up our current backlog of orders and maintain our current momentum against the backdrop, making progress and profitability improvements. This concludes my presentation.

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