Earnings Call: Q3 2019

Feb 21, 2019

Good morning and good evening. Welcome to Lenovo's Quarter 3 Earnings webcast. Thanks to everyone for joining us. This is Jenny Lai, Vice President of Investor Relations. Before we start, let me introduce our management team joining the call today. We have Lenovo's Chairman and CEO, Mr. Yang Yuanqing, Corporate President and COO, Mr. Gianfranco Lanci, Group CFO, Mr. Wong Wai-nin, President of Data Center Group, Mr. Kirk Skaugen, and President of Motorola, Mr. Sergio Buniac. We will begin with a presentation shortly, and after that, we'll open the call for questions. Without further ado, let me turn the call over to Yuanqing. Yuanqing, please. Hello, everyone. Hope you had a good start in the year 2019. Thank you for joining us today. For several quarters, I have talked about our accelerating performance driven by the strong execution of our intelligent transformation strategy. Today, I'm pleased to say, despite the tough environment, we delivered exceptional results across all our businesses. Our strong performance starts at the top line. Global revenue grew year-on-year for the sixth consecutive quarter, reaching $14 billion U.S., the highest in four years. Our pre-tax income reached an all-time record of $350 million U.S., up more than 130% year-on-year. As profitability improved in all our businesses, our net income significantly improved from the loss of $289 million U.S. last year to $233 million profits this year. Since its formation last May, our Intelligent Devices Group has improved both revenue and profitability every quarter. Our PC business delivered a record-high revenue and profit. Our revenue grew by 16%, outperformed the market by more than 17 points. Operating profit also improved by one point. We remain the undisputed number one in both PC and PCSD, with yet another record market share of 24.6% and a share of 17%. We focus on high growth and the premier segments. Our workstation, ThinkCentre line, and visual revenue outgrew the market by over 30 points, gaming by 16 points, and the Chromebook by over 220 points. While we maintained our revenue and profitability in China, we grew much faster and improved profitability outside of China. In our Intelligent Devices Group, we will continue to invest in high-growth segments, focus on customer centricity, and drive the convergence of computing, communication, and intelligent technologies. We are confident this business will continue to outperform the market. The more exciting story is that our mobile business become profitable worldwide for the first time since the Motorola acquisition. This result comes from strong execution of our strategy to reduce expense, simplify product portfolio, and focus on key markets. Our Motorola brand is on track to keep expenses below $1 billion U.S. for the year. In Latin America, we maintained profitability and a number two market position despite the currency volatility and the supply constraints. In North America, we had a breakthrough quarter with improved product portfolio. Volume outgrew the market by more than 40 points. Profit improved $90 million U.S. year-on-year and returned to profitability after six quarters. In China, we quadrupled our revenue year-on-year last quarter. Lenovo never stops innovating. Our Moto Z3 and 5G mod were announced as Verizon's first 5G mobile solution. We will continue to innovate and execute our strategy to resume profitable growth in our mobile business, particularly in our focused markets. Our Data Center Group business continues to grow. Revenue maintained a strong double-digit year-on-year hypergrowth, and profitability improved for the fifth consecutive quarter. This is the result of continued hypergrowth in Hyperscale and software-defined. Our Hyperscale business grows triple digits year-on-year, driven by a majority of new projects being designed and manufactured in-house now. The software-defined grew almost 70% year-on-year. We remained number one worldwide in the supercomputer rankings. We will continue to invest in technology leadership and building end-to-end product portfolios in our Data Center Group business. Our new joint venture with NetApp in China will further strengthen our portfolio and expand our business. We will also further develop our capabilities in software-defined, with the aim of becoming the segment leader. To become the leader and enabler of intelligent transformation, we will continue to drive growth through smart IoT, smart infrastructure, and smart vertical solutions. We demonstrated our execution of a smart IoT strategy at the recent Consumer Electronics Show. We are making devices like PCs and tablets smarter by adding voice and image engines to provide a more personalized service. For example, the Smart Tab we created with Amazon and Baidu. We are also developing smart consumer devices for homes, like smart clock, smart display, and more. Our DCG will drive smarter infrastructure by capturing the opportunities in cloud and edge computing. Our big data and smart vertical solutions revenue showed great progress, growing almost 70% year-on-year. Our software and service revenue continued double-digit growth, reaching $638 million last quarter. In closing, I want to share an analogy with you. I like to think of Lenovo as a mountain climber. Once we reach one peak, we immediately take aim at an even higher goal. Getting from one summit to another one sometimes means we have to go down first before we go up. It means we need to develop new tools, new skills, and discover new paths to reach new heights. But once we set a goal, we never give up. Today, I'm happy that the new strategy we put in place four years ago is showing strong results. New foundation of our company has been built, and Lenovo has returned to Fortune's list of most admired companies. With our strong execution, I'm confident that we will continue to climb and reach even greater heights. Now, let me turn it over to our CFO, Wai Ming. Wai Ming, please. Thank you, Yuanqing. I will take you through Lenovo's financial and operational performance in Q3 fiscal year 2019. Next chart, please. Let me first share with you the financial highlights of our Q3 performance. Lenovo delivered a strong quarter with many parts of our business setting new records through our robust execution of the intelligent transformation. Our group revenue was $14 billion, up 8% and 13% year-on-year, if currency impact is excluded. The revenue in constant currency at $14.6 billion was a record high to Lenovo, led by strong performance from both PCSD and DCG. Gross profit increased by 17% year-on-year, while gross profit margin expanded 1.1 percentage point to 14.6%, the highest in 10 quarters. The result was driven by solid margin expansion in PCSD and better profitability in MBG. We continued to drive operating efficiency, and our expense-to-revenue ratio was reduced by 0.4 percentage points to 11.5%. Group PTI was a record high at $350 million, up $200 million from a year ago. We saw PTI improvement across all business groups. Profit attributable to equity holder for Q3 was $233 million, significantly improved from a loss of $289 million a year ago. Basic earnings per share was 1.96 U.S. cents, compared to loss per share of 2.53 U.S. cents the same period last year. Next chart, please. Our operational cash flow continued to improve and show strong improvement both year-on-year and quarter-to-quarter, thanks to solid performance across all our businesses and strong execution in reducing our inventory in both finished goods and parts inventory. We expect this operating cash flow improvement to be sustainable and will continue to use our cash reserves to invest in business growth. Next chart, please. Intelligent Devices Group. Our Intelligent Devices Group, which includes PCSD and MBG, continued to demonstrate healthy revenue growth with profit improvement both year-on-year and quarter-to-quarter. Revenue growth remains solid at 6% year-on-year, driven by our strong PC business. IDG's PTI improved by 2.1 points to 4.7% year-on-year and is in the fifth consecutive quarter of improvement. PCSD improved its PTI margin to 5.4%. MBG reported its first pre-tax profit since the Motorola acquisition. Next chart, please. Our PCSD business has record high revenue with 12% year-on-year growth. This is the fourth consecutive quarter that we achieved double-digit growth. Our PC revenue grew 16%, outperforming the market by more than 17 points. Strong growth was recorded across the board in commercial business and the segments, including workstation, thin and light, visual, and gaming products. All of them continue with double-digit revenue growth in Q3. We have showcased several new smart devices and smart home products recently at the CES. These are part of our intelligent transformation strategy. PCSD revenue in Q3 was $10.7 billion, setting a new record and driven by market share gain. Its pre-tax income was also a record high at $584 million. We continue to drive market share in commercial and premium segments, resulting in better sales mix. PCSD PTI margin improved 0.9 percentage point to 5.4%. Next chart, please. For the mobile business, we achieved a pre-tax profit in Q3 for the first time since the Motorola acquisition. We executed well with our core market strategy and saw strong momentum in North America and solid business performance in Latin America. Coupled with our efforts in streamlining product portfolios and expense reduction, all this contributed to the profitability improvement. Reported PTI margin thus improved 6.1 percentage points year-on-year and 3.2 percentage points quarter-on-quarter. Our revenue is starting to show signs of stabilization, in contrast to revenue decline in the past several quarters due to our strategy to focus on core markets. We believe the transition is largely completed. A solid foundation has been built, and we are now ready to drive sustainable future growth. Next chart, please. Our Data Center Group delivered another strong quarter with solid revenue growth and profitability improvements. Q2 revenue continued its double-digit growth for the fifth consecutive quarter, while its PTI margin continued to improve year-on-year. Let me provide more detail on this segment performance. Hyperscale had another great quarter and maintained a strong triple-digit revenue growth with margin improvement, driven by incremental contribution from in-house design and manufacturing and customer diversification to more profitable orders. Software-defined infrastructure continued its hypergrowth for the seventh consecutive quarter, thanks to fast-growing hyperconverged systems. Our flash arrays growth also grew at a triple-digit rate, which is more than double the market rate. Revenue from DCG was up 31% year-on-year to $1.6 billion in Q3. PTI margin improved significantly by 3.6 percentage points year-on-year. Moreover, it is worthwhile to highlight the progress we made in our intelligent transformation. The device-as-a-service business continued rapid growth, with its booking revenue more than double quarter-on-quarter, up 111% quarter-to-quarter. Our big data and AI-powered smart vertical solution revenue also grew 68% year-on-year during the quarter. Next chart, please. Looking ahead, we will continue to build our strength as a global company with worldwide manufacturing capabilities, leading supply chain efficiencies with our extensive experience in managing the ongoing volatility in the macro environment. We aim to drive premium-to-market revenue growth and deliver industry-leading profitability for PCSD business. We will continue to improve our user experience, expand our innovative product lineup, and drive future growth. Our investment and capability building in the smart devices and smart IoT are gaining traction to become a future growth driver. For mobile business, we will continue to execute our strategy to resume revenue growth, especially in focus markets, while maintaining profitability. We will continue our strategy in streamlining our product portfolio and driving a more competitive cost structure. We will also continue our investment in innovation, such as our 5G upgradable phone, which will soon be available in the U.S. market. For the data center business, we are confident that we will deliver premium to market and sustainable healthy growth continuously. We have established solid capability in business model, product leadership, and sales and marketing to drive long-term growth. We aim to continue to outgrow the market in every segment where we participate, from IoT to software-defined infrastructure. Meanwhile, we will continue to strengthen our leadership position in high-performance computing and AI, and we expect growth momentum in our Hyperscale business to continue, thanks to our competitive advantages in design, manufacturing, and global fulfillment. In storage and networking, the NetApp strategic partnership and joint venture will capture more business opportunity for us to drive incremental growth. We will accelerate our intelligent transformation across all businesses. We will focus on converging different technologies and devices to address more market opportunities and drive our smart IoT business to the next level. Coupled with a competitive cost structure and strong execution, we remain confident in delivering long-term profitable growth. Thank you. I now turn it back to Jenny so we can take your questions. Thank you, Wai Ming. Now we are open the line for questions, and this session will be in English only. Please be reminded to limit yourself to only two questions at a time. Operator, I will turn it over to you. Please give us your instructions. Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. If you would like to ask questions on the phone, please press star one and wait for your name to be announced. If you would like to cancel your request, you can also press the pound or hash key. Once again, to ask questions, please press star one. We have the first questions from the line of Gokul Hariharan from J.P. Morgan. Your line is now open. Yeah. Hi. Great results, and thanks for taking my question. First question I had was on PC market. I think margins have now come back above 5%. Could you talk a little bit about some of the dynamics in the PC market? First of all, enterprise PC has been pretty strong last year. How much longer do we expect the upgrade cycle-related strength to continue given some of the macro volatilities? Secondly, could you also address what has been the impact that you've seen in the December quarter from CPU shortage, and is that a tailwind from a supply perspective as we go into the next one or two quarters as that situation alleviates? That's my first question. Our COO, Gian Lanci, will answer your question.