Lenovo Group Ltd

HKEX:992

Earnings Call Transcript 2019-Q1

[Hugh Wu, executive]

Good morning, and good evening. Welcome to Lenovo's Quarter 1 Result Webcast. This is Hugh Wu, Vice President in IR and [indiscernible] at Lenovo.

Before we start, let me introduce our management team with us today. We have Chairman and CEO, Mr. Yang Yuanqing; President and COO, Mr. Gianfranco Lanci; Group CFO, Mr. Wong Wai Ming; President of Data Center Group, Mr. Kirk Skaugen; President of Motorola, Mr. Sergio Buniac.

We will first start with our presentation. After that, we will take your questions. Now let me turn it over to Yuanqing. Yuanqing, please.

[Yang Yuanqing, executive]

Hello, everyone. Thank you for joining us to discuss our financial results of the first quarter fiscal year 2018/'19 and our progress in executing our 3-wave [ strategy. ]

Four quarters ago, I shared with you that Lenovo has passed the turning point, and now we are in the face of acceleration, accelerating our transformation strategy execution as well as the upward momentum in business performance.

For the second straight quarter, we saw strong double-digit growth in revenue year-on-year. Global revenue reached almost USD 12 billion, up 19% year-on-year. Profits also followed the momentum. Our pretax income was USD 113 million, an improvement of more than USD 182 million year-on-year. Our profitability improved across all our businesses.

Since we combined the PC, mobile and the smart devices into Intelligent Device Group last quarter, the new group is energized by synergy from the shared platforms and resources. IDG delivered a double-digit top line growth and improved the profitability year-on-year. We remain committed to driving the convergence of computing and communication technologies to enable smart IoT and capture future opportunities through executing our 3-wave [ strategy. ]

In the first wave, our PC+Tablet business continued to deliver strong double-digit growth for the second consecutive quarter, while we maintained the industry-leading profitability of 5%. In PC, we were the fastest-growing player among the top 5, according to IDC. Our revenue grew almost 20%, 12 points premium to the market, driven by strong growth in commercial segments.

Commercial mix reached historical high of 63%. The integration of Fujitsu further solidified our position in PC industry. We have returned to worldwide #1 last quarter in PC by Gartner. We have been #1 in overall PC+Tablet for 4 consecutive quarters by IDC.

We will continue to sharpen customer engagement through direct route to market like e-commerce, relationship model for large accounts, invest in high-growth segments like workstation, gaming, thin and light to drive growth. And we will continue to strengthen our focus on premium products to achieve higher average selling price for better top line growth and profitability. With these efforts, we are confident in sustaining our premium to market growth while maintaining industry-leading profitability.

Our second wave business, mobile, is definitely improving its health through executing the clear [ strategy. ] First, we'll reduce operating expenses by more than $100 million year-on-year. In fact, our goal for this fiscal year is to control the annual operating expense of Motorola business to below USD 1 billion. This means we will reduce the expense by USD 800 million since we acquired this business over 3 years ago.

Second, we'll refine our product portfolio and successfully launch the Moto G6 and the E5 products. Third, we focus on selected markets where we can compete and make a profit.

In Latin America, we continued to outgrow the market in both revenue and volume for 7 quarters in a row. In North America, our volume nearly doubled year-on-year. This is the fourth consecutive quarter of more than 50% year-on-year growth, driven by the wider scaling strategy to expand to all 4 major carriers.

In key emerging markets, China and India, we are committed to further investing in the right brand [ strategy ] and the product portfolio and quickly return to healthy growth. We will continue to invest in innovation. And this month, we announced that the 5G upgradable phone, Moto Z3, in the U.S., with the 5G mod scheduled to ship early next year. We will be the first company to provide the 5G mobile experience to customers.

Another second wave business, data center, is on track to become a sustainable growth and a profit engine for our company. Revenue grew almost 68%, highest since IBM x86 acquisition. And the profitability improved 11 points year-on-year, accelerating double-digit growth for the third consecutive quarter, driven by software-defined infrastructure, high-performance computing and artificial intelligence and hyperscale.

Hyperscale revenue grew triple digit once again while improving gross profit and diversifying our customer base. In addition, Lenovo surpassed HP to become #1 supercomputer provider on the TOP500 supercomputing list with 117 systems. Software-defined accelerated further, driving triple-digit growth year-on-year as well.

We will continue executing our current strategy to improve our hyperscale business model by further expanding our in-house design and manufacturing capability, strengthen our leadership in high-performance computing and AI, grow storage and networking and continue to drive service attach and revenue growth. We will also move aggressively into growth markets like NFV and Edge computing.

In the third wave, we are also making good progress in Smart IoT + Cloud and Infrastructure + Cloud. We are shipping Mirage Solo VR headset and camera smart display in the United States and received very positive feedback. Our consumer smart IoT-based services started to generate revenue in China, Japan and Brazil. Similarly, our smart office also provided key wins at commercial customers like Microsoft and [ Michelin ].

And the Device-as-a-Service business has acquired large deals in Asia Pacific. We are also providing Vertical intelligent solutions and piloting commercial IoT-based industry solutions in selected vertical industries.

Driven by these efforts, our services and software revenue reached almost USD 460 million. With a firm belief in our direction and persistent execution, it is clear that Lenovo has turned the corner. I'm confident that as our execution of transformation strategy and the performance growth accelerate with all cylinders fired up, sustainable returns will follow.

Thank you very much. Now let me turn it over to our CFO, Wai Ming. Wai Ming, please.

[Wai Ming Wong, executive]

Thank you, Yuanqing. I will take you through Lenovo financial and operational performance in Q1 fiscal year 2019.

Next chart, please. Let me first share with you income statement highlights for the quarter 1 performance. Our transformation actions continue to show consistent and accelerated result improvement in Q1. Our revenue grew 19% year-on-year and achieved a record high first quarter with strong PTI improvement year-on-year, led by strong revenue performance from both PCSD and DCG.

Gross profit increased by 20% year-on-year, while gross profit margin increased 0.01 percentage point year-on-year to 13.7%. The result was driven by better business performance in both PCSD and DCG.

Operating expenses increased by 6% to around $1.5 billion, where the expenses to revenue ratio decreased 1.5 percentage points year-on-year to 12.2% mainly due to the expense saving from both the repositioning of strategy in MBG and the group revenue growth.

Group PTI was $113 million, which showed an improvement of more than $180 million from a loss of $69 million a year ago. All business group profitability have been significantly improved.

Profit attributable to equityholders for Q1 was $77 million, also meaningfully improved from a $72 million loss from a year ago. Basic earnings per share for the quarter was USD 0.00065 (sic) [ USD 0.0065 ] compared to a loss of USD 0.00066 (sic) [ USD 0.0066 ] last year.

Next chart, please. Cash generated from operations was at $336 million in Q1, improved from growth year-on-year and quarter-to-quarter thanks to the operational and working capital improvement during the quarter. At the end of quarter 1, we have net debt of $1.8 billion versus $1.3 billion of net debt in the previous year. The high debt position was mainly due to the utilization of additional revolving facilities to finance business expansion.

In Q1, the cash conversion cycle was negative 8 days, 7 days worse year-on-year due to longer inventory days that resulted from our component buy-ahead plan for PCSD and DCG businesses. We expect the buy-ahead will subside in the upcoming quarters with inventory days improving.

Next chart, please. In the first quarter, after we combine PCSD and MBG into the Intelligent Device Business Group, IDG has been able to drive synergy from shared platform and infrastructure, which helped the group expand our ecosystem and achieve healthy revenue growth with profit improvement both year-on-year and quarter-to-quarter on a pro forma basis. The strong double-digit revenue growth were driven by our strong PC business. The PTI margin improved year-on-year for 3 consecutive quarters, driven by PCSD business, which was able to give us industry-leading profitability of 5% while MBG continue to improve its profitability as planned.

Next chart, please. Our PCSD business delivered another strong quarter with 19% year-to-year revenue growth, which is the second consecutive quarter to achieve the double-digit growth even without the contribution from the JV with Fujitsu with our organic growth at 12%. The strong growth not only come from the continued healthy growth from our commercial businesses and workstation products but also from the continued strength in the fast-growing interest, including gaming, thin and light, and visual products, which all achieved double-digit growth in quarter 1.

The group third wave transformation also shows solid growth in Q1 in ramping up its services and e-commerce business that recorded strong double-digit revenue growth, showing our strength in direct reach to users. In addition, the group also launched several new smart devices in consumer smart IoT, including Mirage Solo, Mirage Camera and Daydream, Smart Display with Google, and in commercial IoT, including Smart Office or core Hub 500, smart enterprise solutions with Lenovo big data and Lenovo Connect. These smart device launches demonstrated the group's innovation and leadership in technology.

Revenue in Q1 was $8.3 billion. Pretax income was $418 million, up 43% year-on-year. PTI margin improved 0.08 percentage point to 5% level. Our PTI margin has shown quarter-to-quarter improvement since the previous financial year, driven by improved product mix, focusing on high-growth premium segments and with improved services attach rates.

Next chart, please. For our Mobile business, our execution of turnaround strategy was on track to improve profitability during the quarter thanks to the continued strong momentum in Latin America and North America and the inventory clearance along with our repositioning in emerging markets. Our expense reduction actions were also executed well, thus resulting in a more efficient cost structure and improved margins.

Revenue improved 23% quarter-to-quarter, and pretax loss was narrowed by $44 million quarter-to-quarter and $75 million year-on-year, reflecting signs of business stabilization with our repositioning strategy. We will continue our strategies to streamline product portfolio to reduce the business complexity and continue our focus on increasing scale in the mainstream segments to further improve profitability over time. Reported PTI margin improved 4 percentage points year-on-year thanks to the expense action, resulting in a more competitive and efficient cost structure.

Next chart, please. Our Data Center Group is on track to become a sustainable growth engine for Lenovo. Q1 revenue continued its double-digit growth for 3 consecutive quarters, and the growth of 68% in Q1 is the highest since the acquisition, while the PTI margin continued to improve for 5 consecutive quarters, our GEOs saw high double-digit revenue growth. In North America, we even achieved a triple-digit growth, which is already the fifth consecutive quarter of growth.

In China, we also deliver our record revenue in Q1 with more than 50% growth year-on-year. Our product segment performance, our hyperscale segment achieved triple-digit revenue growth, while margin improved significantly. Our gross margin showed an increase of 13 percentage point year-on-year thanks to our previous efforts in building our in-house design and manufacturing business model and diversifying our customer base.

Our high-performance computing business has become worldwide #1 in the TOP500 list, and the software-defined segments also achieved triple-digit revenue growth during the quarter. Meanwhile, our traditional infrastructure business continue its positive growth trend with strong momentum in the Flash-based storage solutions with more than 40% growth year-on-year.

Revenue from Data Center business was up 68% year-on-year to $1.6 billion in Q1. Our PTI margin improved significantly by 11 percentage points, and pretax loss was narrowed to $63 million in the quarter.

Next chart, please. Looking ahead, we'll continue to focus on driving profitable growth, building on the strong results of the last few quarters. As Yuanqing mentioned, the formation of Intelligent Device Group, combining PCSD and MBG, allow us to drive synergy from the shared platform that we have been building. We'll continue to drive premium to market revenue growth and maintain our industry-leading profitability for our PCSD business. We'll continue to improve the user experience with our innovation products and to drive future growth. Our smart devices are in the go-to-market phase, starting to contribute to our revenue.

For Mobile business, we'll continue to execute a strategy of reducing complexity, streamlining portfolio, driving a more competitive cost structure and continue to significantly reduce operation loss. Meanwhile, we'll focus on driving profitable growth from core markets, growing our strong position and profitability in both Latin America and North America, and strengthening our presence in mature market. We'll also continue our investment in innovation, just like our recent effort to launch the first 5G upgradable phone in the world.

For Data Center business, we are confident to deliver sustainable profitable growth over time. We establish a solid foundation through our organization structure, product portfolio and sales force to drive long-term growth. We'll continue to outgrow the market in software-defined infrastructure. Meanwhile, we'll continue to strengthen our leadership position in high-performance computing and AI; invest further in servers, storage and networking; and continue to expect momentum in our hyperscale business thanks to our unique in-house design and manufacturing business model.

Our industry has now quickly moved into the Smart IoT era. Hence, we will accelerate the convergence of the different technologies and devices, enabling us to address more market opportunities in the future and to drive our Smart IoT + Cloud business to the next level. Coupled with our competitive cost structure and efficiency, we are confident that our profit improvement will continue, and we remain confident in our vision and strategy to deliver long-term profitable growth.

Thank you. Now we can take your questions.

[Yang Yuanqing, executive]

Thank you, Wai Ming. [Operator Instructions] All the Q&A will be English only. Operator, would you please give us your instructions?

[Operator]

[Operator Instructions] We have our first question from the line of Gokul Hariharan from JPMorgan.

[Gokul Hariharan, analyst]

First question on the mobile side. Can you talk a little bit about the strategy in mobile? Is there any strategy to come back into markets like China and India once you strengthen the portfolio a little bit? And the second question I had -- or second part of the question is, is there any profitability target that you have in mind now given the losses have started to narrow quite a bit? That's my first question. The second question is, you are starting to break out your services and software revenues in the last several quarters. I think last year, it hit about $1 billion-plus of revenues -- last fiscal. And this quarter, I think it's about $450 million. Could we have some detail in terms of what exactly are the parts that are included in the service and software revenues? And what is the underlying profitability in the segment compared to the hardware business? Obviously, it's likely to be higher, but could you give us some indication about what the profitability looks like in the segment?

[Yang Yuanqing, executive]

Okay. So I will invite our MBG leader, Sergio Buniac, to answer your first question.

[Sergio Buniac, executive]

Yes. So number one, we're still playing in emerging markets, including India. Warranties, we took a more conservative approach as we -- our target this year is to reduce the loss, right, and keep an eye on the losses quarter-over-quarter and year-over-year. But the dealer is still the same, right. We want to align our expense and shore up stability in that in core strengths. That includes playing the emerging markets with a more conservative approach, reduce complexity, keeping that innovation and profitable [ term ]. So nothing has changed. And in terms of profitability, our commitment still is to narrow the losses on a continued basis quarter-over-quarter and year-over-year, not more than quarter-over-quarter because of the magnitude.

[Yang Yuanqing, executive]

So Gokul -- so why we could improve our MBG business. So I think the period is we have the clear intent for this business. We want to turn around the business as soon as possible. So we have to further the initiatives and be focusing to achieve this [indiscernible]. So first, we've reduced the expense significantly. So last quarter, we have reduced more than $100 million year-over-year. So actually, we are very confident that this year, we can lock our Motorola business. So Motorola is the majority of our MBG business. We have run our Motorola business at below $1 billion expense. So that represents almost 50% year-on-year reduction if you compare to 3 or 4 years ago or right after we acquired the business from Google. Second is we are focusing on the mainstream products. We have successfully launched the G6 and the E5. So that's the reason. The third reason, we are focusing on the selected markets. So definitely and anyways, it's still our stronghold. So -- and also, we think we have more better opportunities by -- in mature markets, particularly North America. So actually, last quarter, we almost doubled our volumes in North America. So these strategic directions definitely give us the good results. But regarding of the emerging markets, so we will only be focusing on China and India to invest. So -- but definitely, the focus is to drive the profitable growth to our largest market in the world over time but definitely in China and India. So not only with sales of Motorola but also with sales of Lenovo as well. So that's related to the Mobile business. Yes, so we are more focusing on the -- our service business, so -- because we believe service business is one of the 3 pillars of Lenovo customer-centricity transformation. Another 2 are customer experience. So we must ensure the product experience, delivery, quality, so these kind of things, to customers. But secondly, the customer engagement. So we must ensure we have direct win [ deposit ] with our customers. So that means we must strengthen our e-commerce, our larger account directed relationship with this model. And also, we need to strengthen our consumer first class, so this kind of thing. That -- those are the first 2 pillars. The number -- the third pillar, our pillar -- the third service business, so definitely, we believe if we can expand our service business, that we will strengthen our customer-centricity transformation as well. So we have made a lot of progress in the past couple of quarters. So we are now focusing on the upscale service -- extension warranty service, premium service. And also -- and so those are related to the devices. And -- but meanwhile, we will strengthen our IoT+Cloud service as well in both the consumer side and the commercial side. So last quarter, I shared with you how we want to build the UDS platform: user, device and the services. So we have in the first half the result in China, in Japan and in Brazil. So we're quickly building the team to establish this business. And also, we see -- we are focusing on providing the intelligent solution for some vertical industries, leveraging the commercial smart IoT, so some active vertical industries. So that's why we can have the better service revenue last quarter. So we have things like the booking revenue for our service is increasing. So actually, last quarter, so the booking revenue increased by more than [indiscernible]. So that's a good segment to us. So over time, we're still going to have the better service -- or even better service revenue. So Gianfranco, you want to add something to the service?

[Gianfranco Lanci, executive]

No. Service, I think we are -- on top of premium, we're also running devices in service. We start to see some very good results. The pipeline is huge. But we also start to see some conversion from pipeline to contract. So I think, as Yuanqing said, we have seen the service growing more than 20% year-on-year. And talking about margin, it's probably 4x the margin we do. Between 3 to 4x the margin we make on the devices, just to give you an idea. And it's a combination of premium service and Device-as-a-Service.

[Yang Yuanqing, executive]

Yes, that's a good addition. Thank you, Gokul.

[Operator]

Our next question is coming from the line of Chris Yim from BOCOM International.

[Seeching Yim, analyst]

I was wondering if the management can comment on the near-term PC and DCG demand outlook with relations to the current commercial upgrade in PC, maybe back-to-school sales. And then on the DCG front, maybe on the -- comment on the continued hyperscale demand outlook. That's my first question.

[Yang Yuanqing, executive]

Okay. So Gianfranco will answer on the PC, Kirk for the DCG.

[Gianfranco Lanci, executive]

But on PC, I think -- as you see from both Gartner and IDC, we are back to growth not only on unit -- not only on revenue but also on units. I think on unit is the first quarter after, I don't know, I even don't remember how many years that it was negative. It is currently, in fact, speaking from, for sure, the upgrade to Windows 10 from enterprise. But we also see a very good growth on SMB, and this is coming from, I would say, overall economic environment. It's not really only coming from Windows 10 transition. Consumer is still slightly behind, I would say, mainly from emerging market. But if I look over the next -- for this year, I think we will continue to see good revenue growth and also some -- [ also ] decent [ CA ] growth in terms of the market. The only question mark is probably exchange rate. That is partially compensated by component growth because it's finally start to go down. But on the other side, we see the exchange rate going up. But I think, overall, we are quite positive. We are quite positive on PC in terms of PC demand and growth. We will continue to see the same growth at least for the next 2 or 3 quarters.

[Yang Yuanqing, executive]

Yes. Double digit.

[Gianfranco Lanci, executive]

Double digit.

[Yang Yuanqing, executive]

Double digit. Okay. So Kirk?

[Kirk Skaugen, executive]

Yes. On data centers -- this is Kirk. I think for hyperscale, as we mentioned last quarter, we have design wins now with 6 of the top 10 global hyperscalers. Our profitability is improving, and we still continue to see strong demand as we bring these design wins to production, which will happen over the next month and next several quarters. So some of these new design wins will be coming into the marketplace next quarter as well as the following quarter. So we've diversified the customer base outside of China. We've also diversified the customer base beyond the top 10 to the next 50 or so because about 40%, I think, of the volume in hyperscale is beyond, say, the super 7. So I think the business model we're using -- we're using our own factories now both in a motherboard level as well as a system level. And now doing over 30 custom products, customized to the unique needs of the super 7, is playing out quite well for us. I think we have more procurement power that's typical of yen. We have a supply chain that sells into 160 countries. And I think our quality has been world class. So I think we're quite bullish on hyperscale. Having said that, it is lumpier than a traditional business. So I think we just have to be aware of that. On the onprem, I think we do see a resurgence on the onprem as well. You see our results in software-defined infrastructure are triple-digit growth. Again, I think it's a testament to a few things. We don't have a legacy network or a storage business to protect, so we're very aggressively moving to the next generation of hyperconverged infrastructure. We've been the fastest or close to the fastest-growing OEM on the planet in software-defined infrastructure now for several quarters. So we're basically seeing a move from a traditional infrastructure to a software-defined. We're seeing us grow our share either 2x or 3x in that move. So the ThinkAgile brand, I think, from that perspective is quite strong. So we do see a resurgence of things like some of these hyperconverged infrastructures are providing a better cost structure for people that want onprem solutions. And as you saw this quarter, we announced the new composable cloud solution around ThinkAgile CP in an exclusive partnership with Cloudistics as well. So we're continuing to expand the portfolio beyond what we've been doing with VMware, Nutanix and Microsoft, Pivot3 and others. So thank you for the question.

[Yang Yuanqing, executive]

Yes, so the -- regarding of the PC, so our growth is mainly driven by the commercial, right. So we grow at a hyper rate, fast, so for example, our Fujitsu business, our enterprise public revenue grow close to 40% year-on-year, right. So our SMB grow by 27%. So actually, last quarter, our commercial mix reached 63%, a historical high. So I think that will also help our profitability because we can make a better profit in the commercial side. So that's what I want to share with you as well.

[Operator]

Your next question is coming from the line of Arthur Lai from Citi.

[Arthur Lai, analyst]

So my question will be focused on the DCG. So in Page 10, you highlight the revenue up over 60% and also profitability improved significantly. So can Kirk tell us that -- what drives the big change and also the -- what we can expect in the next 2 years? This is my first question. And second question is some investor, they just need to ask. Recently, they have been observed the server DRAM spot price start to decline, and they wanted to know is the positive impact to your profitability or actually is the size of the global server demand could be softening? This is my second question. That's it.

[Kirk Skaugen, executive]

Yes. I think if you look at the year-on-year revenue growth, it's been driven by things like our triple-digit growth in software-defined infrastructure, triple-digit growth in hyperscale computing. And then, as we have expanded our portfolio of storage solutions, particularly in Flash arrays, more than 40% growth. On top of that, we've grown our professional services business over 30%, and it's a profitable and growing entity. And we're increasing our premier services as well associated with that. It's quite good margins. So all of those are growth drivers. I think in the future, you should expect it to continue to increase our network attach, our storage attach and our services attach to continue to make inroads on profitability, I think -- overall, I think SSD pricing obviously has been okay and things like that, so that's...

[Gianfranco Lanci, executive]

It's not the demand declining. It's more capacity, [indiscernible] moving to 3D.

[Yang Yuanqing, executive]

So Gianfranco, want to add something to the...

[Gianfranco Lanci, executive]

No, yes, it was SSD and DRAM. They start to go down, but it's not because the demand is slowing down. It is because, most of the manufacturer, they are moving to -- they move to 3D and now capacity is much bigger than 6 or 12 months ago. It's not really because demand is slowing down. It is because there is much more capacity available.

[Kirk Skaugen, executive]

So last thing I would say about the DCG profitability is we've enhanced our training and our selling capability. So over the last year, we've trained over 11,000 certified experts. So they have the ability to sell higher-end, more profitable solutions versus just doing box pushing. So it's a more profitable sale for us based on a more technically trained channel and sales force.

[Operator]

Our next question is coming from the line of Wei Chen from Goldman Sachs.

[Wei Chen, analyst]

So your comments on the PC growth outlook for the next few quarters is pretty positive, and your mix of 63% in commercial PC is also pretty good. But in this reporting season, we've been kind of picking up some data points around a major CPU platform shortage risk in the second half of '18. Can you comment about how this could impact your business? Any risk -- any mitigation plans to move to a different CPU platform? That's my first question.

[Gianfranco Lanci, executive]

No -- yes, I think the entire world knows that there is a shortage on CPUs, so it's difficult to neglect it. There is a shortage. It's mainly on the new technology, while -- if you run on the tradition on the [ tabulator ], you -- it's more or less okay. The real issue that we've been working during the last quarter to go back to the old platform. On that account though, we are also running or working on alternatives to Intel CPU. I think we have today a very good offer from the AMD CPU, too. But we will probably need to do increase even more with the current situation. So there is an impact -- frankly speaking, I would say, we can manage the impact -- we can manage the negative impact within something very, very small. And then, what we said is that we will continue to see double-digit growth and on the high side of the double digit. We also take in consideration the CPU story. Without the CPU story, they probably can be even better. But I don't think that is going to impact -- frankly speaking, most of the industry is moving back to older technology or it's moving to alternative platform.

[Yang Yuanqing, executive]

[ Tabulator ] in the Chromebook, right, so in...

[Gianfranco Lanci, executive]

Even in Chromebook, in consumer, but frankly speaking, even on enterprise, we start to see alternatives to Intel growing nicely. And we start to work already more than 1 year ago. So we have the platform ready. This is a good thing from our side. We have -- most of the platform are ready.

[Yang Yuanqing, executive]

Well, now we are going to take the last question because of limited time. Please read your last question for the interest of time.

[Operator]

Our last question is coming from the line of Thompson Wu from Credit Suisse.

[Thompson Wu, analyst]

Just the first question is on the PC business. I would've thought with the higher mix of corporate in the quarter, we could have seen even better performance on operating margin or pretax margin. A very good job at 5%, but I thought we could assume better scale. How should we think about Fujitsu? Was that a headwind for margins? And if so, how can we think about cost in scaling over the next 12 months? That's my first question. And the second question has to do with the repurchase of the stake and the manufacturing plant for notebooks. How should we think about that plant's utilization over the next few years? Is that intended to build more notebooks? Or is the idea to transition that to build more data center to components like server motherboards? How should we think about that manufacturing within your overall production plans for your businesses?

[Yang Yuanqing, executive]

Gianfranco will answer your first question, and then our CFO will answer your second question.

[Gianfranco Lanci, executive]

But on the first question, you said that you thought that we could be even higher on commercial.

[Thompson Wu, analyst]

Correct. It's a very good performance already. It felt like with the higher record mix of corporate, perhaps pretax margin could have seen more growth. Just was thinking maybe Fujitsu had dragged that down in the quarter and there might be opportunity to...

[Gianfranco Lanci, executive]

No, but if you -- no, I think, as I said, we are 63% the measure against the consumers. I don't think you find any other company with the same mix today. Even though the other company, they said they are very focused on commercial, but at the end, what they push is consumer or Chromebook. Our percentage of Chromebook within the 63% is much smaller than other people. So this -- on -- the other thing when I look at -- when you look at the year-to-year improvement in terms of profitability, I think we are -- it's almost 1 point, right, 0.8. So we are from 4.2% to 5%. So it's a very good improvement, and it's mainly coming from, of course, commercial business. It's not coming -- commercial means both enterprise and SMB but not all consumer. The last thing, if I look at PC alone, only PC, our profitability 5.5%. Then we -- when we include the smart device, tablet [ there, ] it's going down to 5%. And I don't think we can expect much better than 5.5%. We will do our best to keep this for the next -- for the rest of the year. But if you compare with competition, we are running already at probably 2 points better than competition. So -- and SCOC I think just is -- and then I think when we can be much more beat than meet. But we are already running -- we are already producing something between 20 million to 25 million notebook a year in SCOC. So it's a big portion of our notebook, both consumer and commercial. And we'll also start -- starting -- we also produce both for third party, and we're also starting to produce both for DCG.

[Yang Yuanqing, executive]

For server.

[Gianfranco Lanci, executive]

For [indiscernible], for server. And we are being certified by Intel, so we are in a very good position in SCOC today, not only on PC but also in terms of motherboard for server business. But we will continue to maintain the 20 million to 25 million. And if we continue to see this growth, it's probably going to be 25 million to 30 million because it's growing together with our business.

[Yang Yuanqing, executive]

So Fujitsu a business that actually will not [indiscernible].

[Gianfranco Lanci, executive]

[indiscernible] No, sorry, I forgot Fujitsu. When you look at Fujitsu, I think that with the synergy -- but we still need to work on certain things to do as it's only the first 2 months. But with the synergy, Fujitsu will not drag the -- our margin down. It's not going to improve itself, but I think we are going to run Fujitsu with the same margin we are running the rest of PC worldwide.

[Yang Yuanqing, executive]

Actually, Fujitsu has a higher mix in the commercial.

[Gianfranco Lanci, executive]

It's even bigger on commercial.

[Yang Yuanqing, executive]

It's even bigger in the commercial rather than consumer.

[Gianfranco Lanci, executive]

And very good...

[Yang Yuanqing, executive]

That will help us on the commercial mix, and we believe the commercial business will not be just the growth driver but also the profitability driver as well. So that's our view.

[Wai Ming Wong, executive]

So probably I think you probably get it not 100% correct. I think the 49% shareholding in LCIG, that was owned by Compal. That be sold to an independent third party. It's not a repurchase by Lenovo. So our shareholding remain at 51%, and Gianfranco and Yuanqing just now already mentioned about having our continuing use of the tax rate to do, I think, not only PC but also our server business. But I just want to clarify that we do not increase, I think -- take the 49%, that was -- had been sold by Compal and into a third party.

[Hugh Wu, executive]

Thank you, everyone, for your participation in today's call. If you do have further questions, please feel free to contact me or our IR representative directly. This webcast replay and conference [ call ] replay will be available in the next couple of hours. Thank you again for joining us today.

[Yang Yuanqing, executive]

Thank you. Bye-bye.

[Operator]

Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.