Lenovo Group Ltd
HKEX:992
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Lenovo Group Ltd
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Good morning, good afternoon. Welcome to Lenovo's Quarter 3 Result Webcast. This is [ Yu Hu ], VP in finance at Lenovo.
Before we start, let me introduce our management team with us today. We have Chairman and CEO, Mr. Yang Yuanqing; COO, Mr. Gianfranco Lanci; CFO, Mr. Wong Wai Ming; President of Data Center Group, Mr. Kirk Skaugen. We will first start with our presentation. After that, we will take your questions. Now let me turn it over to Yuanqing.
Hello, everyone. Thank you for joining us, and I wish each of you a very happy new year.
Last quarter, following our 3-wave strategy, our execution made solid progress. In the first quarter of this fiscal year, I mentioned that Lenovo has entered a new phase of growth. And the last quarter's result confirmed that we have delivered not only our commitment but also our best results in this fiscal year.
Our revenue was almost USD 13 billion, the highest in 3 years. Our pretax income was USD 150 million, up almost 50% year-on-year. It's also the first year-on-year growth in 5 quarters.
Our first wave, PC business, continued to deliver a strong premium to market revenue growth while maintaining industry-leading profitability. We saw strong year-on-year revenue growth in Latin America, Asia Pacific and Europe, Middle East and Africa. All geographies were profitable for the second straight quarter. We will continue to drive revenue growth while maintaining our leadership in profitability through continued investment in innovation and high-growth segments.
Our second wave, data center and mobile business, also showed more improvements. In data center, the transformation is making progress faster than expected. Data center revenue reached the highest level in 2 years while further improving profitability. Not only did we achieve strong revenue growth year-on-year in the largest data center markets, North America and Europe, for the third straight quarter, we also realized double-digit growth in China and in Asia Pacific. We also saw triple-digit revenue growth in software-defined infrastructure and hyperscale segments.
These are the fruits of our foundation building in the past years. Taking hyperscale, for example, we have improved our competitiveness by strengthening our in-house design and manufacturing capability and by providing customized solutions to our customers. As a result, we have won 6 out of the top 10 hyperscale customers in the world. We will continue to build solid foundation and invest in product and technology in hyperscale, software-defined data center and networking. We remain confident in our long-term plan to return to profitable growth in our Data Center business.
In Mobile business, we continue to see strong performance in our stronghold, Latin America, with nearly 40% revenue growth year-on-year while maintaining good profitability. In mature markets, our volume in North America outgrew the market by 90 points year-on-year, although we still need to sharpen our competitiveness in the high-end segment.
In emerging markets, we are fine-tuning our brand and product strategy to fit the local markets. We will continue to pursue our strategy for Mobile business, strengthening our leading position and profitability in Latin America; aggressively driving breakthrough in mature markets, including North America and Western Europe; and in the short term, maintaining healthy growth with controlled investments in emerging markets. We remain committed to making this business profitable.
In the third wave, we also made visible progress executing our Device + Cloud strategy. Our non-device revenue, driven by software and services, continued to grow, reaching more than USD 400 million last quarter. In the recent Consumer Electronics Show in Las Vegas, we won a record 80 awards and, more importantly, 2/3 of the awards were from our non-PC smart devices. The best examples include Smart Display, our voice-controlled smart assistant with display; Mirage Solo, our cable-free VR headset capable of reading your body movements; and Mirage Camera, a 3D VR camera that can film and livestream 3D VR content. While we will launch these award-winning star products very soon, our Star Wars AR headset launched during the holiday season was the clear #1 in the consumer AR market for the season. We will continue to develop AR/VR devices for both consumer and the commercial applications and build these devices into platforms so that various content providers can deliver their own content applications and services.
We also continue to strengthen our capability in artificial intelligence around the 3 key elements: data, computing power and algorithms. Our smart devices will leverage big data insights to provide more thoughtful services to our customers. Our supercomputing, cloud computing and edge computing capability will make computing faster and accessible from everywhere. And we will leverage our big data platform to drive industrial intelligence as well. Definitely, we continued to make progress in transforming our company last quarter. While we still have much work to do, I remain confident that we will reach a new stage of strong, sustainable growth.
Now let me turn to our CFO, Wai Ming. Wai Ming, please.
Thank you, Yuanqing. Now I will take you through Lenovo's financial and operational performance in Q3 fiscal year 2018. Next chart, please.
Firstly, let me share with you financial highlights for the quarter 3 performance. Our transformation is on track to deliver solid revenue growth, and pretax profit improved both quarter-on-quarter and year-on-year. Led by strong revenue performance from both PCSD and Data Center businesses, our revenue of $12.9 billion reached the highest level in 3 years, representing an increase of 6% year-on-year and 10% quarter-on-quarter. Gross profit increased by 10% year-on-year and 9% quarter-on-quarter, while gross profit margin increased year-on-year to 13.5%. This result was driven by better product mix from both PCSD and Data Center businesses, offset the impact of component cost increases.
Operating expense increased by 6% to $1.5 billion, E/R ratio stayed constant year-on-year at 12% and improved quarter-on-quarter from tighter cost control. Group PTI was $150 million, up 48% year-on-year. Operational profit before taxation was $212 million, excluding the Wuhan property disposal gain of $61 million, severance expense of $61 million and noncash M&A accounting charges of $62 million. This is the third consecutive quarter that we have had around $100 million quarter-on-quarter operational profit improvement. The improvement was mainly driven by the solid performance from PCSD, while the losses in both our DCG and MBG businesses continued to narrow.
On December 22, the new U.S. tax legislation was enacted, effectively reducing the U.S. corporate tax rate to 21% starting from 1st January 2018. As a result, the group recorded a one-time non-cash write-off charge of $400 million in Q3 on our deferred income tax assets, resulting in a loss after tax of $289 million against $98 million net profit a year ago. The write-off does not have any impact on our operations, and we believe a lower tax U.S. corporate tax rate will benefit our operations in the U.S. over time. Next chart, please.
Cash flow from operations remains solid at $211 million in Q3, slightly lower than $364 million in Q2, mainly due to the buy-ahead actions in key components during the quarter. We have net debt at the end of Q3 of $927 million against $155 million net cash in the previous year. The lower cash level compared to a year ago was mainly due to the repayment of $1.5 billion of Google promissory note in July in this fiscal year. However, cash level improved quarter-on-quarter on operational improvements as well as an issue of equity of $500 million during the quarter.
We continue to see improvement in our cash conversion cycle. In Q3, it was negative 16 days, an improvement of 3 days year-on-year. Next chart, please.
Global PC market continued to show signs of stabilization despite the continued component cost hike in Q3. Our PC business continue to do well and achieved a premium to market revenue growth. This is the fifth consecutive quarter of solid revenue growth. We recorded double-digit year-on-year revenue growth in Asia Pacific, EMEA and Latin America. Our PC business in China also regained momentum. We also continue to see good growth in workstation and gaming PC in Q3. Revenue in Q3 was up 8% year-on-year and 10% quarter-on-quarter to $9.3 billion, helped by PC ASP increase, thanks to more innovative products and better product mix, while our smart devices also started contributing revenue.
Pretax income was $416 million, up 13% quarter-on-quarter. PTI margin improved 0.1 percentage point to 4.5% level despite the component cost hike. Next chart, please.
Our transformation in the Data Center business is well on track. Revenue reached highest level in 2 years and profitability improved. All geo saw strong double-digit revenue growth as well as profitability improvement. Our transformation actions in China also started showing results in Q3 with both quarter-on-quarter and year-on-year margin improvement.
On the product segments performance, we continue to closing the gap with #1 player on the worldwide top 500 high-performance computing vendor list. We also achieved strong revenue growth and margin improvement in our hyperscale business, thanks to the operational improvement Yuanqing mentioned. Meanwhile, our software-defined solutions continue to grow rapidly with our industry partners.
Revenue from Data Center business, up 17% year-on-year and 26% quarter-on-quarter to $1.2 billion. Our operational PTI margin improved significantly, and operational loss before tax was narrowed to $56 million in the quarter. Next chart please.
For Mobile business, we continue our strong momentum in our core geography, Latin America in Q3 with double-digit revenue growth and maintained strong profitability. In North America and Western Europe, we continue to strengthen our presence with mainstream models and carrier expansion while continuing to work on the product competitiveness of our high-end models. And in Asia-Pacific and emerging markets, we continue to face challenges on intense competition. And our brand transition in emerging regions of EMEA was slower than expected.
Revenue declined 5% year-on-year but was flat quarter-on-quarter at $2.1 billion, thanks to the increased average selling price despite the slower shipment performance. While operational loss narrowed year-over-year and quarter-to-quarter despite component cost increase, while operational PTI margin improved 0.7 percentage point year-on-year and 2 percentage point quarter-on-quarter, thanks to the margin improvement in both North America and Latin America.
Looking ahead, we will continue to drive better performance under our 3-wave strategy that was already started showing results. Although sudden component cost hike may continue to bring challenges to our operations in the short term, especially in Q4, which is typically the slowest quarter in the year. However, operational profit will continue to improve year-on-year on better fundamentals. We will continue to drive premium to market revenue growth and maintain our industry-leading profitability for our PC business. We'll continue to improve user experience with our innovative products and channel reform to drive future growth.
Our smart devices are now in the go-to-market phase, and starting to contribute to our revenue. To continue the success of our Star Wars AR handset, we will be launching those CES award-winning smart devices soon.
For Data Center business, our transformation is well on track, and we will continue to improve revenue and profitability over time. We have established a solid foundation with a right organizational structure, product portfolio and sales force to drive sustainable growth. We continue to experience strong momentum in our hyperscale business, thanks to our unique in-house design and manufacturing business model. We continue to demonstrate our fast time-to-market capability as we lead in the Purley transition. Meanwhile, we will continue to strengthen in high-performance computing and software-defined infrastructure.
For Mobile business, we will remain in our strong position and profitability in Latin America, strengthen presence in mature markets such as North America and Western Europe and fine-tune our product strategy in key emerging markets to fit local market demand and focus on profitability.
Looking forward, we still see challenges, including component cost increase and a fierce competition in emerging markets that could impact our short-term performance.
To conclude, the group now has a more customer-focused organization and a more compelling product portfolio across all our businesses led by our 3-wave strategy, enabling us to address more market opportunities. Coupled with our competitive cost structure and solid execution capability, we are confident that our profit improvement will continue, and we'll remain confident in our vision and strategy to deliver long-term profitable growth.
Thank you. Now we can take your questions.
Thank you, Wai Ming. [Operator Instructions] The Q&A will be in English only. Operator, could you please give us your instructions.
[Operator Instructions] Your first question comes from the line of Gokul Hariharan from JPMorgan.
A couple of questions. First, on the data center business, Could you talk a little bit about your strategy on hyperscale? You mentioned that you've won 6 out of 10 hyperscale customers. What has changed I think? And could you also mention how does the economics and profitability in hyperscale business looks right now compared to your core enterprise business? I remember that about a year back, especially in China, it was actually a very low-margin business. How has that changed? That's my first question. Second, on mobile. It increasingly feels like the business is primarily a LatAm and North America business, while in Asia Pacific and Eastern Europe and China, I mean, the market seems to be extremely competitive but no meaningful profitability for any of the players. Is the company starting to think about kind of ring-fencing some of the mobile businesses to the more profitable areas where Lenovo Moto is typically strong? Or do we still have aspirations to try to gain share back in Asia Pacific and Eastern Europe? And maybe touch up on the profitability angle on mobile as well.
Thank you, Gokul. So I would ask our data center -- DCG President, Kirk, to answer your first 2 questions.
Yes. So as we mentioned in the last earnings call, we've been transforming the business model on hyperscale. Most importantly, we've gone much deeper in engineering and customer centricity and understanding the unique needs of our hyperscale customers. So we are building now a unique engineering team which understands the environment that each of these unique hyperscale customers require. So we're building customized products that we hadn't done, for example, a year ago. That starts at a customized motherboard level. We're then putting into our own motherboard factories, which is the unique differentiation Lenovo has relative to other multinational companies, and we're also expanding the capability we have at system level integration, all the way at the rack level. And we've opened up new factories, for example, in Europe that's enabling us to have a much more efficient supply chain. So it's really a completely transformed business model where we're able to deliver much better profitability but also better customer centricity by meeting the unique needs of each of these customers, which, at their scale, they require customized solutions. And then lastly, I think we've got a -- in many parts of the business, we have a different leadership team. So this business is now being managed by Paul Ju, who is one of the founders of originally Wiwynn, so he knows how to do this very cost effectively. And so I think we have a very cost-centric view of the world as well. So I expect that this business will continue to improve its profitability as the mix shifts from Broadwell to Purley. We have a better cost structure around Purley. And so as we move that business model, you'll see both the revenue and the profit continue to improve in the future.
Yes. Regarding the mobile business, so as I said at the opening, so we have a clear strategy for this business. We will continue to strengthen our leading position and the profitability in Latin America. So we will try to break through in mature markets, particularly U.S. and North America. And in the short term, we will maintain healthy growth with controlled investment in emerging markets. We remain committed to making this business profitable. So actually, last quarter's performance, so you can see, so we still have a very strong business in Latin America. So not only do we grow by -- so that's 7% year-on-year. So actually, we made money from the market. So in North America, actually, we grew by 85% year-on-year so by volume. So -- but definitely, we still need to sharpen the flagship product to attract more share in the premium price in mature market. So that will be the overall strategy for our Mobile business. Thank you, Gokul.
Next question comes from the line of Arthur Lai from CCPI (sic) [ Citi ].
This is Arthur Lai from Citi. And I will have one follow-up question on the DCG. So I recall, 1 or 2 quarters ago, you mentioned that you want to expand or enhance the service business with data center in the U.S. market. Can you share with more color on that segment? We think this is a segment with more stickiness in the future.
Yes. I understand your -- this is Kirk. If I understand your question correctly, it's how are we performing around the North America market?
In terms of service.
In service. Yes, so I think 2 things. One, North America, I think, is again recovering quite nicely for us. The services and the attach rate on services continues to go up. It's mitigated by the fact that our installed base has been shrinking. But I think as you look at the number of attach rates of the new servers that we're bringing into the marketplace, our services attach rate is up -- they're up nicely with obviously improving margins. So I think we -- what you see as a result is installed base has been going down overall, so that has mitigated some of the growth. But I think our sales force is doing a nice job of delivering a higher services attach on the new platforms around the Purley transition, North America and globally.
The next question comes from the line of Ken Chui from RHB.
My first question will be about the enterprise segment. It's because at the beginning of this year, some semiconductor players, they are very positive on the deferment of high-performance computing. So what -- how do you see the trend of high-performance computing? Would it become a major growth driver for your enterprise segment? That will be my first question. And my second question is that I also look in some of also your PC and Enterprise segment, they talk about that actually in high-performance computing, they could capture more value, so what is your opinion on that comment? Would maybe high-performance computing become a kind of an enhancement, also bring some enhancements to the profitability of your enterprise segment? That's my second question.
Yes, so I think there are 2 parts to your question. One is, I think, top 500 supercomputing and how HPC and AI play into that, and then the broad HPC market. So I believe IDC still views the broad market and Lenovo as the fastest growing HPC company year-on-year, about 17% growth. Within the top 500, we've significantly improved our position relative to the goal, I've said publicly, of becoming the #1 supercomputer company by 2020. I think we're well on track, if not slightly ahead, of our plan to do that. This quarter, we announced our largest-ever supercomputer win in North America, it's SciNet, also largest computer in Canada. We also announced the largest supercomputer win ever in Europe, which is almost I think 3x the size of what we've installed, which is the largest Purley supercomputer in Barcelona, Spain. So with LRZ in Germany, we now have the largest supercomputer in Germany. So that means we have the fastest supercomputer in Italy, Spain, Germany, Denmark, Norway, Australia, Canada and #1 in total number of installations in China. So I think that shows strong momentum. On top of that, each of these folks are starting to play artificial intelligence. So we've announced a significant investment in 3 different artificial intelligence labs in Beijing; Stuttgart, Germany and Raleigh this quarter. And I think lastly, our products, as we've said, the Purley transition from Intel was a significant momentum shift in the industry where we're gaining share. So at the latest supercomputing show, we were named Readers' Choice for not only best server but best storage in the supercomputer market. That's -- so that wasn't a magazine, that was actually the readers voting, and Lenovo achieved so both the best server and best storage award. So we feel quite strongly about our global position for HPC and supercomputing, and it's a foundation for growth in AI that we'll see in the future as well.
And also we installed a supercomputer for Beijing University. It's a water cooling system, and we have another one in India as well.
Yes, thank you. I think this is clear innovation that we're doing. We're in our third generation of warm-water cooled supercomputers. So obviously, these computers take a lot of energy, they're actually analyzing things that are good for the world like helping solve climate change. But we're also sensitive to how much energy these computers consume, so we have multiple dozen patents pending on our water cooling technology. And for example, the Germany supercomputer, Peking University and also now one of the large supercomputers in India for the space administration, all are using our warm-water cooling technology to deliver not just the fastest supercomputers but some of the most energy-efficient computers on the planet as well.
Next question comes from the line of Harvie Chou from Crédit Suisse.
This is Thompson. We -- if we can just switch gears maybe to the PC business, saw very strong growth this past quarter, much better ASPs, pass-through component cost. I guess as a 3-part question, just really going to 2018, maybe we can kind of explore how Lenovo sees the gaming market and kind of how Lenovo plans on attacking this category. Also just a quick update, if we can, on the partnership with Fujitsu. Is that on track to close? I think it's -- it was originally targeted by the end of March 2018, if we can just get a quick update there. And then just bigger picture kind of where we are kind of in the current PC cycle. Where do you expect growth in over the next 12 months? And is it going to be a continuation of Asia Pac, LatAm and EMEA? Or do you see other areas that are starting to correct in terms of demand?
So I will invite our COO and President of PCSD, Gianfranco Lanci, to answer your question.
Okay, thank you for the question. On gaming -- okay, we will continue to see gaming growing at the kind of speed that is -- when you look at revenue, it's growing between 30% to 40% year-on-year, right? And we just got, I think, a few days ago, GSK result for November. I think the good thing is that we are #1 now both on revenue and unit, with even stronger growth on both revenue and units than the market. So clearly, what we have been doing during the last 12 months in terms of new product and new platform introduction is paying off. So gaming will continue to be a key focus in 2019 because the market will continue to grow and, of course, because we want to continue to grow even faster than the market. On Fujitsu, yes, we are...
[indiscernible] premium to the market.
Yes, to the market. On revenue, it's even a little bit more close to 10 points on gaming. On Fujitsu, yes, we are on the right track to close by the end of March. We don't see any major obstacle or any issue preventing us to close by end of March. When we look at PC, I think one good sign last quarter, it told us for the first time after I don't know how many quarters, not only revenue but even units, they were back to growth, right? And revenue, I think, will continue to grow in 2019. I'm not confident that CA will continue to grow, but probably CA will stabilize, but revenue will continue to grow also next year. And our plan is, again, to maintain the 5-point premium to the market in terms of revenue growth. So we see -- overall, we are quite positive about 2019. And if you look, all the geographies today are profitable in terms of PC. Even in the geo like U.S. where we have been slowing down in terms of growth simply because we didn't want to compromise profitability too much, we are still profitable even better than last year. Then of course, there are regions like EMEA and AP that we -- and even Latin America, where we see double-digit on the high side of the double-digit growth. I think we will continue to see the same growth in 2019. One good sign is China. China is finally poised to revenue growth in Q3, and we think we can continue for the entire next year. And we also plan to come back in U.S., we are stabilizing the organization. We announced a new leader in U.S. that we took some action in terms of channel inventory and even product mix. So I think we are also ready to come back in U.S. with a strong growth going forward.
Yes. So if you look at last quarter, so AP grew by 18%; EMEA, 15%; Latin America, 28%; PRC, 2.5%. Only North America has declined by 5% because of -- we are transforming the business there. But even in the U.S., our PTI still improved by 0.5 point year-on-year. So we are very confident in the next year also we will further grow our PC business. So we definitely will keep like a 5-point premium to the market. So that's our goal. And hopefully, we can further improve our profitability. And we will drive the growth through the high-growth area like [ C&M ] products, like workstation, like gaming.
Your next question comes from the line of Melrose Chiu from Morgan Stanley.
The first question is for the Data Center business. May I know the sales breakdown by customers like enterprise and hyperscale in this quarter? And also what's the comparison versus last quarter?
Yes. We're not breaking out the business at that level right now, but I think we're seeing triple-digit growth in both software-defined across all our major partners. So on Nutanix, we're their fastest-growing OEM, so we're seeing significant growth on both [ your ] stack and vSAN with our VMware solution. So across all 3, ThinkAgile and, again, on our new brand, we're seeing good transformation and triple-digit growth. In hyperscale, you're going to see continued triple-digit growth from us as well as we transform the business model. And then in the traditional enterprise, just as an example, I think in the last year alone, in North America, we picked up about 770 new customers. So we're seeing significant growth in the traditional business as well. But we aren't breaking out the exact percentages. But obviously, given our results, what I'd told you is that software-defined, while we don't have the same legacy as a traditional networking or storage vendor, we're seeing very, very rapid adoption. And Lenovo is and is perceived as a disruptor and will continue to do that. And so hyperscale and software-defined, I think, are still our fastest-growing segments followed by the other segments.
Sorry, sir. I have another follow-up question. Yes, another question is regarding -- I noticed that there was one expense related to severance, around USD 61 million in the December quarter. May I know what the expense is for? And also how should we think about the cost improvement benefit going forward?
Yes. So Wai Ming, our CFO, will answer your question.
Yes, I think the $61 million, I think, you referred to probably, I think, is the -- I think where we talked, I think, further action in streamlining the operation, I think making the organization more efficient. I think the $61 million, by and large, relate to, I think, redundancy or other, I think, restructuring expenses-related.
Well, yes, because -- we are going to take the last question because of limited time, and please raise the last question for the interest of time. Thank you, please.
Your final question comes from the line of Patrick Chen from Nomura.
Just a quick one on your mobile business turnaround. Would you say the profit improvement going forward will be more leveraged on the revenue expansion or cost saving? And in order to further expand your revenue, I mean, which area or which geographical market would you be targeting? And how confident are you in order to reach that target?
So we will be more balanced on the growth and profitability. Probably, we will prioritize the profitability. So definitely, even in the geographies so we will have a different strategy or different goal. So we will definitely further strengthen our leadership position in Latin America. So not just further grow this year but also improve the profitability. Actually, we can make very good money from that market. In North America, a mature market, so probably we will invest in that market to drive the growth. So -- but for the emerging markets, so as I said before, so we will maintain healthy business with continued investment. So turning around the business is still our goal, it's still our first priority.
And may I follow up? Would you still stick to the target on your turnaround time frame for the business?
No. I don't have the time line now. So we definitely will improve that quarter by quarter. So we -- that is still our goal, to turnaround this business. That's our first priority.
Thank you, everyone, for your participation in today's call. If you have any further questions, please feel free to contact me or our IR representatives directly. This webcast replay and the conference call replay will be available in the next couple of hours. Thank you again for joining us today. Thank you.
Ladies and gentlemen, that does conclude our conference for today. Thank you.