Lenovo Group Limited
Q3 2021 Earnings Call Transcript

Published: 3 Feb 2021

[Jenny Lai:]

Good morning and good evening. Welcome to Lenovo's 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 Ming; President of Data Center Group, Mr. Kirk Skaugen. We will begin with a presentation shortly. And after that, we will open the call for questions. Without further due, let me turn the call over to Yuanqing. Yuanqing, please.

[Yang Yuanqing:]

Hello, everyone. Thank you for joining us. I'm pleased to discuss yet another record breaking quarter. Our innovative product portfolio and our operational excellence drove growth across all business and our transformation in investments are paying off.

[Wai Ming:]

Thank you Yuanqing. I will now take you through Lenovo's financial and operational performance in 3Q fiscal year 2021. Next slide please. This quarter the group again set several performing records with delivered sales growth across geographies and businesses robust margin all time high group revenue and profits and strong cash flow generation. Our service led transformation continue to accelerate and we further enhance our service portfolio to build new growth catalysts. Our group revenue increased 22% year-on-year to 17.2 billion. PCSD and DCG achieved record sales while MBG grew its revenue at a double-digit rate. The group's growth margin improved 10 basis point year-on-year and our E to R ratio was reduced by 0.5 percentage point to 12.1% a result of our operational excellence and optimization in sales mix. Software and services and e-commerce business grew their revenue strongly by 36% and 45% year-on-year respectively. The high margin rates continue to support our profit trajectory. Our net income grew 53% to an all-time high of 395 million. Record-breaking PCSD profit and consistent private improvement in MBG and DCG helped in setting this new milestone. The basic earnings per share was $3.31 up 53% from the previous year. Next slide please. In Q3 our cash flow generated from operation improved by 1.425 billion year-on-year to 1.963 billion. Our net debt level was reduced by 755 million year-on-year. The supply dynamics remained a challenge for the sector. Our infantry days increased four days year-on-year as we continue to secure critical paths to fulfill strong future demand. Sequentially infantry days lower by five days quarter-on-quarter thanks to strong demand. ER days also improve eight days year-on-year thanks to improved efficiency in our factoring program. Next slide please. PCSD achieved all-time high revenue and profits. The sector demand was strong and above expectation as supported by lifestyle changes including one PC per person trend and rising usage intensity leveraging our operational excellence, product innovation and quick time to market capabilities to address new demand tailwinds. PCSD revenue grew by 27% year-on-year to $14 billion in the quarter. Our unique hybrid manufacturing strategy allow us to have greater flexibility and more supply to fulfill strong sector demand. We boosted our share gain to capture 25.3% of global market share and expanded our market share lead to 4.2 points ahead of the number two player. We also became number one in EMEA for the first time.

[Unidentified Company Representative:]

Thank you Wai Ming. Now we are open online for questions and this session will be in English only. Please be reminded to limit yourself to one questions. At this time operator please now I'll turn it over to you please give us.

[Operator:]

Ladies and gentlemen we will now begin the question and answer session. Your first question comes from Sebastian Hou from CLS. Your line is now open.

[Sebastian Hou:]

Good afternoon. Thanks for taking my questions. I have two. The first one is on the PCSD business. So congratulations on the continued improve on the PCI margin in PCSD business and I wondered how much of it was due to the rising service contribution and also how do we see the margin trend going to firsthand this year considering there is a lot of the components have the price hack due to supply shortage and pricing is to further increase in the first half this year's and how would the margin be affected? And the second question will be on data center business that the margin also improved nicely. If I simply compare the margin you have compared to for example two quarters ago or four quarters ago that you have a similar revenue scale the margin has improved. So can we view it as a structural improvement on the overall data center business and how would you project the margin equivalent direction going forward? Thank you.

[Yang Yuanqing:]

Thank you Sebastian. So for the first question I would like to ask my great partner and friend Gianfranco to answer this question although I want to congratulate him on his retirement this coming September. Unfortunately he cannot start his retirement life yet. He will still be with us for two more earnings cycles as our COO and ensure small transition. So Gianfranco could you answer this first question? Then Kirk will answer the second question.

[Gianfranco Lanci:]

No. Yes. Thanks. Talking about the margin contribution for sure the service growth I think there are two elements when I look at the margin improvement and one is for sure coming from the service growth. The other one if you look at our numbers it's also coming from a better in the sense that despite the growth of Chromebook despite we have seen AUR going up in consumer and also in SMB and a little bit in e-commercial due to I would say a different profile of the demand from customers because we have seen a very strong growth on gaming and a very strong growth on Thin & Light we are back to grow on workstation because we have got a very good premium to market this growing segment. So I think we have this we have been growing service 30% to 40% during the last I don't remember how many quarters but many quarters and of course that there is a good contribution for service but I would say the major contribution is really coming from a different profile of the business and the better average selling price. Coming to components I think that it is true there are some components going up DRAM but on the other side the SSD which is a big portion of our product cost is still going down. So I really don't see for the next six to nine months any major impacts coming from components going up. In my opinion when I look at the PC industry today the only limitation but it's not really a margin limitation it's a growth limitation can only come or is coming only from shortage between IT and in display -- without last quarter results this limitation could be and I'm not dreaming could be even better. So we have been able to manage the supply issue very, very well if we look at the results but we can say that it could be even better without any limitation on the supply. Thank you.

[Yang Yuanqing:]

So Kirk could you please answer the second question?

[Kirk Skaugen:]

Sure. Thanks Sebastian. Yes I think you're correct. We're seeing sustained improved margins in the business and I think it's driven by a number of factors consistent with our strategy that remains strong. The first is in the cloud service provider market we're diversifying from servers into storage and winning multiple multi-hundred million dollar deals in storage. We're expanding beyond Intel architecture into AMD solutions and we're now bringing our motherboard development on these new designs in-house. So we're getting the profit not just on the system integration but also on the motherboard design and manufacturing and we've also talked about significantly expanding our own in-house manufacturing with new factories coming online in Monterey and Hungary to support our customer base. So that's making the CSP the cloud service provider business more profitable. On the enterprise SMB we said we just had our highest quarter in three years despite being in the middle of COVID. That's really being driven by not just efficiencies across the company but by our 4S strategy where we talked about higher profitability. So in storage IDC just published their latest storage numbers we were at 11 point premium to market. We became number two now in entry storage up from number five. So we crossed the number three and number four player and we're just three points away from being number one in entry storage worldwide. In software we have higher attach rates. In software defined IDC just showed in hybrid cloud we grew 58% year-on-year which was a 45% premium to market and then lastly on services we're tracking a double-digit growth year-on-year and our point-of-sale attach rates. We're expanding our true scale as a service offerings and we're delivering more professional services for example almost every HPC install where we had a record we do data center design around our Neptune warm water cooling and we also do data center design for some of the largest cloud players in the world not just providing them servers and storage but actually designing the whole data center for them. So those are things just some of the examples. Hopefully they give you confidence that this is a sustained growth driven by in-house design and manufacturing as well as 4S focus that's improving our profitability and I don't see that changing in the future. I think these trends we feel confident for the future. Thank you.

[Yang Yuanqing:]

Thank you Kirk. Next question please.

[Jenny Lai:]

Thank you. Operator we are ready for the next question please.

[Operator:]

Your next question is from from JP Morgan. Please go ahead.

[Unidentified Analyst:]

Hi I'm management team thanks for taking my question and congrats on the fantastic results. My first question is regarding PC given the very high supply demand dynamics would you consider raising the retail price to reflect the under supply and could we expect for PCSD market improvement in the coming quarters and could also give some updates on the channel inventory level? My second question would be you mentioned some further investment in the service segment using the process from PDR, could you give us some great example of how are you going to use that and any milestone of service segment for example when would you expect the service from the revenue to reach like 15% of total group revenue? Thank you.

[Yang Yuanqing:]

So, the first question is for you.

[A – Unidentified Company Representative:]

Coming to let's say I answer first on the channel inventory because this is probably a very interesting question. I think when I look at around the world to frankly speak I don't think from U.S. to Europe to China to Asia-Pacific I think our channel inventory has never been so low and in some cases during the last quarter we were down to two to three weeks. Usually it's running and the normal channel inventory is running around the six weeks between so we were really down to very-very low level and is still more or less at that level. So the China inventory unfortunately is too low as I said with no limitation on supply the result of last quarter could be even better than what you see in terms of reporting. Are we going to as I said demand is still very-very good? I would say we have not seen any declining demand. There is probably even building up even stronger considering that Q1 is always much lower than Q4. It's even stronger than in Q4 and we are doing some adjustment on the price, but I think it's really not rising because shortage or because tight supply. It's mainly because as I said before we see in terms of demand a very different profile than in the past with the gaming graphic card, better memory, better hard disk, better SSD and bigger SSD. And in terms of margin trend I see very stable margin trend for this quarter and also for the next couple of quarters. So I think we will continue to see a very good growth in terms of CA and revenue and with the stable state or slightly better margin. Thank you.

[Yang Yuanqing:]

So I want to echo to the PC, tablet demand will be still strong for this coming year. As I always said to you so this pandemic is driving the people's behavior change. Now work from home started from pulling -- from home have become the new normal. It drives the information consumption upgrade from one phone per unit to one PC or and tablet per person. So definitely it will drive the strong demand for PC and the tablet. Also today the people spend more time on their PC and the tablet so probably that will drive the faster, the replacement cycle in the future. So that we believe that the demand for PC and the tablet could be stable. So actually I have predicted the PC Time would reach 300 million this year but actually so last year we have already reached 300 million. So we believe this year so the demand will continue to grow by 5% to 10% so that's our focus. So actually today's the supply shortage is driven by the strong demand. So don't misunderstand. So supply shortage will another stoppers to further go. So a second question, could we mean answer the second question regarding of the CDR?

[Wai Ming:]

Yes sorry. I think we obviously I think announced the CDR proposal I think next time next thing will happen is tomorrow we have a shareholders meeting I think including the application and from then onwards I think we will get our prospectus I think ready and then going through the necessary process, the application process and hopefully that it will I think happen within I think the next few months.

[Yang Yuanqing:]

So the question is about the how we invest.

[Wai Ming:]

The investment sorry. I forgot that. Yes I think investment we are actually working primarily investing in technology related I think projects and investment. I think at the moment we are actually working out the details and as we will actually put in more details of where we invest I think in this new technology I think particularly in China I think the new idea infrastructure that offers a lot growth opportunity we will have that disclosed I think much more detail in the prospectus while we are actually in the process of preparing the document and waiting to reveal the document by the regulators will be better just to give you a high-level description of where we invest but we will actually have those in more detail as and when we publish the perspective.

[Yang Yuanqing:]

Thank you Wai Ming. Next question.

[Jenny Lai:]

Yes. Operator we are ready for the next question please.

[Operator:]

Our next question is from Howard Kao from Morgan Stanley. Please go ahead.

[Howard Kao:]

Hi guys congratulations on a record quarter. So I have two questions. The first question is a follow-on on the PCSD operating profit margin. I understand you guys doing a quarter saw higher logistics costs. I was just wondering how much did that impact your margins and when can we expect these higher legislative costs to normalize and the second question is on inventory. I noticed you guys had higher finished goods inventory both sequentially as well as year-on-year in the December quarter. I guess my understanding or I thought because of the strong demand you guys would actually have lower finished goods inventory. I am just wondering what why the finished goods inventory was up during the December quarter.

[Gianfranco Lanci:]

Yes. I could. Coming to the logistic cost when we see the impact is probably in the end of in terms of impact this is -- it is not a big impact maybe 1.2% because such a big logistic cost going up but this is not in Q4. This is already after I would say Q1 last year. So we have logistic cost going up in Q2, going up in Q3 but I think in Q4 we have not again seen an increase compared to the previous two quarters and we expect that slowly they will go down as soon as back to normal in terms of pandemic and with back to normal in terms of travel and so on. But when I look at the impact I think that we are also being able to manage very well in terms of when you see 20 million -21 million -23 million units per quarter despite the cost increase you can see manage to get good discount I would say. It's really how you manage logistic in terms of both price and so on. But we are talking about a very low number in terms of inventory, China inventory is extremely low in terms of three to four week today. We have been building up on the other side in this situation when there is any opportunities to buy ahead we buy ahead any kind of things but it's display, IC because we want to make sure that one we can satisfy demand. Second we can keep the factory up and running. So when I look at the inventory I think it's mainly coming from parts components not only but with this kind of situation when some performance it's very difficult to forecast in terms of delivery. So usually try to beat up with the other components in order to make sure that customers you get the parts, you don't have that problem on the normal supply. So we have been building up more inventory just to make sure that we have enough components in the factory or in our ODM supplier that as soon as we get what is the shortage we can produce finished goods, there is also another consideration is that we have when we look at our finished goods inventory a lot of this is in transit. It is increasing both. It is increasing reaching our customers for Q1 for this quarter demand. And we also beat up some, we have some additional finished goods because mainly for retail in U.S. and in some cases also in Europe. You need to deliver within January and February. In February we should not forget it is Chinese New Year. So production will be a little bit impacted, not too much maybe two, three, four days but with this kind of situation in terms of demand and supply even two or three days of factory shut down for Chinese New Year can be a problem. So it is also the other reason you see some finished goods probably for -- already in terms of finished goods because -- reaching our guidance. Thanks.

[Yang Yuanqing:]

Thank you Gianfranco. So next question please.

[Operator:]

Your next question is from . Please go ahead.

[Unidentified Analyst:]

Hi, good afternoon management. Thanks for the presentation. Questions on the --

[Yang Yuanqing:]

So your voice is broken. Could you please repeat your question?

[Unidentified Analyst:]

Is it better?

[Yang Yuanqing:]

Yes.

[Unidentified Analyst:]

Right. Okay. I just have a question on the restructuring to the three new groups. How different should we think about this three versus the current structure in terms of the performance indicators or would it still be focusing on PTI margins and just how different should we look at it this? Is the current structure? Thanks.

[Yang Yuanqing:]

So we will do this retraction. The first reason is Gianfranco will retire in September. So we need to make some change on our organization and leadership. The second reason is definitely we want to drive our organization to be aligned with our strategy. So we have a service led 3S strategy. 3S means smart IoT, smart infrastructure and smart vertical. So with a new organization so our IDG intelligent device group will address the smart IoT direction. Then our new named infrastructure solution group -- is the DCG will drive the smart infrastructure and definitely so the new establishment smart newly established the solution and the service group SSG will drive the solution and the service direction. So that's a very crucial for our intelligent transformation. So this has been the group we are integrated all the service oriented teams in our group to drive attach the service, manage the service, device as a service, solution and smart vertical, etc. etc. So definitely smart vertical we will be focusing on smart manufacturing, smart retails, smart city, smart education, etc. So in the past couple of quarters we have seen very good progress in our service led transformation. So last quarter our software and the service business grow by 36% year-on-year. So with a new organization so we definitely believe we will keep the strong growth in the service area. So definitely our service business has a much better margin than the average in our company. So that's why we think this is the culture for the Lenovo transformation for our future strategy, our strategy execution.

[Unidentified Analyst:]

Okay. Thank you very much.

[Yang Yuanqing:]

Thank you.

[Operator:]

Your next question is from Chris International. Please go ahead.

[Unidentified Analyst:]

Hi, thanks for taking my questions and congrats again on the strong results. I have a question on PC. Two questions total but first questions on PC. I would like to know what is the enterprise statement well how is the enterprise segment looking this year versus consumer. Historically we see enterprise margin on the PC side higher than consumer announced it seems like it may be changing. So my question my first question is through enterprise demand and also like enterprise versus consumer PC margin. My second question is on your CDR and more on the longer term outlook as we invest more new technologies and innovation how would that impact our offering expense and how would that impact our ICG profit margin? Thank you.

[Yang Yuanqing:]

Okay. So still Gianfranco.

[Gianfranco Lanci:]

Yes. Thank you for the question. When we look at the trend for sure during pandemic with the pandemic when I look at talking about calendar year Q2 and Q3 we have seen a slow down right really slow down on demand when but a big increase on consumer and partially SMB. So it's not only consumer with this very strong demand it's also it was also SMB when I look at Q2 and Q3 calendar year. Q4 we start to see some signal of demand coming back much better than the previous six months and when I look at this quarter I think demand is really back on enterprise, notebook, desktop, workstation and I would say all the key segments or product segment in the enterprise and again I think even on enterprise during the last quarter in this quarter the major concern in terms of is supply and it's really how we can satisfy the demand. So enterprises I think we see a rebound during the last let's say three to four months between November, December and also now January and February and back order is really building up nicely. The margin when we talk about margin I think and when you look at our three-segmented margin on enterprise and also margin on SMB they continue to be very-very strong. The real difference is that but also marginal consumer is becoming very good but is still not at the same level as SMB and commercial but before there was a big gap and I would say the marginal consumer is reducing the gap against SMB and enterprise but still we see one enterprise with a better margin than consumer and more or less at the same level as SMB. Thanks.

[Yang Yuanqing:]

So I want to emphasize what Gianfranco just said. So for the first time we see the enterprise or commercial demand increase. So last quarter so actually the commercial PC increased by 26% in the market. So definitely Lenovo have around 6 points premiere to the market. So that's a very good symptom. The economy the global economy is recovering. So that has less impact than previous quarters. Meanwhile the consumer demand is still strong. So that's the complete landscape for you to consider. CDR. So could you please to answer the CDR question.

[Wai Ming:]

Okay. Yes I think on the CDR while I said in the earlier I think question I won't be able to I think tell you exactly which project or we are testing but generally we are raising the proceeds investing in technology which obviously either when completed will either improve our operating efficiency or will form part of the our services or solutions that we offer to our customers. If you look at the profile of our business solutions and services normally combine on much higher gross margin than our existing devices business. So in that net I think after we actually raise the capital to invest in areas we are very-very confident that and not only will help us to expand further our top line of business but at the same time we'll be able to improve the margin profile of our business.

[Yang Yuanqing:]

Next question please.

[Operator:]

Your next question comes from Securities. Please go ahead.

[Unidentified Analyst:]

Hi management. Thanks for taking my question. I have two questions regarding SSG group, how do you see the growth driver the biggest growth driver for the SSG group in the next few years and also can you give us up maybe the employee number and the breakdown of these employees by functions of this group such as how many employees are from the IND function and the marketing function, etc. Thank you. That's my first question.

[Yang Yuanqing:]

Yes. So even I myself don't have that number so far. So we will integrated all the service oriented teams together but by the April 1 so it will become more clear but the content or the scope of the business is very clear. So they will try to attach the service, manage the service including a device as a service and a solution service for the solution service. So we are particularly focusing on smarter vertical solutions like smarter manufacturing, smarter education, smarter retail, and smarter city. So I definitely believe so in all these areas we can drive the hyper growth. So for the attached survey so although it's close to the -- but now Lenovo's attached rate is still much lower than the industry average. So we still have a lot of room to improve definitely manager service will be the trend. So in the past quarter this business grows by more than 70% year-on-year. So that will be our strong growth, there are so that's the definitely as I said a smart vertical. So it will be the third -- we will drive the growth.

[Unidentified Analyst:]

Thank you. My second question is regarding the mobile business. We can see this business turn profit in the quarter and I want to know how do we see the profitability in the next few quarters and with more Chinese brands are growing overseas how do we see the competition in the overseas market like in the Latin America or Europe and other markets? Thank you.

[Yang Yuanqing:]

So Gianfranco would you like to do to answer the question.

[Gianfranco Lanci:]

No. Yes but first of all mobile business I think is back to profitability already since few quarters. I think we have seen some impact on the profitability just during the last two or three quarters due to the pandemic and due to the demand coming from the impact, with the impact that coming from COVID-19 but if you look at the last six quarters I would say we were already back to profitability before pandemic and then of course we have seen some impact during the pandemic and now we are back to profit and I think that even if I look at the next few quarters I think we will continue to deliver a good profitability. Because the business is back to growth in the U.S., it's back to growth very almost 80%- 85% in Europe where we see really very, very good opportunity to further endeavor of Europe with good connection and good relationship with most of the operators in Europe but it's also back to growth in Asia talking about India or other countries in Asia-Pacific. And so I think we will see growth in terms of revenue but also we will continue to deliver a good profitability like this quarter. The only question mark also on mobile is again supplied with the same model as the same provider we see it on PC, IC and display. What was the other question? One it was yes the Chinese competition but frankly speaking we have seen Chinese brand competition in Europe but despite the Chinese brand competition in Europe we continue to see we have 85% revenue growth and we continue to see a big opportunity. In Latin America we continue to be number two and I would say compared to one, two, three, four, five quarters ago in terms of competition landscape we really don't see a major difference or a big difference. Some of the Chinese brand coming some other less aggressive than before but I would say the overall landscape is the same. There are also some other brands that are they just announced to leave the market and it's going to be another very good opportunity in both U.S. and Europe in terms of growing potential. Thank you.

[Wai Ming:]

Thank you Gianfranco and thank you Yuanqing. We are running out of time to take more questions. Thank you very much for joining today's call. If you have further questions feel free to contact the IR team directly. The replay of this webcast will be available in the next couple of hours on our investor relations website. Thank you again for joining us. Thank you everyone. Bye now.

[Yang Yuanqing:]

Yes. Bye. Bye.

[Operator:]

Ladies and gentlemen this does conclude today's conference call. Thank you for participating. You may now disconnect.