Lenovo Group Limited (992) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen. Welcome to Lenovo 2022-'23 Annual Results Investor Presentation. We are very thankful and happy to see you all in person and online once again. Let me introduce our management with us here today. They are Mr. Yang Yuanqing, Chairman and CEO; Mr. Wong Wai Ming, Executive VP and CFO; Mr. Ken Wong, Executive VP and President of Solutions and Services Group; Mr. Kirk Skaugen, Executive VP and President of Infrastructure Solutions Group. Mr. Luca Rossi, Executive VP and President of Intelligent Devices Group; not the least, Mr. Sergio Buniac, Senior VP of Mobile Business Group and President of Motorola. Now may I invite Yuanqing to start the presentations and followed by Wai Ming on the financial performance. Yuanqing, please.

[Foreign Language] So for quite -- Hello? Can you hear me? So for quite a while, we haven't met our friends here in person. So hello, everyone, and thank you for joining us. Among all the uncertainties over the past year, the market conditions have evolved relatively in line with our expectations. Despite the challenging economy and softer device market demand, we continued to make steady progress in our service-led transformation and technology-driven innovation. For the full fiscal year, we maintained a stable profitability, thanks to our diversified growth engines and operational resilience. We believe that the overall PC market channel inventory digestion will come to an end. And the trends of shipment and activation will become more consistent. The entire smart device market is expected to resume growth in the second half of this year and the IT service market will resume relatively high growth, driving the total IT market in 2023 full year are back to moderate growth. In the mid- to long-term, digital and intelligent transformation will continue to accelerate, leading to bigger growth potential for cloud and the entire computing infrastructure. Last year, we overcome tremendous challenges and achieved a stable profitability. From a full year point of view, our revenue was impacted due to device market softness, but thanks to our strong growth of solutions, services and the infrastructure businesses. Our net margin was keeping flat year-on-year non-Hong Kong FRS basis. Non-PC revenue mix increased to nearly 40%, demonstrating the effectiveness of our efforts in building the diversified growth engines. At the same time, our cash position remains strong, and we significantly improved our cash conversion cycle. With a healthy liquidity, we have been able to remain committed to our investment in R&D around new IT to build our future core competencies. And we continued to deepen our commitment to ESG. In fact, anticipating the decline in PC and smartphone demand over the past few quarters, we proactively took actions to mitigate the risks. With our solid profitability, strong market position, resilient operations and more importantly, reaching new milestones in our transformation from a device hardware company to our solution and services company, we are well prepared to achieve sustainable growth in the future. Now I will talk about each of our businesses. Let's start with SSG, Solutions and Services Group. The new IT services segment within the $1 trillion IT services market continue to expand. By 2025 Device-as-a-Service market and cloud solution market are both expected to grow at a double-digit CAGR. Vertical solutions and services spending will also keep a strong growth. Last year, our SSG delivered a strong revenue growth and higher profitability to become both our growth engine and important profit contributor. Its revenue broke a record to reach $6.7 billion with operating margin standing higher at 21%. Revenue mix of nonhardware-driven Solution and Services has increased that to more than half of our SSG business. Meanwhile, SSG has consistently invested in building scalable and repeatable horizontal solutions or building blocks that can be deployed in vertical solutions or industries, leveraging -- definitely leveraging our own IP. In addition, we have been continuously enhancing our digital workplace solutions and developing TruScale hybrid cloud solutions portfolio. Our Infrastructure Solutions Group, or ISG, continues to benefit from the ongoing ICT infrastructure upgrade. By 2025, the server market will surpass USD 132 billion, storage $36 billion and edge infrastructure $37 billion. Last year, our ISG delivered historical full year performance and became a profitable, high-growth engine. Its total revenue grew 37% year-on-year to almost USD 10 billion and achieved an all-time high. We also achieved record high revenue in server, storage and software, respectively. We have moved up from the fourth to be the third largest server provider in the world and have jumped from #8 to #5 in global storage market. Meanwhile, we have been consistently improving our in-house manufacturing capabilities, cost competitiveness as well as the full stack product capabilities that cover both cloud service provider and the Enterprise and SMB segments. We have also made significant investment in infrastructure innovations empowered by artificial intelligence, such as AI-powered edge computing, hybrid cloud and intelligent operations. For our Intelligent Device Group, or IDG, its business performance was impacted by continued device market softness and channel inventory digestion in the first half of 2023. But given PCs are still the essential productivity tool in this digital era, so we anticipate the PC market will return to year-on-year growth in the second half of 2023 with accelerated growth in 2024. Meanwhile, driven by digitalization trend and hybrid work model smart space solutions continue to see steady growth. First with severe market headwinds, IDG revenue declined year-on-year but successfully maintained our PC market leadership and industry-leading profitability. We increased the revenue mix of premier products to 30%. Our mobile business continues to be profitable for 3 consecutive years and achieved a premium-to-market revenue growth in most of the markets. And our smart space solutions continued to demonstrate great growth potential. We will continue to take actions to manage expense and further sharpen our operational excellence in IDG and we will keep investing in innovations, focusing on premier offerings and adjacent areas, while enhancing smart space solutions for hybrid work model. Let me also briefly cover our fourth quarter performance. It was the most challenging quarter of the year facing pressures from both device market and the global economy. Our IDG revenue declined due to severe downturn in both PC and smartphone markets. But both SSG and ISG maintained a high double-digit year-on-year growth momentum, which helped to offset the device market softness. Last quarter, our non-PC revenue mix reached a historic high of 43%. Furthermore, we have recognized our onetime restructuring and other charges along with various other actions to deliver about $850 million annual run rate total expense savings onwards, helping to establish a solid foundation for our operations in a challenging market and position ourselves for future growth. Finally, I'd like to highlight Lenovo's solid performance in the face of industry downturn over the past year. We are already seeing positive signs of market stabilization. Our strategy has been proven to be working, and our operations continue to demonstrate the resilience and most importantly, even in a challenging market, we have increased rather than decreased our commitment to innovation solutions and services. Lenovo is now fully prepared in a strong position than ever before to capture the next wave of growth opportunity. Thank you. Now let me turn it over to our CFO, Wai Ming. Wai Ming, please.

Thank you, Yuanqing. Good afternoon, everybody. I will now take you through Lenovo financial and operational performance for the fiscal year 2023 and its fourth quarter. Next slide, please. For the fiscal year 2023, the group diversified growth engines set multiple performance records. The non-PC business made up nearly 40% of the combined revenue of the 3 business groups, signaling a quick shift in our exposure towards the growth areas. ISG and SSG spearheaded our group transformation. Their combined revenue and operating profit increased by 31% and 24%, respectively. IDG remained a strong sector leader in both market share and profitability. Notwithstanding sector-wide challenges ranging from channel inventory digestion, the system macro headwinds to extreme exchange rate fluctuations during the year, IDG revenue declined 21% year-by-year -- year-on-year. Thanks to its operational excellence and its premium mix, IDG maintained a robust operating margin of 7.3%, down just mere 30 basis points year-on-year. Group revenue declined by 14% to $61.9 billion or down 9% on constant currency. Gross margin and operating margin delivered 18-year high, thanks to the non-PC strength helping transcend the cycle. We recognized the onetime restructuring and other charges of $249 million among various other actions to deliver an annual run rate group expense saving of about $850 million. We aim to establish a solid foundation to operate in a challenging market and position ourselves for future growth. Excluding the nonrecurring charges, our non-GAAP net profit margin remained stable at 3%, flat year-to-year. We remain committed to achieving our target of doubling net margin in the medium term. Profit attributable to equity holders was $1.6 billion, down 21% year-on-year. Today, the Board declared a final dividend of HKD 0.30 per share. Taking into consideration of the interim dividend of HKD 0.08 per share, total dividend for fiscal year '23 would be HKD 0.38 per share. Next slide please. In Q4, notwithstanding the market challenges, the non-PC business continued to grow 12% year-on-year, and its revenue contribution rose to 43% of the combined revenue of the 3 business groups, thanks to a resilient and well-executed transformation strategy. ISG and SSG combined revenue grew by 37% year-on-year, setting a new milestone. The strength of non-PC revenue reflected our market advantages in capturing digital and intelligent transformation opportunities and help mitigate IDG's revenue decline of 33%. Nonrecurring, restructuring and other charges of $249 million and impacted our Q4 performance. Non-GAAP net profit was $284 million, down 44% year-on-year, and the group profit attributable to equity holders was $114 million. Next slide, please. We continue to optimize group operations for greater business agility and long-term growth. Our cash and cash equivalent balance reached $4.3 billion in March, up 8% year-on-year. We also finished the year with a net cash position for the eighth consecutive quarter with a balance of $366 million. The group improved its cash conversion cycle by 12 days on a year-on-year basis to negative 2 days, returning to the pre-COVID period where such figures was negative. Since Q1, we have seen continuous improvement in cash conversion cycle, a testament to our prudent working capital management. At the same time, we also put in significant effort to decrease our inventory level by over $1.9 billion on an annual basis. Next slide, please. Thanks to the increasing demand for the end-to-end solutions across hardware, software and services as well as subscription-based model, SSG performance continued its upward trend since the business group inauguration in April 2021. Its full year revenue and operating profit grew 22% and 16% year-on-year to $6.6 billion and $1.4 billion, respectively. Its full year operating margin of 21% top all business groups. In the fourth quarter, revenue was up 18% year-on-year, while operating margin was 20%, down around 2 percentage point year-on-year off a very high base. The solid performance was underlined by double-digit growth across all 3 business segments, led by management service. We reported year-on-year revenue growth of 67%, thanks to the strong as-a-service adoption. Our project and Solution and Services segment with a broad base of solutions leveraging Lenovo IP reported year-on-year revenue growth of 13%. Attach and supported services revenue also increased 14% year-on-year with a record PC service penetration rate. Full year deferred revenue reached $3 billion echoing the group's focus on enlarging and sustaining its recurring revenue base. Next slide, please. ISG delivered exceptional revenue and profit growth, with revenue growing 37% and operating profit surging to a new high of $98 million. Fiscal year '23 marked the third consecutive record setting year. ISG was 1 of the world's fastest-growing infrastructure solution providers and achieve premium-to-market growth across several product lines. Such achievement was built on years of investment in creating a full stack portfolio. This product strategy, together with a broad customer coverage and a unique, fully integrated ODM+ business model, were effective in driving revenues of server, storage, software and AI edge to an all-time high. Later third-party statistics affirm ISG's strong market positions. It started off the fiscal year with its market share by revenue in worldwide server at #4 position. It finished the year at #3 position. At the same time, it ended the year with its global share in storage at #8 and exited at #5. ISG is also capturing emerging opportunities in AI and building the most diverse AI portfolio in infrastructure. 70% of new ISG products from patch to core data center products. In the fiscal year 2024, we'll be AI ready. This includes its popular liquid cooling Neptune technology for a high GPU loading AI server training. By customer segment, ISG exposure to CSP and E/SMB segments gave the group a unique advantage in balancing scale and profit. Both segments saw double-digit revenue growth to record levels. In Q4, ISG yet again set another revenue record with a growth of 56%, thanks to its comprehensive product portfolio, an important catalyst for significant premium to market growth. Next slide, please. IDG was impacted by the sector-wide headwinds, including lower demand and excessive inventory. Full year revenue declined 21% year-on-year but remained markedly higher than fiscal [ 2000 ] pre-COVID levels. Operating profit for the fiscal year dropped by 24% with operating margin down 30 basis points year-on-year, reaching 7.3%. This was significantly above the pre-COVID level, thanks to our operational excellence and a favorable mix shifting, enabling higher margin sales. In the fourth quarter, revenue declined 33%, while the business made significant progress in cleaning channel inventory. This inevitably has a negative impact on our operating margin, which was down 90 basis points year-on-year to 6.7%. IDG made great progress in seizing growth opportunities beyond PC products. Non-PC sales made up 19% of IDG's revenue, up 0.4 percentage point year-on-year. Our smartphone revenue declined from overall market demand weakness. Nevertheless, is outperformed in multiple markets such as EMEA and AP by notable margin. Smartphone business also maintained profitable for 3 consecutive years with a growing 5G mix. Within non-PC business, smart collaboration solutions also delivered double-digit growth year-on-year with key wins across regions and global accounts. Next, slide please. Now let me shift gears and talk about our R&D investments. As we continue to invest in innovation, R&D spending as a percentage of revenue rose to 3.5% from 2.9% last year. Digital transformation has never been more important to our growth as we invest in new IT infrastructure spanning across client, edge, cloud network, intelligence. Our investment will accelerate the development of the high value-added products and key components, including edge, storage and cloud in responding to significant growth in the data creation and data consumption. We will also drive innovation to propel our AI smartphone portfolio, scenario-based solution and ESG initiatives as well as expand our services book. Every aspect of our R&D investment has contributed to our record operating margin and long-term competitiveness. Next slide, please. In fiscal year '23, the group has made remarkable progress in ESG. Our commitment to reach net-zero by 2050 was validated and approved by the Science Based Targets initiative, or in short SBTi, a partnership between the UN Global Compact, CDP, World Resources Institute and Worldwide Fund for Nature making us the first PC and smartphone maker and one of the only 139 companies in the world with a net-zero target validated by SBTi. The group's ESG efforts have been well recognized and have received many accolades. MSCI upgraded our ESG rating to AAA, the highest level. CDP also recognized us as a leader in climate change, water security and supplier engagement for the second consecutive year. Additionally, Lenovo was highlighted in the Bloomberg Gender Equality Index for the fourth consecutive year. While the prevailing external challenges could expect -- extend well into the future periods, the group will continue to invest in innovation and high value-added products and components, while fostering the development of the new IT architecture within the cloud network intelligence framework. Looking forward, SSG will benefit from the mega trends such as digital transformation infrastructure upgrades and strong demand for hybrid cloud and remote work and collaboration. SSG will continue to broaden its service offerings, which include digital workplace, hybrid cloud and sustainability services while protecting its core business with product-related services as well as strengthening channel tools and cooperation with business partners. Given this strong growth outlook, SSG will further enhance its financial contribution to the growth. ISG has built industry-leading end-to-end infrastructure solutions and expanded to full stack offering that includes server, storage and software solutions. The E/SMB segment will also capitalize on growth opportunity in AI power edge, hybrid cloud, high-performance computing and solutions for the telco communication sectors. For the CSP segment, ISG has a unique ODM+ business model to address the growing demand for vertically integrated supply chains. The business will continue to diversify its customer base and capture new accounts through design win across technology platforms. The approach will achieve an optimal balance between general purpose and customized offerings while ensuring an appropriate scale and efficient cost structure to enable revenue growth and profitability expansion. The PC and smartphone markets will resume their growth trajectory in the second half of 2023, and accelerate their growth in 2024. IDG will continue to drive efficiency within its lean operations, maintain healthy cash generation and invest in innovation. IDG will lead the global race in device innovation by enhancing features for hybrid working, gaming, entertainment and ESG designs. Scenario-based solutions, including smart collaboration and smart home devices will continue to grow at a stable pace. The commercial upgrade cycle and the trend of premiumization will help IDG drive premium-to-market growth. Its maximum business will focus on portfolio expansion with differentiation to take advantages of accelerated 5G adoption. Meanwhile, the group strives to reinforce its #1 position in the PC sector with leading profitability and accelerate the innovation-led growth in the non-PC and adjacent areas, including accessories. Our strong financial position provides a solid foundation to proactively pursue growth opportunities ahead. Finally, as always, we remain committed in driving sustainable growth and profitability for our shareholders. Thank you. We will now take your questions.

Thank you, Wai Ming. May I invite YY, Ken and also, Luca to come on stage. Please be seated. Thank you. [Operator Instructions] So we welcome the first question from the floor. If there's any question, please raise your hand. Yes.

This is Tony Zhang from CLSA. So I have several questions. First one is how is our view in the global PC market in terms of inventory cycle? How is our plan to issue the new product model in this year?

Luca, please.

So thanks for the question. So I think your question is, one, on the how is the market, how is the inventory and then what is the product development or innovation. So regarding the market, obviously, we have seen -- witnessed softness in the demand -- the end demand, but there is, I think, an important deep dive to do. So that is the difference between the weakness in shipments and the weakness in activation, which is the Windows-activated devices every day. We do the -- we check every day. And you can see a difference of -- a significant difference. The shipments are declining more than 20%, but the real end user demand is declining much less. So this is clearly a sign of a much healthier end user demand than demonstrated by the shipment. And that is the correction of the inventory that has been generated by the overshipments during the COVID period when the shipments were superior to the end demand. Now the inventory is gradually being digested in the channel. And when it comes to our inventory, we think this quarter, this is basically the last quarter with this adjustment and our global channel inventory is basically back to the pre-COVID inventory levels by the end of the current quarter. So we think our level of inventory is now normalized. We'll -- that is why we are confident that we resume in the second half a moderate growth, and that growth should accelerate in 2024. And obviously, innovation is part of the reason why we are confident there will be new devices, new form factors, AI-enabled PCs. So a lot of new things that will accelerate and attract demand. Additionally, we are confident of the end demand because of the Windows 11 transition cycle in the end of '23 and particularly in 2024 should accelerate. And there also should be the replacement cycle of the devices that have been accelerated shipments in 2021, that will arrive to the third or fourth year of life. So the total market, we believe, is increased. Now to be more specific, when we look at the end demand measured by the Windows activation, we believe that the end state will be bigger than the pre-COVID end demand approximately by high 1 digit. Thank you.

Yes. So this cycle has been very clear. So COVID triggered the booming of the PC demand than probably 2021. We faced supply shortage. So in that period, activation is much higher than the shipment. Then it triggered the channel to accumulate the inventory. So 2021 to first half of 2022. So that period, shipment is higher than the activation since the second half of last year. So shipments declined significantly by 20%, 30%. But the activation didn't decline that much. So that means the activation has been much higher than the shipment. So we forecasted by the end of this quarter, so the shipment and activation will be more consistent over time. But definitely as Luca introduced so we have a good chance to keep at a higher than pre-COVID level.

And if I may add 1 thing that I forget to complete your question. Within this activation scenario, it's important to highlight that Lenovo activation share is gaining market share significantly at the high 1-digit premium-to-market compared to pre-COVID, meaning we are at the record level of worldwide device activation with Lenovo brand in the world. Thank you.

Thank you, Luca and YY. Next question? Yes, please.

I'm Edison from Jefferies. So I have 2 questions for the server section -- for the server segment. Number one is that can you share with us what is your revenue distribution from key markets in server? And number two is that in terms of AI server, what is the proportion of your service sales in AI? And what kind of trend are you seeing in 2023 of the AI servers contribution?

So we'll ask our ISG President, Kirk Skaugen to answer the question. Kirk, please.

Yes. So I think the growth of our business is very widespread. And in fact, in the previous quarter, we had over 60 different records, so it's impossible to talk about this. But the key message is it's not just 1 part of the business. We have records in server and storage and software and edge and as-a-service, et cetera. Our strongest geography right now is actually North America, which is also the largest total available market for the infrastructure business. And our weakest market has been China for obviously some of the macro issues that we've seen. But our exposure to China is the lowest it's been in 5 years. So hopefully, that answers your first question. As you can see, we grew 37% year-on-year. If you look at it in the fourth quarter, we grew 56% year-on-year. So we're talking about high double-digit premium-to-market. If you look at the distribution of our business, about 29% growth in server, over 200% growth in storage and that's widespread across midrange storage, all-flash arrays, entry storage where we became #1 in the world and in cloud-based storage. And then software is growing 25% year-on-year. So really broad-based business. From an AI perspective, definitely one of our strong growth areas. About a year ago, we consolidated about 5 different divisions into our edge division, which I really say is Edge AI. I think what we're seeing is that the amount of data in the world is exploding. Most of the statistics say that amount of data in the world will double over the next 3 years, and we're only computing 2% of that data. So this quarter, we grew over 170% in our edge growth -- actually for the whole fiscal year. And a lot of that is AI-driven workloads, things like fleet safety and fast retail, optimizing drive-throughs, line queues in major stadiums, making manufacturing more effective, et cetera. So I would say the first thing on AI is Edge is exploding. Number two, supercomputing or international supercomputing this week in Hamburg, larger and larger portion of supercomputing is AI-driven to solve some of the biggest challenges of the world like cancer research things like that. I'm proud to report this week, we extended our #1 position as the world leader in the top 500. And also, we're #1 in -- the #1 position of the most sustainable supercomputer in the world, meaning we have the greenest supercomputer in the world at the Flatiron Institute of New York. Third, if you just think about Omniverse, Metaverse, digital twins, as Metaverse, digital twins. As Jensen Huang, GTC, stated, we're in collaboration with Microsoft and NVIDIA and we are currently installing and building the world's largest Omniverse instance in the cloud. And I think we're very excited about that. We're working with some of the largest automotive companies in the world as they build new factories for their electric vehicles, new digital twins for the factories, planning next-generation smart cities, planning next-generation 5G networks. So Metaverse, Omniverse is a critical part of our AI story. And of course, Lenovo is unique because we can do edge to cloud and talk with the cloud. So we have the AR/VR devices. We have the workstations, we have servers and we have the storage, which means we're simplifying that for our end users. And then lastly, obviously, generative AI, ChatGPT, we're seeing more than a 30% compound annual growth rate on that. The huge amount of server and storage infrastructure being created. We have about 60 AI-enabled products now in the market and 70% of our new products that we're announcing are AI-ready. So this is going to be a huge growth area for us in the future, and I think we're well positioned. Thank you.

Thank you. Thank you, Kirk. Next question, please. Yes.

I want to ask one more question. My question is how about the current bond structure, especially with the decline of some semiconductor IC and also the memory price. What is the impact to our current outlook for our margin?

Yes, I think -- Okay. And my answer will be for PC. Maybe Kirk will have a -- so definitely, there is some deflationary trend for certain of the components. Well, that's -- potentially, that's a good news. It will depend on the market competition how much it will be able to help. But obviously, we believe is positive for our GP going forward. Together, I think, with other elements, which make us confident on the sustainability of our GP, definitely our designing capabilities, so our ability to build kind of more effective cost structure in the PC segment mix sustaining the GP and also premium mix. So -- but your answer is -- your question is about the commodities. There is a moderate deflationary trend, which we believe will not continue for long because as soon as the demand will rebound, which we said we believe it will gradually happen from the second and second half that is probably coming to an end. Yes. Thank you.

Thank you. Now let us move our questions and let us take some questions from the webcast online. First question is from JPMorgan, Albert Hung. The question is like, why ISG operating profit margin dropped in Q4 FY '23, while revenue remained strong? What is the demand outlook amid weakened IT budget? Shall we expect a slowdown in software revenue near term? What's the implication for profitability? And also the second question is, could we have more color on the restructuring, please? Shall we expect more restructuring costs in the coming quarters? What could we see the cost benefit from this restructuring?

Kirk, you answer the first question. Then Wai Ming, the second.