Lenovo Group Ltd S/Adr

Good morning, good afternoon, and good evening. Welcome to Lenovo's investor earnings webcast. This is Jenny Lai, Vice President of Investor Relations at Lenovo. Thanks everyone for joining us. Before we start, let me introduce our management team joining the call today. Mr. Yang Yuanqing, Lenovo's Chairman and CEO. Mr. Wong Wai-Ming, Group CFO. Mr. Ken Wong, President of Solutions and Services Group, Mr. Kurt Skaugen, President of Infrastructure Solutions Group, Mr. Luca Rossi, President of Intelligent Devices Group, Mr. Sergio Buniyak, President of Mobile Business Group, and President of Motorola. We will begin with Ernie's presentations, and shortly after that, we will open the call for questions. Now, let me turn it over to Yuanqing Yuanqing, please.

Hello everyone, and thank you for joining us. Last quarter, as we all know, the global economy, pandemic, and geopolitical tensions continue to create uncertainties. But for Lenovo, our strategic foresight, operational resilience, and consistent investment in diversified growth engines have prepared us well for these challenging times. Whether our traditional markets are booming or contracting, Lenovo consistently delivers on its commitments. Last quarter was no different. We delivered a solid performance and successfully improved profitability. As our non-PC businesses made great progress to become new growth engines, Today, despite the macro-environment challenges, the overall trend of digitalization and the hybrid work model continue to accelerate, with global spending on digital transformation expected to sustain strong growth through 2025. Last quarter, thanks to strong execution of our 3S strategy to drive digital and intelligent transformation, We stood up to the challenges and delivered positive net income growth and net income margin improvement for the 10th consecutive quarter. All our main businesses contributed positive operating profit, and we are making progress toward our commitment to doubling profitability in mid-term. our revenue was up almost 3% in constant currency year on year, and our new diversified growth engines continued to deliver strong performance. Both solutions and services business and the infrastructure business saw high double-digit growth year on year. With a healthy cash balance, we remain committed to doubling R&D investments in mid-term Last quarter, our R&D spending grew by 15% and headcount increased by 26% year-on-year. Meanwhile, we accelerated our ESG efforts and draw one Lenovo sales platform to support future sustainable growth. Now, I will talk about each of our businesses. Let's start with SSG Solutions and Services Group. The trillion-dollar IT service market continues to grow steadily with faster growth to be expected in DaaS as well as managed services for data center, cloud, and edge environment through 2025. Vertical solutions and services spending is expected to remain strong including in smart education, smart retail, smart city, and smart manufacturing. Last quarter, SSG's revenue grew by 26% year-on-year with a further improved operating margin. All segments, again, delivered a high profitability and a strong growth. For the first time, revenue from non-hardware-tired solutions and services accounts for more than half of SSG business. At the same time, SSG continued to build comprehensive horizontal solutions for vertical industries. For example, our digital store solution embedded with Lenovo AI Edge Server is now powering one of the world's largest grocery retailers to reduce over 75% self-checkout errors without employee intervention. We also further expanded our sustainability offerings. The newly formed Lenovo PCCW solutions has been running since August this year, achieving initial success on business synergy. Our ISD infrastructure solution group continues to capture significant growth opportunity in the market. By 2025, the server market will reach 134 billion US dollars. the edge infrastructure, $47 billion, the storage, $36 billion. Last quarter, ISG achieved a record revenue of $2.6 billion, up 33% year-on-year. We delivered the fourth consecutive quarter of profitability with a record high operating profit of $36 million. Cloud service provider and enterprise SMB segments both outgrew overall market forecast. Edge revenue almost quadrupled and storage more than doubled year on year. Both set new records. Meanwhile, we continued to enhance our comprehensive infrastructure portfolio and to invest in innovation. particularly in age and services. Our operational resilience was further strengthened as we ramped up our new factories in Shenzhen, Tianjin, China, and in Hungary, as well as expanded our manufacturing facilities in Mexico. We remain focused on being one of the fastest growing and ultimately the largest end-to-end infrastructure solution provider in the world while maintaining a sustainable, profitable business model. For our IDG, intelligent device group, while the market size of PC and tablets declined in the short term, it is still expected to stably remain at a higher than pre-pandemic level in the long term. Meanwhile, as we move from smart devices to smarter spaces, the scenario-based solution market will continue to grow. Driven by our operational excellence and consistent investment in innovations, particularly in the high value-added premium segments, Our IDG maintain the industry leading profitability. Despite the PC market softness, we were able to navigate much better and strengthen our number one position, enlarged the gap with the key competitors. We are the clear number one in four geographies out of five, and the undisputed number one brand in commercial segment, which represents around 65% of Lenovo PC revenue mix. At the same time, our smartphone business achieved the tenth consecutive quarter of profitability. We remained as a strong number two and number three player in Latin America and North America, respectively, and achieved hyper growth in the expansion markets. We launched a series of innovative products and enriched our product portfolio. Our scenario-based solution continued to demonstrate growth potential. Smart collaboration continued to grow at a high double-digital year-on-year, and revenue from gaming scenario business set a new record. Lenovo Workstation solutions with artificial intelligence, data science, and immersive computing are enabling our customers in automobile. energy and the entertainment industries to improve their computer-aided design processes. We continue to focus on innovation to drive the extension from smart devices to smarter spaces. We are confident that our success in PC can be replicated to grow our business beyond the PC markets and further win in more markets, particularly in smartphone. Looking ahead, the current external challenges will likely persist for a while. We must remain agile and stay focused on both pursuing our strategy and ensuring ongoing profitability. We will rebalance resources toward our diversified growth engines while driving for efficiency and expense reduction throughout the company. especially in areas where we see a softer market outlook. And we will never lose sight of the long-term opportunities in this year's Lenovo Tech World. We draw strong interest from the industry and the public, showcasing our progress in innovation and the vision in digital and intelligent transformation. Lenovo has built capabilities in horizontal solutions across the new IT architecture of client, edge, cloud, network intelligence to be embedded into vertical solutions. Each of these building blocks, such as IoT, Metaverse, Edge, Hybrid Cloud, and AI can help us not only address customer needs, but also create scalable, repeatable, sustainable, and profitable solutions that will spark new waves of growth beyond our traditional device business. Our solid performance last quarter and throughout the past three years has proven that we have the right strategy, strong execution, resilient operation to fulfill our commitment and transcend the cycle. We are confident that our high quality and innovative portfolio, unique hybrid manufacturing model driven strong supply chain and the global local principle and the capability as well as a healthy liquidity will help us capture the opportunities, deliver sustainable growth, and improve profitability. Thank you. Now, let me turn it over to our CFO, Wei Ming.

Wei Ming, please. Thank you, Yuanqing. I will now take you through Lenovo's financial and operational performance for Q2 in the 2023 fiscal year. Next chart, please. The current economic outlook is deteriorating at an unexpectedly fast pace. Despite this, in Q2, we achieved an annual net income growth of 6 percent to $541 million and net margin growth of 0.3 percentage point year-on-year, marking a step forward, our medium-term target of doubling the net margin from fiscal year 2021. Group revenue declined 4 percent year-on-year in nominal terms but was up 3 percent on constant currency. Our financial results are a testament to our strength in the non-PC business, which now represents 37% of group sales. ISG and SSG both deliver record-breaking revenue and profits. The weakness in the PC market was widespread, but we continue to outperform. Basic earnings per share came in at 4.54 US cents. Today, the Board of Directors declared an interim dividend of 8 Hong Kong cents, maintaining last fiscal year level. We continue to make progress in improving our working capital management and cash flow generation remains strong. Our cash and cash equivalent balance reached $5.6 billion at the end of the quarter. and we increased our net cash by $1.1 billion year-on-year to a balance of $1.1 billion in Q2. To optimize our working capital, we further shortened the cash conversion cycle by 13 days year-on-year and 16 days quarter-on-quarter. Both days of inventory and payables were contributors to the improvement. Our inventory decreased 4% year-on-year. Operating cash flow improved by $523 million year-on-year to a record high level of over $2 billion. Free cash flow also improved by $419 million from last year. The Group's Green Bond, which was issued in July, officially made its way into Bloomberg's MSCI Green Bond Index, a key global benchmark for ESG fixed income funds. Next slide, please. The financial result of SSG echoes the success of our transformation journey. Its Q2 revenue grew at a healthy rate of 26% year-on-year to $1.7 billion. Operating profit increased 29% to $368 million. SSG continued to build a franchise to increase deferred revenue with a balance of $2.9 billion. Within our three services segments, Revenue of managed services increased 69% year-on-year owing to large contract wins in an asset service which delivered the fifth consecutive record-breaking quarter in terms of signings. Project and solution services won signature deals in smart manufacturing and smart education supported by Lenovo's IPs. For example, we won two new VR classroom logos in Q2 leveraging Lenovo Think's reality platform and VR solution to provide classroom users with a fully immersive education experience. Support services revenue rose 16% year-on-year. Its penetration rate rose to a record high, partly due to the highest level of premium booking, of which penetration rate was above average. During the quarter, the combined revenue from many services and project and solution services went beyond 50% for the first time, reaching 52%, four points more than last year. Next chart, please. Q2 marked an exceptional quarter for ISG, as revenue and operating profit both reached a record high. Sales grew 33% year-on-year to $2.6 billion, outperforming the market and delivering record sales levels across Asia Pacific, EMEA, and the Americas. Our Mexico plant has been operating at full capacity while our Hungary plant is expanding to meet the growing demand from contract wins. Q2 operating profit increased by $42 million to $36 million. Cloud service provider revenue reached an all-time high, supported by the segment strategy of growing its client base, product portfolio, and design-in projects. The enterprise and small-medium business segment's revenue reached a record high for Q2, as enterprise customers continue to pursue digital transformation by product, edge, server, and storage, or set new sales records. ISG launched its largest portfolio ever, consisting over 50 new products, solutions, and services to support its future growth and profitability trajectory. Next chart, please. Our IDG business was hit by the far-reaching demand headwinds in the sector. Although revenue declined by 11% to $14 billion, the group's operational resilience enables its operating profit margin to stabilize at 7.4%, a sector high level for profitability. IDG is the undisputed number one in the commercial PC segment as our ThinkPak X1 sales grew by 19% year-on-year. The business group premium mix remained healthy, with sales rising 4%, and gaming sales up by 34%. IDG also widened its market share gaps against player number two and number three in the sector. Non-PC products continue to contribute to IDG's revenue, accounting for nearly 18% in Q2. The smartphone business remained profitable for 10 consecutive quarters despite the challenging market. We defend our number two and number three market position in Latin America and North America, respectively, while achieving hypergrowth in the expansion markets. Smart collaboration revenue maintains double-digit growth year-on-year, supported by the popularity of scenario-based solutions. Next chart, please. Now let's talk about research and development. Despite the total operating expense decreased by 7%, we increased R&D spending by 15% to fuel various growth engines, business transformation, and ESG initiatives. Excluding R&D spend, other operating expenses went down 40% due to efficient cost control measures, highlighting the Group's commitment in innovation investment even in challenging market conditions. The Group's innovative efforts, along with the disciplined cost control, contributed to a record operating margin level of 5%, while operating profit also increased 4% year-on-year to $851 million. Next chart please. We are accelerating our ESG investment. We just published our 16th annual ESG report for the 2021-22 fiscal year on our investor relations website. We welcome you to have a read through it. We are currently awaiting validation from the sign-based targets initiative for our net zero by 2050 target. In the meantime, we continue to strive for progress on our near-term emissions reductions targets for the 2029-30 fiscal year, which have already been validated by SBTI. In 2021, Lenovo began utilizing recycled metals for both the commercial and consumer product lines. We are also utilizing plastic-free packaging by combining bamboo fiber technology with other innovative materials for our most popular ThinkPad X1 and Z series. The group continues to evaluate the application of plastic-free packaging to additional product lines. We are also committed to making the community a better place through both monetary donation and employee volunteer services. Lenovo was included in the Hang Seng Corporate Sustainability Index with an AA plus rating for the second year in a row. We also had the best score in the IT industry. Our ESG performance was evaluated on seven areas from corporate governance to human rights and consumer issues against over 575 Hong Kong listed companies. We received our highest scores in the labor practices and community involvement categories. Next chart, please. While the external business environment continues to be volatile, the strategic opportunities in digital and service-led transformations will support long-term growth for Lenovo end-to-end, user-friendly product and services solution and dependables devices. These external catalysts, coupled with the group investment in innovation and its global footprint, are key to mitigating external challenges and achieving the medium-term goal of doubling its net margin. We are building plans to have a meaningful reduction in expense, to achieve an expense-to-revenue ratio consistent with the pre-COVID levels to maximize profitability, even as some of our traditional markets contract. We will continue to rebalance investment and build momentum in businesses where we see substantial opportunity for aggressive, profitable premium-to-market growth. Looking forward, SSG will continue to serve as the new growth engine. Cost of capital is going up and global interest rate heights, leading to more cautious spending by enterprise customers and cash outlay by switching technology assets. These trends would supercharge demand for support services to ensure the usefulness of assets during their extended life. Our managed service is well positioned to capture true scale as a service, and sustainability demand as enterprise users will also have greater incentives to explore asset recovery services to monetise and recoup the value of their end-of-life assets. The constrained headcount situation in most enterprise IT departments will translate into additional demand for outsourced services, presenting an opportunity for this segment to provide professional consulting and deployment, further accelerating service-led transformation. ISG has built industry-leading end-to-end infrastructure solutions and expanded from server to full-stack offerings that include storage, SDI, software, and services, all with higher profitability. ISG will expand its ESMB portfolio for higher profitability and capitalize on growth opportunity in an AI power edge, hybrid cloud, high-performance computing, and solutions for the telco communication sectors. For the CSP segment, the Group has a unique ODM Plus business model to address growing customer demand by pursuing our customer base and procuring new accounts through design wins. IDG will lead the global race in device innovation by enhancing features that support hybrid working gaming, entertainment, green materials, and ESG designs. Meanwhile, the total available market of the global PC sector should remain at a level structurally higher than the pre-pandemic period thanks to the hybrid work model. The commercial upgrade cycle and the trend of premiumization will help IDG drive premium-to-market growth. Its smartphone business will focus on portfolio expansion and differentiation to take advantage of the accelerated 5G adoption. IDG will further invest to score wins in non-PC areas, including fast-growing accessories and work collaboration solutions, which have become increasingly important for growth. Our strong financial position provides a solid foundation for us to proactively pursue growth opportunities ahead. Finally, as always, we remain committed to driving sustainable growth and profitability for our shareholders. Thank you.