Congratulations to the team at Lenovo Group Ltd for turning things around and producing positive operating profit for the June quarter after a loss the year before.
Investors should be looking hard at where the $186 million turnaround came from, however.
There’s no question the ThinkPad maker’s 19% increase in sales played a large role, and it’s an impressive figure given the challenges in PCs and in mobile, where the Chinese company owns the former Motorola Mobility unit.
Yet the lion’s share of that profit recovery came from cost savings, notably in mobile. Had operating expenses tracked the same rate as a year ago, operating income would have been closer to $1 million, instead of the $180 million Lenovo posted.
That’s not to say cutting expenses isn’t a legitimate way to drive profit. Management should always be on the lookout for savings and improved margins. But the risk is that these savings are hard to repeat: There comes a point where reducing expenses also reduces development, production and sales.
Lenovo points out in its investor presentation that $105 million in operating expenses was cut from the mobile unit in the June quarter compared with the previous year. It also says it’s on track to reduce annual costs at the Motorola unit by around $800 million. That’s great. But then what?
We’ve been hearing for years now of management’s confidence that it will make the mobile and data-center businesses profitable. Its credibility here isn’t strong, and is further eroded by Lenovo’s continued insistence on maintaining inflated goodwill numbers, a writedown of which would trigger massive losses.
Lenovo should crow about its strong financial results this time. Investors need to be assessing the odds of a repeat performance.