Xiaomi Corp

Good evening, ladies and gentlemen. Welcome to the investor conference call hosted by Xiaomi Corporation regarding the company's 2019 third quarter results. I am Steve Lin, the Director of Corporate Finance and Joint Company Secretary. Before we start the call, we would like to remind you that this call may include forward-looking statements which are underlined by a number of risks and uncertainties and may not be realized in the future for bad reasons. Information about general market conditions is coming from a variety of sources outside of Xiaomi. This presentation also contains some unaudited non-IFRS financial measures that should be considered in addition to, but not as a substitute for company's financial prepared in accordance with IFRS. Joining us on the call today are our Founder, Chairman, and CEO, Mr. Lei Jun, our Senior Vice President and CFO, Mr. Shou Zichou. To start with, Mr. Shou will review the business and financial performance in the third quarter of 2019. Following that, we will move on to the Q&A session. I will now turn the call over to Mr. Chu. Hi. Good evening, everybody. And thank you for your continued support of Xiaomi. This is Shou here. I'm the CFO of the company. And I will begin by giving everybody a brief overview of our Q3 2019 results. Now, before we go into the detailed numbers, I would like to share some good news first. The first is Xiaomi was... was ranked number seven on Fortune's future 50 list. And this is an indication that at least the media believes that we have a lot of room to grow for our smartphone and AIoT business in the future. We were also ranked number 57 in Forbes top 100 digital companies in 2019. Now a very important thing in Q3 this year was that we have officially entered the new 5G era. We released our first 5G smartphone in China in September 2019 called Xiaomi 9 Pro. And this phone has been very well received by the market. We believe that 5G will, in the next couple of years, will bring new growth opportunities to Chinese smartphones and in the future will also catalyze a global smartphone shipment change. Apart from investing in 5G, We have also continued to invest in other innovative technologies. For example, in the third quarter of this year, we launched the futuristic Mi Mix Alpha. This phone is the world's first surround screen display phone with a 180% screen-to-body ratio. We believe that this is a breakthrough in screen technology for smartphones. On top of that, On top of that, we also launched Xiaomi CC9 Pro, also known as Mi Note 10 globally, and this is the first smartphone in the world to support a 108-megapixel Penta camera. This is, again, a breakthrough in the camera technology for smartphones. As a result of this, we were ranked by DxOMark as tied number one for overall camera performance for CC9 Pro Premium Edition, And in terms of video, zoom, and texture, we were ranked number one. The reason why we can continue to deliver such innovative technologies is because we have continued to invest in R&D. Our cumulative R&D expense from 2016 to Q3 2019 has reached 16.3 billion R&D. And in the third quarter of 2019, our R&D expenses has increased almost 33% year on year. In terms of AIoT, we have maintained our leading position as a global consumer IoT platform. As of the end of Q3 2019, we have 213 million non-smartphone, non-laptop connected devices on our IoT platform. This number has grown 62% year-on-year. The number of users with five or more connected Xiaomi devices has also grown to 3.5 million people. And this number has grown 78.7% year on year. As a result of this, we were listed on China's National Open Innovation Platforms for Next Generation AI. And we believe that this is a significant recognition of our contribution to the new IoT era. In terms of our financials, If we were to summarize our Q3 performance, it will be that we have chosen to operate prudently. And the reason we have done this is because we are preparing in advance to capture the 5G opportunities that are coming in the future. Our total revenue was 53.7 billion RMB in Q3. This is a quarterly historic high for the company with a year-on-year growth of 5.5%. Our adjusted net profit is 3.5 billion RMB with a year-on-year growth of 20%. Now if we were to dive into each of the individual business lines, we'll first talk about smartphones. Our smartphone revenue reached 32.2 billion in Q3 2019. We sold 32.1 million units of smartphones in Q3 2019. Now, the most important subject in our industry today for smartphones, in particular in China, is the upcoming 5G opportunity. It is true that from 2017 to 2019, the Chinese overall smartphone market has declined year on year. And this is especially true in the first three quarters of 2019, where the overall Chinese smartphone market has witnessed a challenging environment. We believe there are many reasons they make up for this, and one of the important ones is that consumers are waiting for the 5G era to come, in particular after the commercial use of 5G licenses was issued in June this year. We have prepared our R&D resources for 5G for a number of years already. In particular, in February 2019, we launched our first 5G phone, Mi Mix 5G, in Barcelona. In September this year, we launched our first 5G phone in China, called the Xiaomi 9 Pro 5G, and of course, the Mi Mix Alpha. In 2020, we have planned more than 10 5G devices to be launched into the market. Now, in particular, on the 10th of December, which is a few weeks from now, we will be launching the launch event of Redmi K30, which will be the first 5G phone under the Redmi brand. This is a phone that supports both SA and NSA. We believe that this is a significant moment for 5G technology to be brought to the mass market, and we do hope that everybody can give us their support during that day. Now, over the course of our nine years, Xiaomi's mission has always been to relentlessly build amazing products with honest prices to let everybody in the world enjoy a better life through technology. There are many examples of us doing this over the course of our nine years. I will pick a few. The first is our Xiaomi first generation phone, where we launched a flagship phone at a 2,000 RMB price range, bringing flagship smartphone technology to the mass market. In 2016, we launched the Redmi Note 3, which was the first fingerprint technology phone that we launched in the market under 1,000 RMB. In February 2019, we launched the first 48-megapixel camera smartphone at under 1,000 RMB to the market, and this Redmi Note 7 was very, very well received. Recently, we launched our first 5G smartphone in China at a price starting at 3,700 RMB. Now the reason why I raise these examples is to display that Xiaomi is very, very good at making use of our industry-leading operating efficiency to bring the best technologies to the mass market as quickly as possible. We believe that at the beginning of the 5G era, the cost of producing 5G phones will initially be high. Now because the cost of producing 5G phones will be high, we believe that this will enable our superior operating efficiency to shine even better as we bring 5G phones quicker to the mass market. Now in preparation for this, in the third quarter of 2019, our focus was on healthy operations. This has led to continued margin expansion as our gross margin for smartphones increased from 6% in Q3 2018 to 9% in Q3 2019. Our net income margin has also increased as a result. Also very importantly, our inventory turnover days has gone down to 52 days, reflecting a very healthy inventory level as we prepare to capture the 5G technologies, the 5G opportunities, especially in the Chinese market in the few quarters ahead. Now, on top of this, we have continued to execute our smartphone multi-brand strategy, with Xiaomi establishing itself in the mid- to high-end and diversified user market, and Redmi continuing to offer products with the ultimate price-to-performance ratio across a lot of major price points. Moving on to our AIoT business, we have maintained our leadership in the global consumer IoT market. Our IoT and lifestyle product revenue stream reached 15.6 billion in Q3 2019. This represents a year-on-year growth of 44%, maintaining a high growth rate. Now, in particular, our smart TV shipments reached 3.1 million units in Q3 2019, with a year-on-year growth of 59.8%. This is a high growth rate on a large base. We were also ranked number one by shipments in mainland China and number five globally last quarter. We launched the Mi TV 5 series on November 5th, 2019, which is an all-round upgrade at better price points for the future home. Now, outside of televisions, we have also further expanded into home appliances. We launched our Mi refrigerator on the 11th of October this year, completing our wide goods offering of refrigerator, air conditioning, and washing machines. We also launched a very important device on the 5th of November, which is our Mi Smartphone. If I were to summarize what this product does, it is basically a small smartphone that you can wear on your wrist. Because it supports eSIM, it is extremely convenient to use, and it has received a very strong fanfare from our Mi fans. Our AI assistant monthly active users also reached 57.9 million, representing a year-on-year growth of 68.6% in the third quarter of this year. Our AI touchscreen speaker won the 2019 Red Dot Design Award, the U.S. Industrial Design Award, the U.S. IDEA Award, and the Good Design Award. Next, our internet services business. Our internet services revenue reached $5.3 billion in Q3 2019, representing a year-on-year growth of 12%. Our advertising revenue, excluding pre-installations, achieved a positive growth of 6.9%, reflecting a few trends. One, the shift in preference for a lot of advertisers to more advanced advertising platforms outside of pre-installation, which we have diversified and captured, and also the overall challenging advertising market in China today. Despite this, our advertising revenue has increased quarter by quarter in 2019, from 2.3 billion in Q1 to 2.5 billion in Q2 to 2.9 billion in Q3 2019. We believe that this is the result of our increased efforts to diversify our advertising base and to strengthen our overall advertising offering. On top of this, we launched MIUI 11 recently. MIUI 11 focuses on a few things, including minimalistic design, efficiency and connectivity, especially with IoT devices, and also smart travel. As a result of all this work, we have experienced a strong monthly active user growth on our handsets. Our global MIUI MAU has reached 291.6 million globally, while our mainland China MIUI MAU has remained flat year-on-year at 101. 12.8 million. Our internet service revenue stream is also increasingly getting more diversified. Today, 37.2% of our internet service revenue is from internet services outside of advertising and gaming for mainland China smartphones. This, if you recall from last quarter, includes Youpin, our fintech business, our overseas internet services revenue, and also internet services revenue from our IoT products, including televisions. This increasing diversification is also experiencing fast growth. These revenue streams that I just mentioned experience a year-on-year growth of 87.8% in Q3 2019. In particular, we have continued to strengthen our overseas internet services. Just as an example, our major internet services in India, including our app store, our browser, our security center, video and music, are ranked number one or number two on our smartphones in India today. We believe this serves as a very strong base for future monetization opportunities. Now, speaking of overseas, our overseas revenues continue to grow year on year with a growth rate of 17.2% in Q3 2019. Today, our overseas revenue represents 48.7% of our total revenue. For example, in India, we have maintained our leading smartphone position for nine consecutive quarters. Our Q3 2019 market share in India for smartphones remained at a very high 27.1%. Another big highlight for us is our growth in the Western European markets. We are ranked number four by smartphone shipments in Western Europe in Q3 2019, with a year-on-year growth, according to Canalyst, of 91%. Our Spain smartphone market share has increased to number two in the country, with a market share of 22.9%, experiencing a 64% growth. Now, if we look outside carriers and only look at the open market, we are now ranked number one in the open market in Spain. Moving on to a few key financial highlights. First, we'll start with growth margins. As mentioned just now, due to our focus on healthy operations in Q3, while we are waiting for the new 5G opportunities ahead, we have increased our smartphone growth margin from 8.1% in Q2 to 9% in Q3 2019. Our IoT and lifestyle products growth margin has also gone up from 11.2% last quarter to 12.8% in Q3. Our internet service gross margin is at a strong 62.9%. The reason why it marginally declined from Q2 2019 is because of the greater proportion of FinTech business as a percentage of our total internet services revenue, and the FinTech business has a slightly lower gross margin profile than the advertising business. The second is we are pilot testing and advertising network business. And at the initial stages of this pilot test, the margin profile is not as high as our traditional advertising business. We believe that this gross margin will continue to be stable for the foreseeable future. In terms of our operating expense, as mentioned just now, our R&D expenses has increased 32.5% year-on-year in Q3. And as a percentage of our total operating expenses, it has gone up to 3.8% versus 3% in Q2 2019. Now, despite this, we are still at a very efficient operating expense ratio of about 10%. We believe that the R&D efforts will pay off as we capture future 5G growth opportunities. And we believe that we will continue to have industry-leading operating expense ratios. In terms of inventory management, as mentioned just now, Our inventory turnover days has gone down from 65 days in Q1 to 52 days in Q3 2019. This is again due to our focus on healthy operations before the new 5G era, and we believe this puts us in a very favorable position as we have very healthy inventory levels today. Our operating cash flow has also performed strongly in Q3. Our adjusted operating cash flow, adjusted for internet finance, is a positive 3.6 billion RMB in Q3 2019. As a result of this, our cash resources have increased to 56.6 billion RMB by the end of the third quarter. If you include the book value of our investments, the book value of our office and other real estate, and deduct our financial debt, our total cash assets is now at 80.7 billion RMB. And this has increased by 5.1 billion in just one quarter. This number was at about 75 billion in Q2 2019. This concludes my very short presentation before we go into questions. In summary, the focus in Q3 for Chinese smartphones was on healthy operations as we prepare ourselves for the new 5G opportunities ahead. Our AIoT operations continue to grow strongly. Our overseas business continues to expand at a rapid pace. Thank you for your attention, and this concludes my short presentation. We will now move on to Q&A.

Thank you. Ladies and gentlemen, we will now pull for questions. If you'd like to register for a question, please press star 1 on your telephone. Thank you. Our first question comes from Grayston with Morgan Stanley in Hong Kong. Just go ahead. Thank you.

Thank you for taking my question. My question is about the 5G smartphone replacement cycle. Can the manager share with us about what's the status now and how much do you expect the 5G smartphone will be by end of next year actually? And what are the key successful factors to contribute to the replacement cycle? And what's Xiaomi's competitive edge in this 5G upgrade? Thank you.

Great. Thank you, Grace. Let me translate for management here. So the first question is,

OK.

明年是5G普及的第一年,我们明年预计发布10块以上的5G手机。 Next year is the first year of proliferation of 5G smartphones, and we will be launching more than 10 models of 5G smartphones next year.

我们预计中国市场的话,5G手机的渗透率会到40%到50%。

We believe that the 5G total penetration for the market in China could be between 40% to 50% next year. Once we enter the 5G era, the 5G cost of production is higher than 4G phones. Because of our superior industry-leading operating efficiency, we are very well positioned to launch 5G phones at a very, very attractive price. And we believe that this will be very attractive for a lot of users.

我觉得未来,随着5G时代开始,未来30年,我相信几乎所有人的手机都会换成5G手机。 Within the next 3 to 4 years, almost everybody's smartphone should become a 5G smartphone.

是一个巨大的市场需求。 This is a very massive market demand.

我觉得小米今天还有一个非常重要的优势,就是我们今天采用了非常稳健的经营手段。 所以此时此刻的话,我们现金积累非常好,而且我们的库存极其良性,无论是自由库存还是渠道库存都非常低,使我们为5G的开局打下了良好的基础。

Also, very importantly, over the last few quarters, we have emphasized on healthy operations. This means a few things. It means that our cash reserves are very, very adequate. It means that our inventory levels are very healthy, both inventory levels on our balance sheet and also within our channels. This will give us a very big advantage in capturing the opportunities when the 5G era begins very, very shortly. We'll have the next question for you.

Sure. And this question comes from Lei Pinghuang with CICC in Hong Kong. Just go ahead. Thank you.

Thank you for taking my question. So the question is also about 5G. So when we will see the 1,000 IMB 5G, my question is, when will the 5G be available?

Let me translate the question first. The question is, when will 5G phones be at 1000 RMB price point? In order for smartphones to reach 1000 RMB retail price, and for this to be pushed to the mass market, this could be something that will happen in 2021.

The second question is about your overseas development on the smartphone. So what's the progress since we see a lot of opportunities, especially in the overseas operator market? So when we can see what's the latest progress on Xiaomi? 第二个问题我想问一下就是我们在海外市场 特别是因为看到欧洲市场有一块很大的真空现在在出来 就是不知道我们小米现在 我们在欧洲省能拿到多大的规模?谢谢。

We have made a huge progress in the European market in the past two years. We are currently ranked 4th in Europe, with a growth of more than 90% or more than 70%. So our growth is very fast. In Spain, for example, we are ranked second in the market in Spain, and ranked first in the public market. So I think overall, the progress is very fast. Of course, I think we have only been in the European market for two years.

We have only been in the Western Europe market for roughly two years, and today we are already number four in the market, experiencing very high growth at 70 plus percent year-on-year. For example, in particular in Spain, we are now number two in the overall market with about 22.9% market share and number one in the open market. Now, this is a relatively incredible achievement to have been achieved in only two years. Now, regarding the carrier market, this is a to-be business, and we will need a bit of time to expand and scale. We'll take the next question, please.

Thank you. Our next question comes from Donnie Tan with Nomura in Taiwan. Please go ahead. Thank you.

Good evening, management. My first question is regarding to smartphone growth margin in third quarter. So the growth margin in third quarter improved from 8.1% to 9%. Could you quantify how much percentage is from like foreign exchange or product mix in power to overseas market. And my second question is regarding to our smartphone gross margin next year. If we at the same time want to regain some market share in China with more 5G smartphone streaming, what kind of reasonable gross margin for smartphone business would be? And my third question is regarding to internet business. So if we assume like the internet sales from China smartphone related business to be flat, what kind of sales percentage would be from non-China smartphone business going forward? So in third quarter, we have already around close to 40%. is from non-China smartphone-related internet business. So what kind of percentage we should expect going forward?

Thank you. Give me a moment, please.

I think our mobile phone's毛利率提高到9%,我觉得表现非常正常,主要体现我们今年稳健经营的特点。我觉得小米的整个商业模式,我们预测我们的毛利率会稳定在8%左右。 So what you just asked is how many factors are foreign exchange, how many factors are product combination, how many factors... I think basically in a stable state today, Xiaomi's net profit is about 8% to 9%. I predict that next year we should also be between 8% to 9%.

So for your first question on gross margins, we believe that the 9% gross margins that we have in this quarter is actually a reflection of normal operations. And this is a normal gross margin for us to have. In normal conditions, our gross margins should be at around 8% to 9%, and we believe that this should be stable over time, including for next year. So your question on how much of it is Forex, how much of it is overseas market, how much of it is product mix, we think this number just reflects a normal gross margin profile that we should have. So that's the first question. And the second question. Regarding your internet question, so your question was, what percentage of our, in the future, what percentage of our internet services revenue will be from smartphones outside of China. Now today, our internet services revenue from FinTech, from Yopin, from overseas phones, and from and from TV is increasing at 88% year-on-year. And it's already at 37.2% of our total revenue. Now although this is quite some distance from the majority, the growth rate is very fast. The work we are doing right now in certain geographies, for example, in India and Indonesia, is to make sure that we are building very strong internet services for our users. For example, our app store, our browser, our video, our music apps in India are already at the number one or number two position in terms of VAU on our smartphone platform. Now, once you have the users using all these services, you create the inventory and the opportunity to monetize. So I think we're on the right track. Now, we won't give a forward-looking statement on exactly what percentage it is, but I think you can look forward to a bigger percentage of our internet services revenue coming from the overseas market in the future. We'll now take the next question.

Thank you. Our next question comes from Kino Wong with Credit Suisse in Hong Kong. Please go ahead.

Thank you for taking my questions. I would like to ask about the R&D investment or the TAPAS investment for 5G in the future, because we see that in terms of R&D spending, it actually went up in third quarter, and this kind of level will be sustainable or not. Should we also consider more R&D effort in next year in preparation for 5G or even thousands of price points of 5G phone in 2021. So and also the CAPAS because we also like know that the some factory in Beijing that is for like some testing or like some self I mean preparations for the 5G. So wanted to see if there's any further CAPAS investment for 5G phone as well. This is first question. The second is about the internet business. In terms of the fintech business we see is high growth but Is this sustainable? What should we expect in the future? Because there's some kind of uncertainty in the market, maybe related to regulations and all things. So should we also expect this would be one of the key drivers in 2020 in telebusiness? Okay, Gina, give me a second, please. Yep.

OK. I think Xiaomi has steadily increased our R&D investment in the past three or four years. In the third quarter, it has increased by more than 30%. I expect our R&D investment this year will be around 71 RMB. I think next year we will increase our R&D investment by a reasonable proportion. I think at this stage, Xiaomi's R&D and investment supports our current scale. I think it should be no problem at present. And we will steadily increase our R&D investment based on our wealth. This is the first question. The second question is, in the era of 5G mobile phones, because we developed 5G

Okay, for the first question, our R&D expense for Q3 this year had a year-on-year growth of more than 30%. And Lijun expects that by the end of this year, our total R&D expense for the year should be at around 7 billion RMB. Now, he believes that for 2020, it will be at a reasonable level. And our R&D today is appropriate for our current business plan. And of course, you know, we will plan and adjust our R&D cycle according to our business needs. So this is something that he believes is appropriate at this level. And we will increase, you know, appropriately over time. So that's the first question. Now, in terms of the second question on 5G, we began our... R&D in 5G starting from 2017. And he thinks that we are well prepared to take on all the opportunities that the 5G smartphone business will bring for the future. Just to clarify, this R&D expense is in our P&L. It is not a capital expenditure. Now, in terms of the factory news that you heard just a few days ago, this is a pilot test where we are trying to push the industry to innovate in efficiency and automation. It will be a pilot test at a scale where we can continue to push the industry forward. And for the foreseeable future, we intend to continue to maintain very strong working relationships for the manufacturers who perform assembly for us at this point in time. Now for your second question on the FinTech business, our FinTech business is generally speaking, you can understand it as two pillars. The first is the consumer finance business, which mainly revolves around our smartphone users. We provide it as an additional internet service to our smartphone users, and we have the appropriate license and comply with all the rules and regulations in terms of this business. Now, the future growth of this business is still something that we can foresee, even after complying with all the rules and regulations locally. And this is because we have the resources to get all the licenses in place. But the second part of the business, which is very exciting for us, is the supply chain financing business, where we are making use of our strength in the manufacturing space and also our deep relationships with our partners to build a fintech business for our supply chain. Now, sometime in the future, when it is the right time, we may further break down these two businesses to disclose appropriately. But I just wanted to give you a sense of what it actually is. Okay, we'll now take the next question.

Our next question comes from with Goldman Sachs in Hong Kong. Please go ahead.

Thank you for taking us through your 5G opportunity. If you dig deeper through that, could you give us a sense of what you think your strength is as you roll out 5G smartphones in the country? in the 5G smartphone business in China. And finally, what it implies for our user number for China, which has been flat year-on-year, 112 million, so we can get a better assessment of what it means for profitability for the overall business. Thank you. Okay, give me a second to use it.

I think in the 5G era, Xiaomi has these advantages. The first advantage is that Xiaomi's efficiency is relatively high. Xiaomi has consistently maintained a very high-efficiency price increase. For example, we only added 9% of the net profit. Because our colleagues may need to add 100% of the final retail price. So when the hardware cost of 5G mobile phones increases, Xiaomi's cost-effectiveness advantage will appear. I think the first one is Xiaomi's innovation in the model. It will help 5G mobile phones with very high costs to spread faster. I think this is Xiaomi's first advantage, 5G mobile phones. Second, Xiaomi entered the 5G era. This year, they started to prepare. Now, now, 我们几乎没有恶性 其实我们的库存在极低的水位上 我们为5G打下了良好的基础 今年的双11竞争非常激烈 因为小米打得很保守 可能很多人不理解 其实是因为我们库存压力不大 我们没必要巨额亏损 Let me translate these two first.

The first advantage in the 5G era comes back to our operating efficiency. Our 9% gross margin means that we only need to add roughly 9% to the price for us to break even here, whereas some of our competitors need to add a lot more in order to break even. So we believe that our operating efficiency will allow us to very quickly bring 5G devices to the mass market because of our operating efficiency and the model that we have employed. Now, the second advantage is we have prepared very early for this 5G transition, and actually we talked about it in quite a bit of detail last quarter as well. Our inventory levels now are very healthy. And Leijun gave an example for the single day sale that happened recently where we were very conservative. And some people didn't understand why we were so conservative. It is because we don't have unhealthy levels of 4G inventory and there was no need for us to take massive losses for this. So because we are prepared earlier for this 5G transition, what we see internally is that, and I quote, we have basically cleared out our warehouses so that we can take off during the 5G era. Loosely translated, unquote.

The third point is that Xiaomi's intense development and investment and its own innovative culture have greatly enhanced Xiaomi's technical strength in the past three years. Let me give you an example. I heard that 70 billion yuan of development is now a very large number in China. Of course, we may invest more. I think the culture of innovation is very important. In the case of the investment of 7 billion yuan, let me give you an example. There is a camera that is very powerful. And there is a more authoritative evaluation institution called DxOMark. As a result, we both rushed down. Today, Xiaomi is number one in the world in terms of cameras. 所以包括我们在无线充电技术上全球领先, 这其实我们最近的整个技术实力得到了空前的增强。

Okay, the third is we have a very innovative culture and a very sustained R&D investment and effort. This has led to a lot of technology breakthroughs for us. Now, 7 billion R&D is actually a very large number for R&D expense in China. Now, of course, you may be comparing us to one company, which claims to have a very big R&D expense. But what is also important is not just the mere numbers, but you need to have a very innovative culture. Now he gave two examples. One is the SID competitor has always been very proud of their camera technology, and they found a very authoritative third party called DxOMark. And within two years of us innovating in this field, we are now tied, number one, in terms of camera technology, according to DxOMark. It only took us two years to get there. In terms of wireless charging technology, we are now leading globally. So this R&D, continued R&D investment and innovative culture is a very significant advantage that we have. We'll now take the next question.

The next question comes from Goko Hariharan with JP Morgan in Hong Kong. Please go ahead. Thank you.

Thanks for taking my question. So first of all, on the service business, Could you talk a little bit about margin trends across the different businesses, ads versus internet finance versus value-added services? And secondly, what is your outlook for advertising, given even pre-installed it's growing at single digit? What does the current building of your own ad network business, et cetera, do? to recatalize the market, recatalize Xiaomi's advertising growth in internet services. Okay, give me a second, Goku.

Goku, I'll answer this question. So it's broken down into a few parts. Your first question on margin trend, I think the overall answer is that this current margin level of 62 point something percent, we believe is a very sustainable number for the foreseeable future. Now the breakdown of advertising, internet, finance, and value added services can get very complicated, but you can think about it this way. Overall blended and based on what we can see for future growth, we believe that this kind of 60% plus margin profile is sustainable for the foreseeable future. Now in terms of the advertising outlook, I think it's fair to say that it has been soft since the beginning of this year for the Chinese market. Now, because it is soft, I think it has compelled us to start building sort of more sophisticated recommendation engines and deliver better ROI for advertisers starting from very early this year and the back end of last year. And what you're seeing now with the growth of our X pre-installation advertising revenue, especially the growth for two consecutive quarters on a quarterly basis, is the initial results of us strengthening these parts. So it is about building a stronger recommendation engine. It is better use of the big data, you know, subject to all the privacy compliance that we need to adhere to. And it is also about expanding our advertising base from internet companies only in the past, which is about a year ago, to more traditional advertisers such as the traditional finance industry, such as small to medium enterprises, such as education, so on and so forth. Now we believe that a diversified strategy is the best way to make the business more robust. And because if you compare our advertising revenue to the entire advertising industry in China, the proportion and penetration is still very small. So as we diversify our base, this will allow us to continue a very sustained path of growth. And then as the advertising market turns, as the economy sort of picks up in the future, we believe this puts us in a good position for even more accelerated growth. Okay, thank you. Next question, please.

And our next question comes from Donnie Tan with Nomura in Taipei. Please go ahead.

Thank you, management, for taking my question again. I just have one follow-up question regarding to Chairman's smartphone growth margin target of 8% to 9% next year. Originally, I was thinking that Xiaomi's priority is to regain some smartphone market share in China. So to do that, Xiaomi may need to have a more aggressive pricing strategy when entering into the 5G era next year. And also considering that the bone cost of 5G smartphone may be like 300 to 500 RMB higher than 4G smartphone. So I would be surprised if Xiaomi can regain market share in China and at the same time to maintain the gross margin at 8% to 9% next year. So could you elaborate more how could we do that by, is there any specific strategy or reason behind? Thank you.

Okay, give me a second, please.

I think Xiaomi's model is 8% to 9% of the profit. I think 8% to 9% of the profit, in fact, Xiaomi's cost performance is a relative concept, that is, the same thing, its price is the lowest. After 5G increases a lot of costs, the price of their products will be more ridiculous, will be more expensive. So in comparison, under the same product, Xiaomi's cost-effectiveness will be very outstanding. I think 8-9% interest rate is a very low interest rate. And our sales model focuses on e-commerce sales. So in the end, the price that customers buy will be very cheap. The most important thing is that our own interest rate is very low. And the middle channel is very short. So in the end, the price in the retail market is very attractive.

我认为小米模式在5G时代不需要做太大的变化。 So our price to performance ratio is a relative metric. It means it is always relative to the pricing of our competitors. Now, precisely because the bomb of 5G phones will increase, our competitors have a higher operating expense, and they basically have no choice but to increase their prices. So it is a relative metric, it's a relative measure in terms of us having better prices in the market. And this is a reflection of our superior operating expense. Now, 8 to 9% gross margins is actually already not high. It is a low number. And because, you know, our business model focuses on more efficient channels like e-commerce, So at the end of the day, the consumers can still get a phone at a very good price, even if we sell our phones at 8% to 9% gross margin. So there is no contradiction in the way we look at it. We will now take the last question.

Thank you. Our final question comes from Robert Kong with Exit Research in Shanghai. Just go ahead. Thank you.

Hi, management. Thanks for taking my question. I also want to ask about 5G, but I'm interested in the implications that the transition to 5G is going to have on your IoT business. How are you thinking about IoT in the context of 5G era? Thank you. Okay, give me a second, please.

5G will have a huge impact on IoT, but the first thing that will affect 5G will be the end of mobile phones. I don't think it will have a big impact on our IoT devices in the future, because these features of 5G are essentially designed for IoT.

So Legend believes that the new 5G era will actually have a very profound impact on the IoT experience for users. And of course, initially, 5G will initially sort of benefit smartphones first, but because the whole 5G technology is actually designed for the Internet of Things, so maybe in 2021, 2022, you can see how this technology will be brought to more and more IoT devices. And because we already have such a leading advantage in our consumer IoT platform today, we are very well positioned to capture these opportunities in the future.