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.