Xiaomi Corp

Ladies and gentlemen, thank you for standing by and welcome to Xiaomi's 2019 fourth quarter and annual results announcement conference call. Today's conference is being recorded. If you have any objections, you may disconnect at this time. I would now like to hand the conference over to your host today, Mr. Steve Lin. Thank you. Please go ahead, sir.

Good evening, ladies and gentlemen. Welcome to the investor conference call hosted by Xiaomi Corporation regarding the company's 2019 annual results. I'm 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 various reasons. Information about general market conditions is coming from a variety of sources outside of Xiaomi. This presentation also contains some non-IFRS financial measures that should be considered in addition to, but not as a substitute for, company's financials prepared in accordance with IFRS. Joining us on the call today are our President, Mr. Wang Xiang, Senior Vice President, President of International, and CFO, Mr. Shou-Tzu Chu, and our Vice President of Finance, Mr. Richmond Li. To start with, Mr. Wang will share strategic initiatives for the company in 2019, and Richmond will discuss the business segment and financial performance. Once the managers complete their prepared remarks, we'll move on to the Q&A session. I will now turn the call over to Mr. Wang. Good evening, everyone. Thank you for joining our Year 2019 Annual Result Earnings Call. I'm Wang Xiang, President of Xiaomi Corporation. A little bit myself, I joined the company in 2015. Before my current role, I was in charge of the Xiaomi international business, the IP strategy and the legal affairs. So I'm going to be your new friend. In the future, we'll spend more time together. So this is my first time presenting our result together with Sho and Richmond. So I look forward to partnership with you. Actually, 2019 was a very important year for us, just simply because in a few days, Xiaomi is going to celebrate our 10-year anniversary. So probably it's a good time for me to do a little summary about what we have done since we were founded in 2010. So actually, the company was founded in 2010. Two years later, we achieved or surpassed RMB 10 billion RMB as a revenue. And in year 2017, we surpassed 100 billion RMB. Last year, year 2019, the company revenue surpassed 200 billion RMB. Not only that, actually, this is the first time Xiaomi has listed a Fortune Global 500 in August, ranked number 468. Also, we are also listed by a branding organization called BrandZ as the most valuable consumer brand in the world. is a very, very important milestone for us as a 10-year-old company. Let's talk about year 2019. The total revenue was 205.8 billion RMB, up 17.7% year-on-year. A digested net profit was RMB 11.5 billion, up 34.8% year-on-year. And also, I want to mention the major business, for example, the internet service business grow 24.4% year-on-year. And IoT business grow 41.7%. Our smartphone business increased 7.3% in the entire year. Let's talk about the Q4 number. The total revenue in Q4 was 56.5 billion RMB, up 27.1%. The adjusted net profit was 2.3 billion RMB, up 26.5 year-on-year. So also, we have significant increase in our internet service in Q4 last year, which was 41.1%. IoT business increased by 13.5% in 2004. Smartphone business 22.8% growth. So let me highlight some strategic things we were doing in 2019. First thing is we continued to increase our investment in R&D. So from year 2016 to year 2020, our R&D expenses expected to surpass 28.6 billion. And in the year 2019, our R&D expenses was 7.5 billion. Based on our plan, year 2020, this year, we're going to spend more than 10 billion RMB in R&D. So another very important thing is we are successfully get or entered into premium tier smartphone sales business. We launched Mi 10 series in February. So Mi 10 Pro was the first premium-tier smartphone sell at over RMB 5,000. This is the first time we sell premium-priced product. And also, with the long-term RMB investment, actually, we achieved several technology, make several technology achievements. For example, DSOMark. Redmi 10 Pro is the first time we were in the top of the DSOMark on the camera, video, and audio scores. And also, in the entire year 2019, The company executed proven operation strategy because it's 2019 is the technology migration time period from 4G to 5G. In order to promote 5G in the future, actually, we are very carefully managing our inventory and our cash flow. So we have a zero 4G inventory so that we can be very, very ready to aggressively promote our 5G products in year 2020. Another very important thing is in December year 2019, we launched a very important 5G product we call Redmi K30 5G. It was the first 5G product selling at a R&B below R&B 2000. So that product actually got very, very good market response from consumers. So we'll continue to promote the Redmi brand with the extreme performance price ratio and bring the latest technology widely available to the mass consumer. I think at this point of time, the people concerned about the virus, the COVID-19 outbreak has the impact from the virus. Actually, let me do some summary about what we see, the virus, and what is the impact for our near-term and mid-term business. From the supply side, actually, we were suffering during the February timeframe, early February, for the production. Actually, it was a very challenging time to find laborers to resume the factory. But after a month, more than a month's effort, actually, today, as of today, I'm happy to share with you our production capacity, our capability, resumed to 80 to 90 percent of the normal level. as end of March 2020. And let me talk a little bit about the mainland China market. During early February, actually because many cities are locked down, the shopping malls closed, so the demand was affected very, very heavily. But starting from late February, we see a very strong rebounce of the market. So up to now, the China smartphone market recovered about, I think it's around 80% to 90% of the January consumption. It's a very good signal. And also it tells us smartphone may be, we call the rigid demand. So people actually need smartphones to communicate, even during the virus timeframe, when they spend more time with families at home. And the overseas market right now is in the outbreak period. We see a lot of serious situations happening in Europe, in India, and other parts of the world. I think the market will be, the impact will be expected in Q2, year 2020. I think May, April and May mostly. And the demand likely be deferred rather than lost. Based on the experience in China, smartphone demand is resilient and will be rebound quickly. With a strong global foothold and continuous expansion into new markets, the long-term growth prospect is in act. We remain confident for the rest of the year. So regarding to the Internet service, we see both time span and the value added service revenue grew strongly. advertising budget from certain client vertical were impacted. But the general Internet service was not impacted heavily. So I think this is the overall picture of year 2019. So I would like to invite Richmond to give you details in the different business units for the business. Hello, everyone. I'm Richmond Li, VP of Finance at Xiaomi. I will now walk you through our business segment performance, as well as key financial indicators. First, our smartphone segment delivered solid performance in 2019, as the revenue reached $122.1 billion, an increase of 7.3% year-on-year. with smartphone shipments totaling at 124.6 million units. In the fourth quarter of 2019, smartphone revenue was 13.8 billion, an increase of 23% year-on-year. We also want to highlight that in the fourth quarter of 2019, we achieved the highest year-on-year growth of smartphone shipments among the top five smartphone companies, according to Canada. In 2019, our smartphone's new brand strategy achieved very remarkable results. On one hand, Xiaomi's brand focused on pioneering advanced technologies and successfully established itself in the high-end smartphone market. After unveiling the Mixed RF of 5G, a concept phone featuring surround display, we launched our flagship 5G smartphone models, the Mi 10 and the Mi 10 Pro, in February 2020. Mi 10 series offers ultimate performance experience across all functions by deploying in the leading processor, display, camera, and across the charging technology. As Xiangzong just mentioned, Mi 10 series is well received by our customers. On the other hand, Redmi brand offers production with ultimate price-performance ratio to the mass market. In 2019, Redmi also launched its first 5G smartphone, Redmi K30 5G. and followed by the Redmi K30 Pro factory, which it was launched last week. Redmi has launched competitive products across different price points, from $699 to $4,000. Let's move on to the IoT segment. This year has seen strong growth of our IoT and lifestyle product segments. As we continue to grow our IoT product portfolio and enhance and the connectivity across our products. The IoT and laptop products revenue was 62.1 billion in 2019, an increase of 41% year-on-year. While the revenue in the first quarter was 19.5 billion, up 31% year-on-year. As one of the global leading consumer IoT platforms, we continue to expand our IoT user base At the end of 2019, the number of connected devices on our IoT platform, including the smartphone and laptops, reached 235 million units, an increase of 56% year-on-year. The number of users who have five or more devices connected to Xiaomi's IoT platform reached 4.1 million, an increase of 77 year-on-year. We have achieved leading positions in key IoT products that are critical to our IoT platform. Among lots of popular products we offer, Xiaomi TV is one of the star products. In 2019, our global TV shipments reached 12.8 million units, an increase of 52% year-on-year. According to ABC, we are the number one TV brand in China, in mainland China, with about 20% of market share of shipments in 2019. and we shipped over 10 million units in mainland China last year, setting a very good industry record. Our smart TV ranks number five globally and number one in India. In 2020, we will offer our smart TV in more countries and regions. Besides the TV, Xiaomi also leads the market of wearable bands, ranking number one globally. According to Kennedy, Our wearable band treatment reached 35.6 million units, an increase of 55 percent year-on-year, with global market share of 21 percent. Also, meanwhile, our old AI assistant, Xiaoye Gongxue, had 50.4 million MAU in December 2019, an increase of 56 percent year-on-year. The AI assistant supports new functions, including continuous conversation innovative graphical and voice user interface, AI smartphone assistant, and voice print recognition. The newly added functions received highly positive responses by our users. Moving over to the internet service segment, in 2019, internet services revenue reached 19.8 billion, up 24% year-on-year. For the first quarter, The revenue was 5.7 billion, an increase of 41% year-on-year. Of that, advertising revenue grew by 18%, online gaming grew by 44%, and the other internet services grew by 104%. Such solid growth is supported by our expansion of the user base. In December 2019, The global MIUI-MAU increased by 28% year-on-year to 310 million, while MIUI-MAU mainland China accounted for 109 million. Besides the smartphone, our smart TV-MAU also grew by 49% year-on-year to 27.7 million. Last year, despite the challenging macro environment in China, as our advanced advertising business achieved consecutive quarter-on-quarter growth. This increase was mainly attributed to our consistent improvements in our mobile internet apps, which boost their MAUs. And this is further because of our efforts to increase the monetization because of the diversification of our advertising customer base and optimization of our recommendation algorithm. Diversification is a key growth driver of our internet service revenue. For the first quarter of 2019, our internet service revenue, outside of advertising and gaming from mainland Chinese smartphones, increased by 112% year-on-year. And this accounts for 43% of our total internet service revenue. This business refers to our FinTech business and U-Ping e-commerce platforms. TV internet services, and overseas internet services. Next, moving on to our international business. The overseas market offers us tremendous growth room. In 2019, we further expand our global footprint with overseas revenue account for 44% of our total revenue. Overseas revenue was 91.2 billion in 2019. and the increase of 30% year-on-year. Our smartphones were sold in over 90 markets, and our smartphones ranked top five for 45 markets. In the fourth quarter of 2019, our overseas revenue increased by 41% year-on-year to $26.4 billion, and this accounts for 47% of the total revenue. We witnessed the growth across all regions where we operate, but India is still our single largest overseas market achievement. In the fourth quarter of 2019, we maintained the number one position for 10 consecutive quarters with market share of 29%, according to IDC. We also gained the market share in Western Europe. According to Canada, in the fourth quarter of 2019, We ranked number four in Western Europe, with smartphone shipment growing 115% year-on-year. In Spain, we were the number one, the number two with 23% of market share, and just 1% less than the number one. We also ranked number four in France and Italy. After reviewing the performance of business segments, I'd like to share some financial metrics with you. First is our gross profit margin. Compared to the year 2018, smartphone gross margin increased from 6.2% to 7.2%. The IoT and laptop products gross margin increased from 10.3% to 11.2%. And the gross margin for internet services remains 5. In terms of expenses, our operating expenses ratio increased from 9.1 percent to 10.2 percent. This is mainly attributed to our elevated investment in R&D activities, as well as the branding activities in overseas markets. In 2019, our R&D expense increased by 30 percent year-over-year. For the working capital, our matrix remains healthy, compared to the fourth quarter of 2018. In the fourth quarter of 2019, our inventory turnover days decreased from 65 days to 54 days. And accounts receivable turnover days decreased from 14 days to 17 days. Accounts payable turnover days decreased from 115 days to 101 days. The cash flow results were very strong in 2019 as well. The adjusted operating cash flow was $27.1 billion for the full year 2019 and $11.3 billion for the first quarter of 2019. Accordingly, our cash position was further boosted. Cash resources amounted to $66 billion by the end of 2019. And with our investment portfolio, and the book value is $30 billion. And our office and other real estate, the book value is $11.3 billion. And then deducting the financial debt of $17.6 billion. Then as a result, our net cash as assets were about $89.7 billion by the end of 2019, increased by $25 billion from 2018. The strong balance sheet, should enable us to well position in front of any unexpected market change. Last, I want to talk about our investment performance. As of December 13, 2019, we have invested in more than 290 companies with an aggregate blue value of about $30 billion. An increasing number of our investing companies have gone public. In February 2020, the global rock, Shidou Keji, one of our investing companies, was successfully listed on the star market in China and became the first ecosystem partner company of ours to lead on the A-share market. We believe that this is a recognition to our ecosystem business model by the A-share capital markets. As our business continues to grow, we believe that more and better companies will go public in the future. And that's why we want to reiterate our pledge. Our mission is to build amazing products with honest price to let everyone in the world to enjoy a better life. In 2018, as approved by our board, we pledged to our existing and potential users That's starting from 2018. Xiaomi's hardware business, including smartphone and IoT products, would have an overall net profit margin that now exceeds 5%. And for this year, 2019, our hardware business was profitable and with an overall net profit margin which is less than 1%. So this is to fulfill our pledge. This is my prepared remarks. Thank you very much. Thank you, Richman. We'll now proceed to the Q&A session. In order to allow more people to ask questions, please limit your questions to a maximum of two.

The question and answer session is now open. To register your question, please press star 1 on your telephone keypad. Should you wish to cancel your question, please press star 2. Your first question comes from Le Ping Huang from CICC. Please ask your question.

Thank you for taking my question. I have two questions.

One is about the impact of the virus outbreak in India and Europe. The second question is about your strong performance of your internet business in fourth quarter.

So I just read a letter to the investor saying that in Mandarin it's about keep high efficiency is the ultimate solution to overcome the crisis. So I want to know what is the latest situation of your business or business in India and the major European cities like countries like Spain, Italy. And what's your plan to overcome this challenging situation due to the virus? And the second question is that I see you are doing very well in your internet business. I see the growth rate of your internet business actually re-accelerates to about 40% in fourth quarter from

I want to know what's the reason behind and considering, if I understand correctly, it's mainly in China, so what will this driver remain strong in the first quarter of 2020 considering the virus situation in China?

Thank you. Yeah, maybe I'll answer the question and then Shou and Richmond can add. So the first question is related to the impact, right, the COVID-19 impact on our business in India and Europe. So right now in India, I think the Indian government take a very, very big step to prevent the whole country into, to try to help the people to prevent the more infection. I think it's the right decision. So the whole country right now is shutting down. So we see definitely will impact our business. But based on the, but still, although everything is shutting down, we still see a lot of customers in France still buying our smartphones from different channels. That's a good indication that the consumer consumers need smartphones even in the very difficult situation. So based on the experience we have in China, we see a strong bounce back of the market. So we believe after the recovery from the virus, actually we will see a strong recovery. So in China, China's appearance told us right now, in March actually, the run rate of smartphone sales is about 90% of the January consumption. It's a very good signal, and it tells us the smartphone demand is a resilient demand. In Europe, same thing. Right now, many countries, including Spain, Italy, and France, their focus is fight against the virus, right? So we see a demand drop, but gradually, after a week, gradually stabilize. So maybe later I would like to show to give you a detail.

Yeah, sure. Okay. Hangzong, so this is Shou here. I would just sort of reiterate a few things that Xiangzong mentioned just now. The first is, based on our experience in China, based on experience in China, smartphone demand rebounds quickly. And our own assessment of this, based on going through a full cycle here in China, is that smartphones is closer to the spectrum of essentials than on the spectrum of sort of luxuries in this time. So the good thing about our Chinese demand was there was deferred consumption in the month of February, in particular, when a lot of cities were shut. Of course, e-commerce did a little bit to mitigate this. And as all of you know, our e-commerce presence in China is significant compared to a lot of our peers. So this is the experience we had in China. Now the situation outside of China is very dynamic. We are operational in 90 countries, and as of now, almost every single country has imposed some sort of restrictions within the country internally. Now there are only a handful that have imposed the highest form of restrictions, which is even the logistics and fulfillment doesn't work. Only a handful of countries are in this category. The large majority of countries are in the category where there is social distancing policies. Some offline retail shops are shut. But in general, the country is not at a complete, complete standstill. So what we are seeing, you know, based on our numbers, first of all, you know, we understand the gravity of the situation. We see a fall, but we see it sort of stabilizing. In particular, in some countries, we actually see a slight recovery. It's across 90 countries around the world, so different countries are in different stages of this. The second is, what we have seen is, in China, the consumption gets deferred. So, at least in China, in the second half of March, what we are seeing is a relatively robust recovery. So this is something that we take to heart. Now, the third thing that we see, and we have to be very factual here, is that almost every country, maybe except for Australia, where we don't really have too much business, is imposing sort of different types of social distancing and lockdown until the middle of April. Most countries are in this category. Now, whether or not this gets extended, I think, really is an assumption at this point in time. So based on all these assumptions, you know, our current assessment, and we do this on an almost daily basis now, our current assumption is that undoubtedly there will be impact in demand. Undoubtedly, you know, there will be impact, particularly for our overseas business, in the second quarter of 2020. But right now, you know, we are... We think the whole situation is currently manageable. And overall, for the year 2020, we expect to grow as a business.

For Internet, I'll talk about the Internet service growth. So in the fourth quarter of 2019, our Internet growth was 41%. If you look at it, all the security growth. or advertising grew 18%, or gaming grew 44%, or other value-added services grew over 100%. So if you look at this, I think one difference from the past few quarters is advertising. Advertising in China, in smartphone in particular, was a draft in the past few quarters. Starting from fourth quarter, if you compare to 2018 fourth quarter, because the weakness in China's smartphone advertising market started in 2018 fourth quarter. So the year-on-year price drop on advertising was less severe starting from fourth quarter of 2019. So that is one of the reasons. And another reason is a lot of our fast-growing advertising business has become larger. So we talk about the diversification of our internet service revenue. Twitch, or Yopi eCommerce, or Oversea Internet Service, or TV Internet Service, and our FinTech business together right now already accounted for 43% of our internet service revenue in Q4 2019, and was growing at over 100%. So this fast-growing business has become even larger and contributed to an even larger growth. So those are the reasons for the growth in Fort Code 2019.

I would just add one more thing here. you may have noticed that our advertising revenue has grown quarter on quarter for four consecutive quarters in 2019. I think many of you know that 2019 for China advertising was not the best year. It's a relatively challenging macro outlook for the year 2019 for advertising. Now, the reason why we achieved quarter on quarter growth is really down to the few things we have been talking about consistently over the last many quarters, which is One, diversifying our advertising base, transiting from only sort of majority internet company advertisers a couple of years back to more verticals like small to medium business verticals and direct e-commerce players, so on and so forth. The second is you may have noticed in our announcement that our news feed service, for example, now has 76 million monthly active users. Now, this is very prime advertising platform. uh space particularly for location-based services so uh and for small and small to medium businesses so so these are the things that we've put in effort in the past and the third as we have said several quarters now is our investment in you know optimizing our advertising recommendation systems um and and the combined effect impact of this is advertisers just get a better return and as a result you know allows us to grow our advertising business so so um I think we have been doing all the work that we have been saying for quite some time and I think fourth quarter you see a little bit of the results of this. Thank you very much.

Thank you. Next question please.

Your next question comes from Cherry Ma from Macquarie. Please ask your question.

Hi. My first question is, is it possible to give us some color on the overseas Internet service revenue? What is the rough percentage breakdown within the segment in 4Q? And any rough idea on how much overseas ARPU is?

Jerry, so we don't want to go beyond what we have disclosed in our announcement. The four revenue streams, YoPin plus FinTech plus TV advertising, particularly from membership, plus overseas revenue, combined is 43% of our total internet revenue in Q4 2019. And combined revenue growth is at 112%. So that's what we disclosed in our announcement. But qualitatively, I can tell you that Again, this is very consistent with what we have been talking about for many quarters now. Step one, sell phones, IoT devices, get users. I think this is proving, well, this is something that we have been growing every single quarter. So that's the first thing. The second is provide more internet services. And we disclosed an announcement in particular in India you see the introduction of Mi Video, Mi Music, our Mi Speed, even our App Store. And all these are the services that eventually get you the inventory to monetize. And then the third step is to monetize. So we are not in the phase where we are fully – our energy is on step one and step two. Step three is something that we are doing, we are building, it's growing very quickly. But the management focus here is on step one and step two, which makes sense for the future.

Okay. My second question is on the Airstar Virtual Bank. I noticed there's a stock opening today. Congratulations. How much does Xiaomi own in this virtual bank and how should analysts model this business going forward? Any guidance would be helpful. Thank you.

We own 90% of Airstar. It's still a key material in terms of our P&L and our balance sheet at this stage. It's operated by the Xiaomi Finance entities, which Xiaomi Finance is 100% owned by Xiaomi today. The idea is to bring great financial services to our users in Hong Kong at this point in time. It's very early. I think it's It's too early to talk about the modeling at this stage. But yes, we do have a soft launch. For those in Hong Kong, you are free to sign up. For the first $20,000 Hong Kong dollar deposit, it will give you a 3.6 interest rate.

Unbelievable. That was good. Thanks.

Okay, next question please.

Your next question comes from Tina Wong from Credit Suisse. Please ask your question.

Hi, management. Thanks for taking my question. It's a great result in the fourth quarter. And I wanted to check is about the ASP and also gas margin in the fourth quarter that we see for the smartphone side. There's a decline because of the mix from the overseas. And also the gas margin is also slightly below from the third quarter as well in terms of smartphone. So just wanted to know the trend going forward because this year, 2020, that we see obviously that contribution will continue to increase and what's the mix that will help in terms of ASP and what is your expectation now that the gross margin, if it could maintain, I mean, in that level or we should expect there will be more variations in this year? So that's the first question. The second one is about the recent launch of the Mi 10 and also the Huawei P40, the P40, actually pricing a similar range in the premium segment. Do you worry about the sales expectation in the Mi series because there's a hard-to-hack competition in the segment after Huawei launches P40? with the same price at the lower segment. Thank you.

Yeah. Thank you for the question. Let me answer the question number one regarding the ASP and the gross margin, right? So I think it's a seasonal thing. Q4 year 2019 actually is a very important selling season. We do a lot of promotions. We drive huge volume in China and outside of China. We ship a lot of devices to India, to Latin America, to Europe, to everywhere. So we drive a significant volume with the promotion and the branding. So that's why you see the ASP is a little dropped. The growth margins is a little declining. I think it's a seasonal thing. So in the future, we'll continue actually to drive two things. Number one, we want to drive, we want to develop premium tier smartphones in China and in the rest of the world market. In China and in Europe, basically, for the premium tier. So you see, we launched Mi 10 and Mi 10 Pro in December. Sorry, in February. And also... will continue to do that also we lost that similar product the same product in Europe last week actually both Europe in China we all received a very good response the shipment actually is a is a exceed our expect original expectation I think the setting result is good although we see a Other companies are shipping or launching a similar product. You just mentioned the P40 and the P40 Pro. But we're still very happy with our shipment because we really drive the performance to a new level. So I believe our customers, our fans, love to use our product. It's a very good signal. I just want to add one more thing.

You mentioned some other products in the market. Let's talk about the P40. There are three variants of it, P40, P40 Pro, and P40 Pro Plus. If you want to compare prices, you need to compare P40, because they haven't launched in China. You need to compare P40 with Mi 10, which we launched in Europe last Friday. And if you take these two products and put them side by side, yes the two prices are the same, but P40 is much inferior. So I just want to point that out.

Okay, thanks.

Thank you. Next question please.

Your next question comes from Thompson Wu from UBS. Please ask your question.

Thanks, and good evening. Hope everyone is relatively safe tonight. Wang Zong, welcome to the call. I have just two quick questions. The first one, I think, goes back to Kina's point about smartphone ASPs and Wang Zong's comments about expanding overseas and investing in new product categories. It seems like selling and marketing exiting fourth quarter was growing at a fairly healthy clip. How should we think about selling and marketing this year, should we expect to see some scale by second half 2020? That's my first question. My second question is, as you start moving into some of the more premium price bands and smartphones, what kind of impact can we expect with your IoT and internet services business?

Tom, do you mind repeating the second question? I apologize. The second question.

Sure. No problem, Joe. It's just as you move into some of the more premium price band categories, I know this has been a focus for your company for a number of quarters. As you move into $3,000 or above price bands within China, what kind of benefits or impacts do you expect in your IoT and Internet service business?

Let me answer your first question first. So you're talking about the marketing. Actually, in Q4, yes, because we are, as a company strategy, want to bring more premium-tier product to China and also to Europe. So we started building our brand in Q4 last year. That's why you see the marketing expenses increase a little bit. But in the long run, we'll continue to build to offer the best performance product to the consumer with a very, very efficient way of marketing. So we highly focus on efficiency in the long run. But at the same time, we will do brand promotion to promote our brand in Europe and in the rest of the world. I think in the future you will see that.

On your second question, if I understood it correctly, first of all, going into a higher end segment allows us to capture a set of users that we didn't have before. So that is clearly beneficial because it's just new users. The other metric that you could be looking for is that there is a correlation that the higher ESP users do have a higher R pool across internet services. So there is a positive correlation to this.

Perfect. Very clear. Thanks, guys.

Next question, please.

Your next question comes from Yingbo Shi from Citix. Please ask your question.

Thank you for having my question. This is Yingbo from Citix. I have two questions. The first one is that we noticed that the margin of the smartphone of the first quarter dropped a little bit. So we're curious about how we see the trend of the margin of the smartphone next year on that next several quarters. This is my first question. And the second question is that we still expect a fast increase in the IoT area. Could you please give us some colors on next year's IoT area? What kind of big products can we expect in IoT area? So, thank you.

I'll do the first one. So, gross margins, as Xiangzong said, Q4 is seasonal. There are a lot of events happening in Q4. November 11 sales, Diwali, Black Friday, it all happens in Christmas. It's all in Q4. So it's natural that gross margins go down a little bit due to some promotional activities. Now we said the last quarter that what we achieved in Q2 is a very reasonable gross margin to expect in a normal quarter. So I think there is no changes to that statement. So that's the first question.

Yeah. The second question is related to the IOP growth. Yes, we will continue to grow our IoT business globally. I think I can talk about the TVs, for example. We are launching TV products, not only in China, but in India, Russia, Indonesia, but also in Europe. We'll continue to bring more and more TVs, smart TVs to Europe. That's an example. And also, in China, we'll talk about the white good, the air conditioners, washing machine, refrigerator, these kind of appliances is an area. Of course, we'll continue to focus the connected IoT devices and various other traditional strengths. So, for example, the smartwatches, and others. So I see the great potential, not only in China market, but overseas market, the same thing, especially in Europe and Latin America. Our IoT product is widely received by the consumers in those areas, those markets. Thank you.

Next question, please.

Your next question comes from Frank He from HSBC. Please ask your question.

Thank you for taking my question. I have two. The first is about the supply chain security. Given that the COVID-19 is spreading across the entire world, I guess some of your suppliers are located in the U.S. and European countries. So I just wonder, do we see any disruptions or any shortages of key components And what's our inventory at this moment for the finished goods and also the raw materials?

Okay. Thank you for the question. Actually, yes, we have suppliers. We have many, many suppliers around the world, not only in Europe but also in many different areas, the Asia Pacific region, Japan, Korea. some of them are Europe and the U.S. So far, at the moment, actually, we haven't seen a significant impact from the barrels at the moment. But we realize that we have some peer, how to say, indirect suppliers, the material suppliers. Some of them are located in Asia Pacific, for example, Philippines, Malaysia, they may have some national policies to untie the virus. So potentially there could be a risk, but so far we haven't seen it. But we have a team to monitor the development every day. Actually, we have a daily meeting to monitor everything we need on a global basis. So we monitor very, very closely.

Okay, got it. And then second question is about your smartphone users' behaviors during this crisis period. Given the experience you have observed in China, can you share some colors regarding the overseas viewers how they are using their phones and how that should impact our internet service revenue in Q1 and Q2. Thank you.

In China, actually, it's very interesting. We see the DAO and user time becomes longer when people stay at home. So people have much more time playing with their smartphones. So our revenue generated from the game, from the message, from browsers, increased significantly. But overseas market, because right now it's still in the outbreak period. We will monitor the progress. We don't have the data yet. So we see probably the same thing.

i don't know if uh... if uh... show grease but uh... first of all the gdpr europe so you know that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that that streaming quality so that's not to congest internet traffic globally. So I think it's quite clear that this is... I'm not sure if any one of you have been quarantined. I have. You spend a lot more time online.

Okay. That's helpful. Thank you.

Thanks. Due to the time constraint, we'll now take the last question.

We'll now invite the last question, which will come from Roku Hariharan from JP Morgan. Please ask your question.

Thanks for asking my question. First, I have a question on 5G. Could you talk a little bit about how do you see the progress of the two products you've launched? Maybe quantify a little bit if you could, GridMaker 30 5G as well as Mi 10 5G, how things have been going? And could we also talk a little bit about how much, like roughly like 8 or 9% market share right now in China in the 4G era. What is your target combined Xiaomi, so me and Redmi in terms of 5G market share in second half? China moves to a much more 5G centric market. That is my first question. Second question on the FinTech and Internet finance business. There have been some concerns about some of the more lower tier companies starting to face higher delinquency. Could you talk a little bit about what do we think about the health of the business right now, the quality of the loan book? as well as how should we think about growth for this business given that it's been the fastest or one of the fastest growing, not the fastest growing part of the internet revenues last year. Thanks.

Goku, thank you. It's Shou here. So how is 5G going in China? In China, it's actually going very well. What we are observing is it's a real trend selling point for devices in China at this point in time. We have K30 5G, which was launched in November at $1,999. So that cracked the 2000 RMB price point. And we have Mi 10, which is flagship. And both devices so far have exceeded our expectations. The way I will phrase it is we are glad we don't have 4G, sort of a lot of 4G inventory at this point in time in China. So I you know, it's on track, it's meeting our expectations. It's actually slightly beating our expectations. But, you know, we have described this at length over the last few quarters. You know, this is what we're prepared for. So we are executing this at this point in time. Now, we don't give guidance, so I unfortunately cannot say, you know, where we think our market share will end up at the end of this year, but clearly higher than last year. So that's that question. Your question on FinTech, I think a few points here. one we are strengthening our fintech capital advantage cost of capital advantage over time in january we got a consumer finance license it's one of the bigger licenses in china it allows you to get access to to lower cost of capital uh for our consumer finance business so so we're building it you know uh in a very robust way uh playing up the three strengths that we have one strength of acquisition of traffic because we have a significant UI user base. Second, it's the strength of our data in China where, you know, data allows for more robust risk models. And the third is that we're building up the cost of capital sort of advantage by getting a lot of, you know, difficult to get licenses. I think in general, you know, our motivation for doing finance is to help is to help our consumers and our supply chain get better access to capital. We are prudent in our operations. This is not something that we believe in charging ahead without a huge respect for the risks involved. So our balance on the whole is to err on being conservative. So right now our coverage ratio for And that is higher than all the numbers that we need to hit. So that's the way we think about that.

Thank you all for joining us tonight. We'll now conclude the call. Thank you. Yeah, thank you. Thank you very much.

This concludes the conference call today. Thanks again for joining us. You may now disconnect.