The impact of the epidemic is short-term, and the economic slowdown is the main culprit (Hikvision 22Q2 conference call)

Hangzhou Hikvision Digital Technology Co. Ltd (002415.SZ) released its semi-annual financial report for 2022 on the evening of August 12th, Beijing time, following the closing of its Longbridge A-share market. The following are the main points:

Quarterly data overview vs. market expectations (Bloomberg consensus expectations):

1) Revenue end: In the second quarter, revenue reached RMB 20.7 billion, a YoY increase of 4.3%, which was lower than the market expectation (RMB 22.775 billion).

2) Gross profit margin: In the second quarter, the gross profit margin was 42.7%, down 3.2 percentage points YoY, which was lower than the market expectation (44.83%).

3) Net profit attributable to shareholders: In the second quarter, the net profit attributable to shareholders was RMB 3.475 billion, lower than the market expectation (RMB 4.232 billion).

4) Business situation: Hikvision's revenue from its main products and services business in the first half of the year reached RMB 30.25 billion, a YoY increase of 6.8%; its innovative business revenue reached RMB 7 billion, a YoY increase of 25.6%.

5) Three major domestic business groups: ①The domestic public services business group (PBG) fell by 1.4% YoY; ②the domestic enterprise business group of large enterprises (EBG) achieved a YoY growth of 2.6%, mainly because the EBG market was affected by the epidemic, which weakened the consumption market. The real estate industry was affected by factors such as shutdown and delayed procurement, and the growth rate of EBG's commercial enterprises and smart buildings was down, which put some pressure on the overall EBG performance. ③The domestic small and medium-sized enterprise business group (SMBG) achieved a YoY growth of 4%.

For detailed financial information, please refer to Dolphin Analyst's analysis "Another white horse, can Hikvision come out of its difficulties this time?"

Combining Hikvision's financial report this quarter and conference calls, Dolphin Analyst believes that Hikvision's poor performance in the first half of the year was mainly affected by the slowdown in economic growth, domestic epidemic control, and intensified industry competition. As Hikvision has grown into a leading company that pervades multiple industries, it has been greatly affected by the overall economic situation. With the easing of the domestic epidemic situation, Hikvision's performance in the second half of the year is expected to improve compared to the first half of the year. However, to return to the past compound growth rate, the company still needs to regain growth momentum in the economic aspect.

1) Domestic business group situation: ①The PBG declined; mainly because during the epidemic, many local governments invested the majority of their resources into epidemic prevention and control, resulting in slow implementation of projects. ②The EBG domestic business group of large enterprises achieved a YoY growth of 2.6%; mainly because the EBG market was affected by the epidemic, which weakened the consumption market. The real estate industry was affected by factors such as shutdown and delayed procurement, and the growth rate of EBG's commercial enterprises and smart buildings was down, which put some pressure on the overall EBG performance;

2) Overseas business situation: The company's main overseas business grew by 18.89% YoY in the first half, as most areas outside of China have gradually recovered from the epidemic. Political activities and the political environment affected business expansion in countries and regions such as the US, UK, and Australia, which faced some interference. The Asia-Pacific and Latin America regions grew better overall. The company will operate more conservatively in unfriendly countries such as the US and Australia, while increasing its development efforts in Asia, the Middle East, and Latin America. 3) Innovation Business Situation: The year-on-year growth rate of innovative business in the first half of the year was 25.62%. Under the influence of the epidemic, To C businesses such as Yingshi and Hikvision Storage were under some pressure in some markets; businesses with stronger industrial properties had stronger growth momentum.

4) Gross profit margin: The gross profit margin for the first half of the year was 43.14%, a decrease of 3.16 percentage points from the same period last year. ①Affected by factors such as shortages and price increases in 2021, the base of gross profit margin was relatively high; ②In an environment where the epidemic has impacted and demand is relatively weak, the competition has slightly heated up; ③When the economy is not doing well, customer expectations for expenditure may also change. When meeting the same demand, customers tend to choose solutions with lower costs.

5) Business Outlook: The economy is definitely slowly improving in the third quarter, but the degree of improvement is not too strong, and the short-term outlook may not be so optimistic. Hikvision will maintain a stable operating style in the second half of this year or the next period. In the long term, it is still very optimistic, and the company has a broader and deeper layout for the industry.

6) Research and Development Investment: Regarding the growth of R&D investment in the first half of the year: ①Personnel investment is not synchronized with current income. R&D personnel invested last year will incur expenses in the first half of this year; ②There was a salary increase in the first half of this year to narrow the gap with the Internet industry and improve the company's competitiveness in terms of compensation. In terms of cost composition, the company focuses on innovative businesses. Next year's R&D investment will be slightly controlled in terms of personnel investment if the overall economic environment is relatively weak. The specific situation depends on the economic trend.

2.1 Company Business Overview

In the first half of 2022, the trend of deglobalization continued to intensify, and conflicts broke out in some countries and regions, bringing ongoing uncertainty to enterprise operations. The severe situation of epidemic prevention and control domestically has brought significant challenges to the economy. In the face of various uncertainties in the external business environment, the company maintains its confidence, fully utilizes the company's technology, products, solutions, manufacturing, marketing and other aspects of characteristics, strives to better meet user needs externally, focuses on management work internally to enhance our ability to grow. The company's overall operation is stable.

During the reporting period, the company achieved total operating revenue of 37.258 billion yuan, an increase of 9.90% over the same period last year; and a net profit attributable to shareholders of the listed company of 5.759 billion yuan, a decrease of 11.14% over the same period last year.

Regarding the domestic main business, the total revenue of three BGs in the first half of 2022 was 20.092 billion yuan, an increase of 1.58% year-on-year. The impact of the epidemic lockdown on the domestic market in March to May was relatively direct. The situation improved somewhat in June. Among them, the PBG Public Service Business Group achieved revenue of 6.975 billion yuan, a year-on-year decrease of 1.40%; EBG Enterprise Business Group achieved revenue of 6.831 billion yuan, a year-on-year increase of 2.58%; and SMBG Small and Medium Business Group achieved revenue of 6.286 billion yuan, a year-on-year increase of 3.97%. In the public service market, during the epidemic period, many local governments have put most of their energy into epidemic prevention and control, resulting in slow project progress. With the stabilization of epidemic prevention and control work, the gradual implementation of stable economic policies, and the initial signs of improvement in some government (livelihood) and public security industry businesses, the economic development momentum of local governments will gradually emerge. Under the policy traction of a digital society and digital governance, there is still good expectations for the medium- to long-term growth of PBG. In the EBG market, the weakness of the consumer market due to the impact of the epidemic, and the downward pressure on the growth rate of EBG commercial enterprises and smart buildings due to factors such as shutdowns and procurement delays in the real estate industry have brought some pressure on the overall performance of EBG. Over the past few years, EBG has actively promoted digital transformation in various industries, accumulated resources and experience in various industries, established good industry application cases, and enabled digital transformation for the vast number of industry users, which laid a solid foundation for long-term business development. Currently, the investment confidence of more and more industries is gradually recovering, and we believe that the overall situation of EBG is improving. In the SMBG market, the company continues to optimize the online platform, use the advantages of online and offline channels, constantly enrich the product categories of channel products, and open up more sources of business. At the same time, the company actively carries out marketing activities to reduce the impact of the economic downturn.

In terms of the main overseas business, this period achieved revenue of 9.686 billion yuan, a year-on-year increase of 18.89%. Most areas overseas have gradually recovered from the epidemic and maintain rapid economic growth, laying a good foundation for the company's business growth. The expansion of operations in countries and regions such as the United States, the United Kingdom, and Australia has been somewhat disturbed by political activities and political atmosphere; the overall growth in the Asia-Pacific and Latin American regions is better. Due to the wide coverage of overseas business by Hikvision, the company's overseas base is relatively stable. The company's long-term accumulation in technological innovation, product research and development, and production supply helps the company maintain good competitiveness and ensure stable and healthy growth of overseas markets.

In the first half of the year, the revenue of innovative business reached 7.008 billion yuan, a year-on-year increase of 25.62%. Under the influence of the epidemic, To C businesses such as Yingshi and Hikvision storage are under some pressure in some markets; businesses with stronger industrial properties have stronger growth momentum. The rapid development of innovative businesses brings more possibilities for synergy in technology, business, and supply chain, promoting the overall stable development of the company.

On the gross profit margin, the gross profit margin for the first half of the year was 43.14%, down 3.16 percentage points from the same period last year. On the one hand, due to the influence of factors such as shortage of goods and rising prices in 2021, the base of gross profit margin is relatively high; on the other hand, in the environment of epidemic impact and relatively weak demand, the industry is more concerned about the gain or loss of individual cities. The competitive atmosphere has slightly intensified. From the current competitive landscape, we believe that the gross profit level will fluctuate, but there will not be a significant fluctuation. In addition, starting from the end of 2021, freight has been adjusted from sales expenses to cost items, and there is a financial statistical difference of about 0.6 percentage points compared with the previous period in terms of gross profit margin. Expense ratio increased due to insufficient revenue growth in the second quarter. Starting from early May, the company has controlled the growth rate of personnel appointment to match the current economic environment. Due to the high grant price of the equity incentive in 2021, the equity incentive expense of approximately 320 million yuan was generated in the first half of the year. The cost growth of innovative business is faster than that of the main business, which has a certain impact on the overall cost growth.

The exchange gains generated in the current period are about 490 million yuan. The tax refund of key enterprise software has been completed in the second quarter, and it is expected to be completed in the second quarter in the future.

The company continues to maintain a high level of inventory to cope with the uncertain business environment. The company strives to maintain good inventory aging management, as quick in and out as possible. The turnover days of accounts receivable and accounts payable are basically stable.

In terms of operating cash flow, the cash flow is slightly weaker than last year, and it is equivalent to the same period in history.

The overall domestic economy is currently relatively weak, and the economic macro environment poses objective challenges to the company's operation. Due to the occasional occurrence of the COVID-19 pandemic, the uncertain impact on cities, industries, and individuals continues to exist, which to some extent affects consumer confidence, investment and other aspects. Looking overseas, the energy crisis and rising prices are generally impacting the economies of various countries and regions, and the political direction is profoundly changing the global economic pattern.

We see the pressure, but we also see that the company's technological capabilities continue to accumulate and the market space is constantly opening. The company's technological foundation, industry status, and other capabilities have not been damaged due to short-term insufficient demand. With the continuous recovery of confidence in various industries, we have confidence in the development of the domestic economy. Hikvision has strong resilience, and we maintain a cautious and optimistic outlook on business growth in the second half of the year.

Q&A Session

Q: The performance of the To B part of the innovative business is still relatively good, and EBG is also To B. Therefore, some investors may not understand why the innovative business is more robust when they are both To B?

A: From our perspective, the growth of the To B business in the innovative business is also affected by the external environment and has not reached our expectations. Compared with other companies and our other businesses, the current growth can be considered good.

From the perspective of base number, the innovative business is exploring new markets in new business areas, and by adding new product categories and more new customers, the business growth can be promoted. As for the main business of Hikvision, because the base number is relatively large, it is not possible to offset the pressure of overall demand weakness caused by the macro economy by adding a new product category or some new customers.

Q: During the May Day holiday, foreign media reported, and investors have been paying attention to the follow-up progress. It is now the disclosure point of the semi-annual report. After about three months, from the comprehensive information of the company, what are the latest judgments and opinions? Thank you.

A: This issue is indeed very sensitive, involving the diplomatic attitude between countries, which has a huge impact on our company's future expectations; the information involved is also relatively complicated, and now both the East and the West have some relatively radical media, if the media cannot fully express our meaning, it is also easy to cause misunderstandings. We had some concerns about responding publicly. Initially, due to incomplete information, our response was somewhat passive and conservative. However, after a few months, more information became available and our investors had many channels for acquiring information, and all feedback we have received so far has been relatively positive. I believe that your question today is representative of the doubts that investors commonly have, so I would like to respond positively.

First of all, I would like to make a clarification. If this question and answer are referred to in the future, we hope that you will quote us as comprehensively as possible. If you quote fragments of it, I am afraid it may lead to misunderstandings.

From 2018 until now, the topic has always revolved around whether Hikvision has violated the rights of the Uyghur people. What is the truth? In fact, from 2018 until now, no mainstream international media has approached the company to inquire about the situation or verify the information. What is circulating in the market is basically a story-a story that attracts attention.

With regard to the issue of Hikvision's violation of the rights of the Uyghur people, no mainstream media has come to us to inquire about the situation or verify the information from 2018 until now. The camera is a faithful recorder of the scene's information. Regardless of what is recorded, the camera remains as a recorder. There is no "human rights violation" difference between our cameras and American or British brands in Xinjiang. Hikvision complies strictly with Chinese laws and regulations in all its Xinjiang businesses and strictly follows the bidding procedures. After winning the competition, the company did not engage in any illegal or irregular behavior. The commercial opportunities that Hikvision has obtained are no different from those obtained in other countries and regions around the world.

In the second half of 2018, I communicated with the US Department of Commerce, the State Department, and the Department of the Treasury by email on behalf of the company, hoping to have the opportunity for face-to-face communication. Later, they agreed, and Hu, the chairman of Hikvision, visited officials of these departments in the US and presented Hikvision's business in Xinjiang. The communication between the two sides was very good and some misunderstandings were clarified. At the time, officials present praised us as the first Chinese company to proactively request communication to clarify misunderstandings. Since then, we have been communicating by email and updating the Hikvision business situation.

In late 2018, to clarify misunderstandings, we hired a professional US lawyer to conduct a special audit of five projects in Xinjiang. The lawyer reviewed documents from all aspects, interviewed relevant personnel, and also visited China. The lawyer's conclusion was that "In the end, we found no evidence to suggest that Hikvision had the intention to violate human rights or to engage in knowingly or intentionally violating human rights, or to engage in intentionally ignoring human rights issues."

In October 2019, the US Department of Commerce placed Hikvision on the Entity List on the grounds that Hikvision assisted in violating the rights of the Uyghur people. The decision by the US Department of Commerce to sanction Hikvision for engaging in business activities in Xinjiang, which allegedly involve assisting in violating the rights of the Uyghur people, is a decision made by the US government. If the US Treasury Department were to sanction us again now on the grounds of assisting in violating the rights of the Uyghur people and penalize Hikvision for any violations, what violations of regulations would the Treasury Department consider that we have committed? From a reasonable perspective, I think there should be no sanctions for SDN. Of course, some people may argue, what if the U.S. government is unreasonable? Hikvision is just a company, and we don't have the ability to confront the U.S. government. However, we believe that the Chinese government will not sit idly by. If the U.S. sanctions a company without good reason, sanctions a group-operated company, and our business covers more than 150 countries and regions worldwide, this sanction will also turn into huge harm to the U.S. government's credit. Meanwhile, the possibility of a financial war breaking out between China and the U.S. cannot be ruled out, and both sides will ultimately suffer significant damage. At present, I think it has not reached this point yet, and I trust that reason and justice are in the hearts of mainstream U.S. officials. Thank you.

Q: Last year the company said that it was currently in a development opportunity period. Based on the medium- to short-term view while the current market environment is weak, what is our qualitative judgment and expectation? Looking at the next 2-3 years or 3-5 years, could Mr. Hu or Mr. Huang give us a qualitative or quantitative interpretation? Thank you.

A: It is already mid-August now, and I think everyone can feel the situation in Q3 may not be too optimistic. The economy is certainly slowly recovering, but the recovery is not too strong. This is normal because China's economy has grown rapidly over the years and is now facing an adjustment phase. The world is also going through a major adjustment phase, which has brought many impacts. Therefore, the short-term outlook may not be too optimistic. However, Hikvision's business penetration is relatively broad and resilient. On the one hand, Hikvision will not be affected by a single industry. But when many industries are affected, Hikvision's business will also be affected. Under such circumstances, in the second half of the year or the future, we will maintain a steady operating style.

We believe that we are currently in a period of development opportunities. The development of many Chinese companies has moved from the opportunity orientation to the problem orientation and then to the strategic orientation. The core of the strategic orientation is innovation-driven, and Hikvision is a technology innovation-driven company. With the wave of anti-globalization, on the one hand, it brings pressure. On the other hand, it actually opens up some business opportunities that were not possible before for Chinese companies. We can see this opportunity, so we believe it is a period of development opportunities. In the past few years, unexpected events such as the epidemic, Sino-U.S. trade conflicts, and the Russo-Ukrainian war have occurred. In the next two or three years, some events may have some impacts, which will bring some fluctuations. However, we still believe that our business will have a relatively stable development. Looking long-term, we are still very optimistic. We have a broader and deeper layout in the industry. Thank you.

Q: I remember that Mr. Hu described the security industry as "fast and small" in the interviews in the past few years, and there are many fragmented demands in the industry. Hikvision's core competitiveness in the industry is to serve the fragmented market. Now the company has upgraded its positioning to AIoT - intelligent Internet of Things. I would like to ask what you think the characteristics of this market are now? What is Hikvision's core competitiveness in this market?

====== output: Q:

A: The characteristics of "fragmented demand and scattered market" in the security industry are also applicable to AIoT, which is very similar to the security industry. IoT has a very broad range of applications, and when combined with AI, it can satisfy this fragmented demand.

Currently, many people believe that the development of artificial intelligence is not as expected, mainly due to the lack of large-scale applications and scenarios to support the performance growth brought by AI applications. In the face of fragmented markets, the market space for enterprises is probably larger to some extent, whether they are large or small.

Hikvision's competitiveness is demonstrated by our comprehensive capabilities in technology, products, marketing, supply chain, etc. Hikvision is a comprehensive company. Our global marketing network is already very dense; in terms of supply chain management, we have met flexible demand through flexible production in the past 17 years; in terms of products, we have explored a model for managing so many SKUs generated by a large number of specific scenarios; in terms of technology, we separate products from technology, and the construction of technology platforms has basically become a system today. Therefore, I think Hikvision is a comprehensive company, which is not supported by any single point. This model will be more suitable for fragmented markets. If you ask what unique features Hikvision has, I think Hikvision has almost no shortcomings, which is an advantage, thank you.

Q:

A: There are two aspects to consider. First, we need to observe the macro environment. Many people have felt the decline of the macro economy. This may continue for some time, including geopolitical issues, the problem of anti-globalization, the energy crisis, and even the problem of food security, all of which will bring many effects. In some countries, inflation has already become prominent, which is not a good sign. We need to observe how much impact this will have on business.

The second aspect is for Hikvision. Hikvision will firmly continue its international development strategy while also making adjustments. Under the trend of anti-globalization today, we should adopt more conservative business strategies in unfriendly countries like the US and Australia. In more countries, such as Asia, the Middle East, Latin America, and even some developed countries, we still believe that there are many opportunities.

The changes in the environment do bring many objective impacts, but we view this calmly. We believe that Chinese companies like Hikvision that produce video and IoT-related products still have global competitiveness. Even in the face of massive exchange rate fluctuations, our products always have better cost-effectiveness, and our overall business still has strong competitiveness. Therefore, we are still optimistic about our overseas business. Q: In terms of innovative businesses, the growth rate of smart homes and smart storage was not very high in the first half of the year, while the growth rates of other businesses were relatively fast. What are the expectations for the growth rate in the second half of the year?

A: Within the realm of innovative businesses, C-end businesses were greatly impacted by the economic downtrend in the first half of this year, and B-end businesses were also affected much more than we expected. At present, we cannot say that there has been any significant improvement. Storage businesses are more sensitive to economic environments and thus respond more quickly to changes, whereas the pace of rebounding in the smart home arena may be a bit slower. Economic volatility results in changes in consumer expectations, leading to a sense of hesitation and interference in consumer behavior, but market demand always exists.

Now we need to observe the market trends. Currently, the overall market is still relatively fragile, and everyone tends to be cautious and unwilling to consume, both enterprises and consumers alike. The current internal and external situation may also undergo rapid changes, so we need to be cautious and watchful.

Q: Regarding expectations for the second half of this year, there was relatively high operating pressure in the second quarter. If the economy continues to trend positively, can the previous losses be made up for in the second half of the year? Can it return to stable growth like that of the first quarter?

A: As for expectations for the second half of this year, we feel that overall the situation is heading in a good direction, but there are still many unclear factors, such as the fluctuation of the pandemic. Recently, there have been many places that have resorted to lockdowns, and there are various other uncertainties that cause everyone to adjust their expectations and strategies for the future. Governments, enterprises, and consumers are all adjusting their expenditures. This is an area where there are significant uncertainties in business operations, so we remain cautious.

Compared to others, Hikvision's foundation is still rather strong, and we have confidence in ourselves. In terms of regional segmentation, product segmentation, and industry segmentation, in customer management and enterprise operations, Hikvision will be more detailed, and under such circumstances, will consolidate its foundation even further. If there are opportunities to be grasped, we will grasp them as much as possible, and we will not undertake any business that we should not do. Otherwise, we will burden ourselves in the future. We will be very cautious in managing our business. Thank you.

Q: In terms of gross profit margin, there has been a certain degree of change in the intensity of competition during the first half of the year, which has had a significant impact on gross profit. Apart from the changes in accounting standards, what is the pressure on gross profit margin in the second half of the year, and can the gross profit level be maintained at a stable level?

A: We know that the gross profit margin is dynamically reflected in product prices and project quotations. As business opportunities shrink, in general, everyone will become more proactive in their efforts and competition will become more intense. As the economy improves and market demand increases, business opportunities increase as well, and everyone can earn more money. With more to gain, people's mindset will become more stable. Players in the industry all have similar mentalities and this is the same for Hikvision. Therefore, when demand is relatively weak, we will explore competition in more depth so as to become more proactive in grasping more suitable opportunities.

On the other hand, when the economy is not going so well, people's expectations for investment spending may also change. When the same demand is met, people tend to choose lower-cost schemes. So there will be changes in customer product selection, with a preference for product combinations that are competitively priced. Changes in product combinations will also affect gross margin performance.

Hikvision's product categories and businesses are diverse, in fact, it is a big mix, and gross margin is a reflection of the overall business environment. We need to observe more now, still looking at the pace of the market and economic recovery to see what kind of business opportunities we can capture. From the perspective of gross margin stability, we believe that there is a relatively small possibility of significant fluctuations. Thank you.

Q: This year we have clearly felt that the change in China's economic growth paradigm is very significant, from being driven by real estate in the past to being driven by innovation. So for Hikvision, what adjustments and changes will be made to the products and services provided in the future? Hikvision has basically maintained a steady compound annual growth rate of 20% for many years, and this year it should be the first time to see a decline in semi-annual profits. Could Mr. Hu please share his thoughts on Hikvision's medium- to long-term growth in the main business? Can we still maintain a compound annual growth rate of 20% in the past 5-10 years?

A: There has indeed been a decline in semi-annual profits this year, and I think this day will come sooner or later, high growth cannot always be sustained, there will always be fluctuations. The fluctuations come more from changes in the economic environment, because after the volume becomes larger, it is difficult to support with small actions.

In terms of the company's positioning, we have a very clear idea, which is AIoT, no longer just security. In terms of expanding intelligent perception, we have completely pulled away from the market. We have been doing actions for intelligent perception for many years. In 2016, we started the product line of far infrared detectors, and now it can not only do far infrared, but also many detectors. We also have a millimeter wave product line, which enriches our applications in more environments and more scenarios, including mobile monitoring, target detection, etc. We are also doing X-ray product lines, and we have reached the signal processing stage. I believe that Hikvision will have its own unique competitiveness in these product lines. In the audio field, we have been very cautious in the past because speech in monitoring involves privacy. Currently, from speech to infrasound and then to ultrasound, they have their unique values in many applications. With the changes in Audio in the environment, AI technology can perceive things that we could not perceive before using other methods, especially for some mechanical execution structures, it has its unique detection methods, so this product line is also growing very fast. China is a manufacturing power, and I think there are still many opportunities here. At the same time, we also look at the micro world. Hikvision has made hyperspectral cameras to do some special component analysis and detection, which is also a huge space that can be well developed for Hikvision.

I can't guarantee what kind of growth there will be in the next 5-10 years, because there are too many factors that affect it, but I am confident in Hikvision's growth in capabilities and business expansion. Whenever Hikvision enters any segment of the market, we have a firm goal of striving to be in the top three. Of course, some business leaders say that if we don't do the first, we haven't done well. This has been the goal for so many years, and everyone has this mentality, so this is why Hikvision has resilience. As a technology-based company, it was a tech-led team during the startup phase and still has unique preferences for technology. I also believe that in the next 10, 15, and even 20 years, the driving force of China's economic growth will come from two things: innovation and operational improvement. Operational improvement is about how to make companies more efficient internally, but more importantly, it is innovation that can better meet user needs. So, I'm not going to say that 20% compound annual growth is possible in the next 5-10 years, but the future prospects for Hikvision are still very good, and we see a lot of things and are working hard. Hikvision will always disclose results when a business sector achieves success. However, we may be more cautious in disclosing progress before success, thank you.

Q: The semi-annual report shows that the company's overseas business has grown steadily. Given the complex external environment, how does the company balance risks and investments overseas? How to formulate overseas development strategies?

A: The current overseas environment is complex, and we believe that Chinese companies will maintain strong product competitiveness abroad in the long term. China's industrial chain is complete, from raw materials to complete machines to design capabilities are all available. Moreover, China's huge market size helps to reduce companies' overall costs, achieve economies of scale, a condition other countries and regions currently do not have.

In the past ten years, when it comes to design and deeper cooperation, by collaborating with local suppliers, we have benefited from the convenience of language and cultural communication, and communication and coordination have become smoother.

We have improved supply chain security, for example, the lens industry chain; in the past more than ten years, China has completely solved the supply problem from raw materials to lenses to lenses. For example, sensors, which are now basically resolved; for example, CIS, Chinese companies' competitiveness is gradually increasing; for example, SOC with low process requirements, from design to manufacturing links, are now basically resolved. So I believe that China's position in the international industrial chain will not change for a relatively long time.

Overseas risks mainly come from US sanctions, with limited impact from other risks. First, the control of the Entity List has been ongoing for several years, and the company has gradually adapted to it. Second, Hikvision has made some adjustments to the financial risks related to the US dollar system, with the proportion of US dollar settlement significantly decreasing to around 20%, with most of it being non-US dollar.

Regarding fixed assets, the company's overseas assets are mainly current assets, with a limited proportion of fixed assets. For example, the local warehouse in Amsterdam, the Netherlands, has an investment amount of about 10 million euros; the factory building in India is leased, and fixed asset investments in other regions are controllable. The company has a relatively small risk in terms of current assets, with good turnover, and higher gross profit margins overseas. We will continue to iterate and gradually reduce risks.

The company is very cautious about investments and will adjust overseas strategies appropriately to avoid confusion or stimulate others while working on the basics. Recent events such as the Russia-Ukraine conflict and Pelosi's visit to Taiwan have brought subtle changes to the international situation, while there are great opportunities for developing countries' markets. Therefore, the company will further increase its overall investment overseas, gradually reduce investment in some countries structurally, and further increase investment in countries with clear opportunities to seize opportunities in complex environments.

Q: The current international supply chain is tight, and the company is responding with a high inventory level. How long will the company's high inventory level be maintained?

A: Currently, globalization is facing many potential risks, and economic turmoil, the impact of the epidemic, local conflicts, and other issues all affect supply chain security, so Hikvision will maintain a high inventory level for a relatively long time.

Regarding raw materials, the company's inventory is mainly dedicated materials, which require suppliers to provide a relatively long-term forecast and conduct transactions in the form of futures, with limited price fluctuations. For example, DDR, Flash, and other universal materials that are traded in spot transactions, have large price fluctuations and are relatively sensitive. They account for a limited proportion in our supply chain. The impact of the decline in raw material prices and the rise in metal and other commodity prices on Hikvision is relatively limited, and the impact on gross profit is relatively small compared to market expectations and other general electronics companies.

Regarding finished products, the company mainly focuses on embedded products. Different from consumer products with large price fluctuations, the price of embedded products is stable. The impact on Hikvision's cost is relatively small, so Hikvision will maintain a high inventory level for a long time.

We expect that after the easing of Sino-US conflicts in the future, the company will switch back to lean production and the just-in-time mode. But currently, controlling supply chain security issues is more important.

Q: In the second quarter, the company began to control personnel growth to adapt to the overall macroeconomic situation. What is the company's outlook for personnel growth for the whole year?

A: We are very optimistic about the next 5-10 years, so we will continue to increase company personnel. The company will plan personnel growth according to the needs of business development, but will not adjust personnel for the purpose of improving short-term financial indicators.

Q: The growth rate of the robot business and automotive electronics business in the first half of the year was relatively fast. Can it maintain or even achieve higher growth rates in the second half of the year? Is there a growth plan for next year?

A: In the first half of this year, especially in the second quarter, enterprise investment and the automobile industry were affected by many factors. The robot and automotive electronics businesses were also affected.

However, I believe that Chinese manufacturing companies will continue to improve their competitiveness through quality improvement, automation, cost control, and investment in technology and equipment. So I believe that the robot business will achieve the same level of growth in the second half of the year or even higher level of growth as in the first half of the year.

For the automotive electronics business, in the past few years, we have seized opportunities for some joint venture and foreign suppliers' shortages and achieved certain results. If there is no epidemic or other interference in the second half of the year, it is expected to achieve better growth than the first half of the year.

Q: Are there any comparisons between the gross profit margin levels of robot and automotive electronics businesses and other sub-businesses? If the robot and automotive electronics businesses maintain high growth rates, how will the overall gross profit margin level of innovative businesses change?

A: Gross profit margin is determined by competition and is difficult to plan. Qualitatively, the industry's mentality and the level of competition determine the gross profit margin situation. Currently, Hikvision's main business and innovative businesses are under pressure, and Hikvision's peer companies in various business lines are also under pressure. Afterwards, if capital remains rational, the gross profit margin will not change much; if capital becomes too wild and crazy, such as continuous burning money competition in the AGV industry, it will have a greater impact on gross profit. We believe that the economic downturn in this round has touched everyone, and more people, as well as capital, will tend to be rational, so in terms of gross profit, I think everyone does not need to worry too much.

The gross profit margin of innovative business can be regarded as a pool, which is a comprehensive reflection of the gross profit situation of multiple segmented businesses. The growth changes of different innovative business subsidiaries will affect the internal structure of gross profit. For example, the gross profit of automotive electronics and storage is relatively low compared to other businesses. If its revenue growth accelerates, it will affect the overall gross profit margin of innovative business.

In the future, with the independent listing of Yingshi and robots, the data level will be relatively clearer, and we also need to pay attention to which business grows faster. It is difficult to judge how the actual gross profit situation changes at present.

Q: A single AI algorithm cannot solve all problems, and more accumulation is needed. How does Hikvision understand this? What did the company do in the first half of the year to promote the development of the industry?

A: In the past, the market had high expectations for AI and hoped that AI would explode in the short term. Hikvision also had similar expectations, hoping that AI could quickly empower a large number of industries as a general technology and get good returns. In the past few years, the overall commercial landing process of the AI industry has not been ideal, but Hikvision has done a good job, and through the full-chain investment in algorithms, products, systems, and implementation, Hikvision has relatively better returns.

At present, we judge that in the era of weak AI, a single algorithm is difficult to bring significant improvements to the industry. However, we see many opportunities brought by AI, and behind each opportunity is a relatively small fragmented market that needs to be dealt with step by step and grow together with users. This is similar to the early development process of the computer industry. In the early stage of computer application, customers had higher requirements for professionalism, and later with the popularization of computers, the difficulty of use gradually decreased, and the industry matured thereafter. We believe that AI will also go through this process, with pioneer customers and pioneer markets leading the way. Hikvision also has its own unique experience and competitiveness in these pioneer fields and is also promoting many works, but the specific details are not suitable for communication in the current situation due to commercial information involving customers.

Q: Can you share your views on the competitive landscape? It was mentioned earlier that in the short term, due to relatively limited opportunities, competition may be strengthened in some disguised forms. It was also mentioned just now that the competition in the entire industry will tend to be more rational. Can we understand that short-term demand will bring some competition intensification, but because opportunities accompany crises, there may be some improvements in the competitive landscape, such as some small and medium-sized players may withdraw, including enterprises in the AI field. Will they also see improvements in the competitive landscape?

A: From the perspective of the competitive landscape, we have also talked about it before. This market can basically be divided into three types of competitors. One type is traditional players who come from the security industry. In this area, whether it is in the traditional business or the exploration of new technologies and solutions, they all just follow closely, and the competitive landscape is relatively stable. We think it is unlikely that there will be major changes. The second part is about the innovative companies in AI algorithms that have been favored in the past few years. Now that many of these companies are listed and their financial reports are publicized, it is still important to return to the basic judgment of whether they can solve problems for end-users and create value. Therefore, the concerns people had in the past about the impact on the industry are slowly being put aside.

The third part is about the cross-industry giants that people were particularly worried about for Hikvision in the past few years. From this year's situation, these giants also have their own troubles, so for fragmented businesses such as the IoT, it may not be like the big investment status they talked about in the past two years, both in terms of intention and investment.

From the perspective of the competition pattern of the industry, I personally think it is slightly better. Of course, in the short term, the competition at the level of project orders at the city or regional level is not enough to talk about the competition pattern at this level, thank you.

Q: Looking at the second half of the year, how is the recovery pace of several BGs? It was just mentioned that the overall situation is improving, but it may not be so fast. Will there be some differences in the recovery speed among several BGs?

A: We also see that the overall situation may be improving, but we are also worried that there will still be more interference, so it is not easy to make specific judgments.

I still want to reiterate that everyone hopes for a rapid rebound in the second half of the year, and we also hope for a rapid rebound, but we still need to look at it rationally. It is still dominated by policies in China, and there are also expectations of the whole society. Are everyone's expectations consistent? If it was opportunity-oriented in the past, most people looked at it from the perspective of seizing opportunities and are used to growth every year. Now this situation may be a turning point. I think that China's government, enterprises, and individuals are becoming more and more rational. If the impact of the 2020 epidemic is a wave of shocks, I think that this year's economic adjustment is another wave of shocks, which is a good thing, making everyone more rational, including making investors more rational about this matter, thank you.

Q: In fact, the company also mentioned before during the annual report communication that we didn't go to do some large projects before, but now our attitude may be more open. Including I found that the growth of engineering construction in the first half of the year was quite fast. Will there be some driving force in this regard this year?

A: Regarding large projects, we still need to look at them in the context of the competition pattern changes. Some projects are very large and complex. If they are done by these system integrators and construction companies, their capabilities may not be able to keep up, but when a company like Hikvision does it, customers feel more at ease, and it can better guarantee the implementation of the project. When doing these large-scale projects, more resources need to be invested, and some application scenarios may be more complex or difficult than before. Therefore, Hikvision's participation in these projects can not only polish the project, improve their own systems, promote the improvement of products, and bring new opportunities for products, but also many demands need to be addressed in the project, and these problems cannot be solved within the company. On the other hand, doing these projects is not to improve performance, but it is an environmental change that brings about too large and comprehensive projects. From the user's perspective, there are considerations for the successful implementation of the project. Needs large manufacturers to back up. If it is not a total package to back up the project, sometimes the demands of interest among everyone may not be consistent and may bring some contradictions. In this case, Hikvision came to do the project.

Taking into account the comprehensive factors, Hikvision will do some large projects, but will not treat them as a business to do, thank you.

Q: We can see that some chip categories have experienced some price declines. I don’t know if it is because the company previously adopted a high inventory strategy, which may require some time for the cost reduction of upstream to be reflected on the report? In addition, although the company maintains a high inventory level strategy as a whole, there have actually been some adjustments in the middle. At some time points, there may be a temporary slowdown in the stock-out, and I don't know when this rhythm may appear, or what factors may cause some changes in the short term?

A: Everyone may not need to worry too much about inventory issues, because the company's operating team will take the initiative to adjust. For example, as I said before, there are futures markets, spot markets, and Hikvision's business mainly comes from futures markets. The price fluctuations of futures markets are very small, and they are only supplied to this industry and used for this product line. There is almost no fluctuation. In addition, some raw materials that fluctuate faster, such as DDR and flash, have spot markets, and it is easy to catch them. Hikvision will do some inventory, but will not make the inventory very large. For example, some products may need to be withdrawn, or under certain specific circumstances, they may make inventory for two years, and some may make inventory for one year, some for six months, and some for only two weeks or one month. Therefore, we will continuously optimize and adjust the inventory according to changes.

For Hikvision with so many models of products, and relatively stable sales prices, the impact of price fluctuations under the high inventory strategy is limited; on the contrary, in order to ensure delivery, the impact of insufficient inventory after some events are more significant. Therefore, in terms of inventory, some companies may have encountered a situation where they need to make a lot of inventory provisions after a sudden industry downturn, which has a significant impact on financial indicators. This kind of thing is not likely to happen at Hikvision, so everyone may not need to worry too much. In addition, the inventory we pull is not the same for all categories. Some raw materials that have been kept in high inventory for a long time may still be in short supply in the market, so we need to look at this difference in a classified manner, rather than generalizing, thank you.

Q: From the perspective of the structure of inventory, in the first half of this year, because our income did not actually increase much, the product inventory increased rapidly. Why is that? Is it because the project we started in June has not been delivered yet due to the gradual decline in the impact of the epidemic at the end of May, resulting in an increase in inventory of products?

A: This is also normal. We have planned production and customized production. For some models that are not customized, universal, we will do it according to the normal production plan, so there is no need to worry about the product inventory. It maintains the balance of our production, and the total amount itself is not large, thank you. Q: In the past, the growth center of the enterprise was about 20%, while PBG was about 10%. In the second half of the year, the economy may experience a weak recovery. Can the management give a rough quantitative data, such as whether it can achieve the central level of the past or feel some pressure?

A: We also want to have a definite number to make everyone feel more secure, but there are indeed too many uncertain factors. We will try our best to do it, but we shouldn't intentionally set a number. If we can't achieve it, it will be said that the management of Hikvision is not pragmatic. If there are many opportunities to catch up later, it will be asked why the error is so large. Therefore, in the case of uncertainty, we still need to accept uncertainty. Thank you.

Q: Because of some policy reasons, our overseas business has undergone great changes. Can you give a rough proportion of various regions overseas?

A: It is roughly balanced now. In the past few years, the United States has been the most affected, from 25% of our overseas revenue to less than 10% now. It will further decline this year. Developing countries are growing faster, but there are also fluctuations in some countries. Southeast Asia and the Middle East are growing faster, and Latin America is a relatively large market. Europe is a traditional big market. We further divide Europe into single UK, three countries in Southern Europe (Italy, France, and Spain), and the traditional Hikvision is relatively difficult place in Northern Europe, where Axis is situated. As that place is relatively affluent, some people are not friendly to China. Growth is still good in Eastern Europe. In Asia, East Asia's Japan and Korea are growing faster. There are often fluctuations in the five Central Asian countries, including South Asia's India. When the relations between China and India are tense, it will be affected, and when the relations between China and India improve, it will be improved. And we are doing through a joint venture in India, not a wholly-owned company, because we were unsure of India at the time, so we decided to establish a joint venture in 2008 instead of a wholly-owned company, so it is quite fortunate.

Therefore, Hikvision's distribution overseas is relatively balanced. The main drag on the past few years is the United States, which should not be so low, of course, due to the pressure and normal reasons. Thank you.

Q: In the first half of the year, the company's R&D investment increased relatively quickly, even higher than the income growth. How does the company look at the future? What is the attitude of overall recruitment? Are there any updates to the personnel management concept? Will the personnel investment be controlled?

A: Regarding R&D investment, in the short term of the year, it matches the annual plan, and resources are allocated according to the output of the plan. From the perspective of the SP that rolls over every three years, it mainly invests in key businesses according to the company's strategic plan. Strategic business investment will not yield immediate output. Overall, it is a balance between short-term and medium-to-long-term investment.

Thank you. Regarding the increase in R&D investment in the first half of the year, in terms of the source of the increase, one is that personnel investment is not synchronous with current income. The R&D personnel invested last year will incur expenses in the first half of this year, which was relatively small in the first half of last year, and this will be reflected in the year-on-year growth in R&D expenses in the first half of this year; the second is that there was a salary increase in the first half of this year, which was to narrow the gap with the Internet industry and improve the company's competitiveness in terms of compensation. In terms of cost composition, we have been focusing on innovative business when investing in personnel in recent years. Because the revenue growth expectation of innovative business is higher, and it is done according to strategic planning, so the growth rate of R&D personnel invested in innovative business is relatively high. When the revenue growth of innovative business is insufficient, the cost growth also exceeds the income growth rate, which also has a certain impact on the overall R&D cost growth of the company.

Regarding the personnel investment plan for next year, because we still have confidence in the company's medium and long-term development, we will not make a big move to control personnel investment in terms of personnel investment. If the overall economic environment is relatively weak, we will slightly control personnel investment and observe it. If there are more obvious positive signals in the second half of the year, or the investment confidence in various industries will be strengthened next year, we will also strive for the opportunity to allocate resources. We have not yet decided on the personnel investment plan for next year and are still observing the trend of the economy, whether it is recovering at a relatively slow rate or at a faster pace; we may have to decide the personnel investment plan for next year by the end of this year.

Regarding future R&D personnel investment, the company will maintain dynamic adjustment between resource input and output. At the beginning of the investment, it will judge what needs to be done and how much personnel investment is needed. If the effect is good after investment, it will definitely increase investment; if it is not so ideal, it may need to be adjusted; there will be a lag effect, which is a continuous optimization process. At the same time, in the process of dynamic adjustment, we will definitely focus more resources on certain businesses, increase efforts to do them, and these businesses will have more resources; for other businesses, we will adopt a wait-and-see attitude and maintain appropriate investment; some businesses may reduce investment; overall, it is a continuous optimization process and dynamic adjustment.

Q: Regarding the B-end business, the growth rate of the EBG business in the first half of the year is significantly different from that of the robot business. For the EBG business, if we exclude industries that were affected by policies in the first half of the year such as smart buildings, has there been any changes in its focus on enterprises, penetration rate and future prospects?

A: There are some differences between our EBG business and robot business, the robot business is more direct and has short-term effect, so its growth rate is higher, while the EBG business is not that immediate.

The growth rate of the EBG business is not as high as that of the robot business. One is that it covers more industries, and some industries such as smart buildings were indeed greatly affected by policies in the first half of the year, which also had a great impact on the EBG business. However, some industries such as energy and metallurgy have good benefits, development and investment, and the growth of the EBG business in these industries is also very good.

Dolphin Analyst's research on Hikvision

The second strategy that some companies adopt when the economic environment is unfavorable is to wait and see the future economic development trends, slow down business investments such as basic transformation plans, and control or reduce the scale of debts.

From the perspective of EBG's overall business, because it includes both industries with good and bad development, its overall growth rate is not that high. However, in the current environment, we are still satisfied with the operating performance of EBG business.

Looking forward, we think that EBG business is still a very good business, whether it is in terms of scale or deep relationships with various industries. We are optimistic about the future development of EBG business.

Q: Apart from the existing eight innovative businesses, how is the progress and future prospects of the company in other innovative businesses? If there are plans for investment, will you consider new directions?

A: Our investment concept is now clearer than before, knowing what we should do and what we want to do. Regarding investment layout, we still think more about long-term business development positioning, not to improve short-term operating performance or business data growth.

I would like to add something else.

In recent years, many things have happened, both in the macro environment and in our own company. It is normal to encounter these things in the process of corporate growth, and it is normal for economic fluctuations to occur during social development. We used to be accustomed to high growth, so when we looked at things with a high-growth mentality, everyone felt uncomfortable when they encountered these things, and we can also understand it.

We believe that the next 10-15 years will still be a very good era for the Chinese economy, as well as for ourselves, it is a development opportunity period. In the past, globalization was our opportunity. We used global resources to improve the competitiveness of our products. Now, anti-globalization is still our opportunity. We can also go upstream and horizontally in the industry. We don't think the future is so pessimistic. After all, China has a population of 1.4 billion, and there are still many developing countries and populations in the world. Appropriate economic fluctuations allow everyone to shift from opportunity-oriented to operation-oriented and innovation-oriented, which is also good. It is also an opportunity for companies like us. We also hope that in the future, more rational companies in China will become more mature, seize this opportunity, and take China's entire industry to a new level.

Dolphin Analyst's research on Hikvision

Deep Research

On December 22, 2021, the company published "Hikvision (Part 2): Copying Zhang Kun's Homework, Will it Get Chopped?" (https://longbridgeapp.com/topics/1572584)

On December 14, 2021, the company published "Hikvision (Part 1): Betting Against the Trend, Adding to the "Security Ma", What is Zhang Kun Betting On?" (https://longbridgeapp.com/news/52007303)

Financial Report Season

On August 13, 2022, the company published "Another White Horse Stock Collapse, Can Hikvision Turn Sorrow into Joy This Time?" (https://longbridgeapp.com/topics/3309030?) channel=t3309030&invite-code=294324)》

Telephone Meeting Summary on April 21, 2022: "Hikvision's Outlook for 2022, How Does Management View It?" (https://longbridgeapp.com/topics/2384341)

Financial Report Review on April 16, 2022: "Hikvision: Inflation and Pandemic Pressure 'Security Maos'" (https://longbridgeapp.com/topics/2335950)

Risk Disclosure and Statement for This Article: Dolphin Investment Research Disclaimer and General Disclosure (https://support.longbridge.global/topics/misc/dolphin-disclaimer)