After the comprehensive decline of the financial report, how will the management explain it? (Xiaomi 22Q2 telephone conference)

Xiaomi Corporation (1810.HK) released its Q2 2022 financial report (ending in June 2022) after trading hours on the Longbridge Stock Exchange on the evening of August 19, 2022. The main points are as follows:

Q2 Core Data vs. Market Expectations:

1. Revenue: $ Xiaomi Corporation-W.HK achieved $70.2 billion in Q2, a year-on-year decrease of 20.1%, in line with market expectations (CNY 69.9 billion);

2. Gross margin: Q2 gross margin was 16.8%, a year-on-year decrease of 0.5ct, in line with market expectations (17%);

3. Adjusted net profit: Q2 achieved 21%, a year-on-year decrease of 67.1%, in line with market expectations (CNY 2 billion).

4. Business Segment Analysis: (1) Smartphone Business: Quarterly revenue was CNY 42.3 billion, a year-on-year decrease of 28.5%; gross margin was 8.7%, a year-on-year decrease of 3.1pct; (2) IoT Business: Quarterly revenue was CNY 19.8 billion, a year-on-year decrease of 4.4%; gross margin was 14.3%, a year-on-year increase of 0.9pct; (3) Internet Service Business: Quarterly revenue was CNY 7 billion, a year-on-year decrease of 0.9%; gross margin was 73%, a year-on-year decrease of 1.1pct.

For detailed financial information, please refer to the Dolphin Analyst's review "Layoffs cannot save Xiaomi from its deepening problems".

I. Incremental information from the telephone conference:

1. Overseas internet income growth: (1) Pre-installed: With the continuous increase in our smartphone shipments, the ARPU that can be realized on each pre-installed smartphone in overseas markets has also increased; (2) Search revenue: With the continuous growth of our MAU, the increase in search volume has led to continued improvement in search revenue.

2. IoT business: (1) Chinese market: Q2 YoY growth was very healthy, driven by highly competitive new products, including smart white goods, pet products, and wearables; (2) Overseas market: The performance was slightly worse. The logistics cost of overseas IoT business was hit by very high transportation costs. With the continuous increase in fuel costs, logistics costs continue to remain high.

3. Xiaomi Auto: Self-develop as much as possible, no intention of licensing technologies such as autonomous driving to other companies.

II. Telephone conference transcript:

Q: The sales of the smartphone business in the second quarter increased, but the gross profit margin declined. Looking ahead to the third quarter, will the release of Xiaomi's high-end models improve the gross profit margin of the smartphone business? What are your expectations for sales and gross profit margin changes in future quarters?

A: Among the factors that contributed to the decline in gross profit margin in Q2, 618 was one of them. Also, compared to last year, the appreciation of the US dollar has clearly increased our costs. In addition, last year we launched some high-end products, but this year, due to waiting for the new Qualcomm chips and new agents, the launch of the Xiaomi 12 series and other models has been postponed until the third quarter of this year. Q: The second quarter is mainly about cleaning up old products, leading to lower profit margins. Will the inventory increase in the first half of the year be offset, and will the gross profit margin be affected?

A: We strictly follow IFRS accounting standards in inventory impairment provisions. For long-term inventory, we will make provisions for these tail products. If we sell more than we expected, we can turn it back. But as mentioned earlier, this is some old inventory we carried in the second quarter, but we still need to clear inventory over time. So it is clear that during 618, we successfully cleared a lot of inventory, especially in the Chinese market. Therefore, in China, our inventory has now fallen to a fairly healthy level. As for the inventory of finished products in this quarter, it is much higher, mainly due to overseas markets. Overseas market inventory has always been relatively high, mainly due to inflation such as foreign exchange leading to lower purchasing power in overseas markets. We will try to digest some of these finished products in the second half of the year in many ways, including promotion, adjusting our production schedule, and so on, to reduce it to a more normal level.

Q: How do you view the growth of MAU and advertising revenue in the second half of the year, especially as China's macroeconomics become more stable in the second half of the year? How should we view China's revenue in the second half of the year? What is the percentage of high-end smartphone shipments to total shipments, and what are the goals?

A: As for MAU, our MAU continues to grow quite healthily. This shows that many new users came to Xiaomi and were willing to try our phones, especially the high-quality smartphones we offer. This has laid a very solid foundation for our future Internet service revenue in China and overseas markets. But obviously, in the short term, the overall advertising budget in the Chinese market is not healthy due to the COVID-19 epidemic and regulatory restrictions. But at the same time, as we mentioned, we have seen quite healthy growth from overseas markets with the help of MAU growth.

Regarding high-end smartphones, our focus this year is to improve the quality of our high-end smartphones, which will establish our brand image and improve the shipment volume of our high-end smartphones next quarter. Another thing is that due to the timeline set by Qualcomm, there have been some delays in our schedule this year. So we think this is different from what we disclosed in the first half of last year. In addition, high-end smartphones can also help us increase our Internet service revenue. A good sign is that we will continue to increase MAU in China and overseas to constantly increase overseas service revenue. Q: Could you share with us what are the driving forces behind the strong growth of our overseas internet business in this quarter, as well as our long-term strategy for our overseas internet business?

A: One of the factors driving the growth of our overseas internet revenue is pre-installation. With the continuous increase of our smartphone shipments, the ARPU on each pre-installed smartphone in the overseas market is also increasing. The second factor is search revenue. With the continuous growth of our MAU, the growth in search volume is improving our search revenue. In addition, in the search revenue, the revenue from users in more developed markets is higher than that from users in developing markets. As we have more users using our search engine or other search engines in developed markets, we can obtain part of that revenue or search revenue. Looking forward, we do believe that there is still a lot of room for growth in overseas internet revenue. As we are still expanding our market share, we ranked second in Europe this quarter, so we believe that there is still a lot of room for improvement in monetization in these areas. At the same time, we are also exploring other monetization methods, not just advertising. We can explore monetization opportunities in areas such as games and literature, which are areas we have been exploring all along.

Q: We are very interested in CyberOne robot. Can management share our long-term strategy in this field?

A: Currently, CyberOne is still in a very, very early stage and the cost is still very high. We will continue to invest and explore for the future.

Q: Can you share more information about the IoT market and overseas market?

A: This quarter, on the IoT market side, the quarter-on-quarter growth in the Chinese market is very healthy. I think it is driven by some super-competitive new products we have launched, including smart white goods, pet products, and wearable products. However, the overseas IoT market has performed poorly, mainly due to the very high logistics costs affecting our overseas IoT business. As fuel costs continue to rise, logistics costs remain high, which affects pricing. Secondly, macroeconomic factors including high inflation and high interest rates have indeed hit the consumption of many of our users in overseas markets. They have cut some discretionary spending on electronics. But we still believe that the overseas IoT market is a huge market, and we believe that the market will rebound in the future. In the short term, I think the overseas market must work hard to cope with some of the factors we mentioned regarding high inflation and some geopolitical uncertainties, and then we can expect overseas market growth to pick up again.

Q: Could you share with us the latest market demand situation in the overall overseas smartphone business, specifically in Latin America, India, and Africa?

A: I think we will continue to develop our business in Latin America, India, and Africa. Once we solve the supply problem in India, there will be a lot of shipments in the market during Diwali. In fact, we had some issues with entry-level supply in the first half of the year, but the situation has improved and we will continue to prepare with partners for Diwali in the second half of the year. Practical Speaking, the demand for the global smartphone market in this quarter has also been declining. Competition in India is also very intense. Some people ask why our market share in India is declining. The main reason is that we do not supply the low-end market. But we believe that losing market share does not cause too much damage to our business. Obviously, in Latin America, although the overall market is difficult, our shipments continue to increase every quarter. We can gain market share in these regions. Our market share in Latin America has increased by 3%, and our shipments have increased by 24%. So we think it is very healthy. In Colombia, we will remain in the first place. And in Chile, we have maintained the second position. So I think we still have great potential in Mexico, Brazil, and other Latin American countries.

Q: Due to the decrease in revenue, we see that the operating efficiency in the past few quarters is also decreasing. Considering the investment in electric vehicles, how do you balance investment and operational efficiency during this difficult period?

A: We will continue to invest in research and development. If you look at R&D investment, it is actually increasing significantly. I think the challenge we face is that due to demand issues, our revenue has decreased, which will affect operational efficiency. But we are very, very confident in the long term. Therefore, we will continue to invest in R&D, including mid-to-high-end products and new strategies. At the same time, we will do everything possible to increase our sales volume and market share, such as Latin America and Europe I just mentioned.

Q: Do you have any minimum requirement for operating profit margin?

A: Historically, our operating profit margin is around 10% to 12%. Therefore, if the environment improves, we hope to return to this level.

Q: It seems that Xiaomi has adopted more full-stack strategies in terms of electric vehicle development, including effectively manufacturing and developing full-stack of autonomous driving, etc. Can we talk about how Xiaomi decides which are internal businesses and which are cooperation with other suppliers?

A: In terms of electric vehicles, we consider all possibilities. We have done our own research and development, and we have also acquired companies like Deepmotion. We have also invested in many related technology companies through our investment team. So I think we have adopted a quite open approach, so we will consider all possible things and find the most suitable thing for us to do. This is our approach.

Q: Regarding autonomous driving, considering that you recently demonstrated your solutions, should we consider Xiaomi as a competitor of Baidu Apollo or Huawei, or more like a partner of software-centric companies?

A: Regarding autonomous driving technology. I think we just hope to use all these technologies within our own car business. We have not thought about authorizing it to others. This is also a similar approach we have adopted in the smartphone business.

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