Earnings Call: Q2 2020

Aug 18, 2020

Hello, ladies and gentlemen. Thank you for standing by for Huami Corporation's 2nd Quarter 2020 Earnings Conference Call. At this time, all participants are in listen only mode. Today's conference call is being recorded. I will now turn the call over to your host Ms. Grace Zhang, Director of Investor Relations for the company. Please go ahead, Grace. Hello, everyone, and welcome to Huami Corporation's 2nd quarter 2020 earnings conference call. The company's financial and operating results were issued in a release via newswire services earlier today and are posted online. You can also view the earnings press release and the slides to which we we will refer on this call by visiting the IR section of the company's website at www.farms.com/investor. Participating in today's call are Mr. Huang Wang, our Chairman of the Board of Directors And Chief Executive Officer and Mr. David Chang, our Chief Financial Officer. The company's management will begin with prepared remarks and the call will conclude with the Q And A session. Mr. Mike Yang, our Chief Operating Officer, will join us for the Q And A Before we continue, please note that today's discussion will contain forward looking statements made under the Safe Harbor provisions of the U. S. Private Securities Litigation Reform Act of 1995. Forward looking statements involve inherent risks and uncertainties. As such, company's actual results may be materially different from the views expressed today. Further information regarding this and other risks and uncertainties is included in the company's annual report on Form 20 F for the fiscal year ended December 31, 2019. And other filings as filed with the U. S. Securities And Exchange Commission. The company does not assume any to update any forward looking statements, except as required under applicable law. Please also note that Huami's earnings press release and this conference call includes discussions of unaudited GAAP financial information as well as unaudited non GAAP financial measures. Huami's press release contains a reconciliation of the unaudited non GAAP measures to the unaudited most directly comparable GAAP measures. I'll now turn the call over to our CFO, Mr. Fan Wang, please go ahead. Hello, everyone. Thank you for joining our earnings conference call today. I want to start by highlighting 4 key takeaways from the quarter's financial and operating performance. First, in what was the difficult quarter for the industry, we delivered good revenue growth in the 2nd quarter and first half as or near the top of the industry group. 2nd, we are well positioned with our latest new product and others yet to come as we go into the fall run up to the end to year end holidays. 1st, the consistent investments in R&D to continue our active development pace and innovation into 2021. 4th, recent insurer wins for our analysis offerings. Partnerships such as the 1 announced yesterday with Aspen Imaging Healthcare and progress with our university research partners give me confidence in the future for the institutional side of our business. Despite global disruptions caused by the COVID-nineteen pandemic, we delivered good growth on both revenue and product shipments. In particular, our mainstream brand Smartwatch shipments grew 30% year over This result brings witness to our strong value proposition. Recognition of our own Amazfit brand and expanding sales and marketing strategy. Another achievement in the second quarter was that we successfully shipped Xiaomi's Mi Band 5 the 5th generation in the popular product line. I hope everyone show today's launch of our new ZEP brand, which is our healthcare services brand. Today, we are kicking off with a premium tier of smart devices, beginning with 2 new smart watches. We are reintroduced. We are re introduction the ZEP brands, which we acquired in 2018 with a broader smart ecosystem vision. As part of it, we are rebranding the consumer phone app to ZEP as well in the U. S. The first of the new Zapp models, the Yee will be available in the next week on zapp.com and on Amazon. These new products are part of our continuous execution on our mission to connect health with technology. In order to build a comprehensive health and fitness ecosystem, strong capability in hardware big data analysis. Episodes and product certifications are all indispensable. To tackle this, many companies choose to find solutions from outside suppliers. We chose a road, a few talk, developing the solutions ourselves. I firmly believe one cannot excel in software without expertise in hardware and vice versa. And people who are really serious about big data to make their own sensors. We developed not only smart devices, but also AI chip sensors healthcare related data and, algorithms and now have a comprehensive ai driven health management platform. During our first ai Innovation Convention in Jurn, we launched RealBIP 2, and upgraded cardio health monitoring algorithms, which significantly improves the executive detection of atrial fibrillation at night and during the day by 87% and 564% respectively compared to its predecessor. We also launched Action Bit, which enables near medical grade fraction level measurement for our smart devices. Furthermore, in the second quarter, we launched the new generation of our bio sensor, bio tracker 2, as well as completed the design phase for our self developed AI chip Wongsan II. Wongsan II has more processing capability than its predecessor and enables more healthcare related functionalities that will further differentiate our future smartwatch products. We plan to start volume production of 1.2 in fourth quarter of this year. And by the first half of twenty twenty one, making it available to our users through our smartwatches. In July, our wholly owned subsidiary PIEHealth announced an agreement with Prudential Corporation Asia to incorporate PaiHealth's science back activity metrics into Prudential's digital health app. Pops. Later this week, We will be announcing a follow on expansion of our relationship with Provincial. To codevelop new consumer solutions that maybe make available to their users as well as Huami's. As you know, Huami's connecting health with technology strategy is broad While we have already achieved significant market change on the consumer side of health Technology, We have mentioned industrial side of the business focusing on the insurance and medical institutional side of the industry can help us make devices smaller possible less expensive and allow us a care provider to aggregate more medical data for anarchy services. PyHealth's recent success is one example Yesterday, we announced a new venture with Aspen Imaging Healthcare which is pioneering new X-ray technology. We expect to leverage and combined engineering expertise of both companies in cooperative product development. We expect and we will explore potential investments in the company. Aspen, this is based in Plano, Texas is creating some disruptive technology for medical imaging which can open or expand new applications. Additionally, we are very pleased to have partner with an internationally renowned respiratory expert and a fellow of Chinese Academy of Engineering, Doctor. John Nanshan, to establish the church laboratory facilities. The purpose of this lab is for the ongoing study of lungsperatory disease, tabletation management using waste valuable devices. That's leveraging our expertise in smart wearable technology. AI algorithms and big data biometric analysis. While the first half of twenty twenty was a challenging period for all of us. We are proud of our performance in smart wearable product shipments and the strong execution of our health service strategy. We are confident that our device shipment volume will continue to climb in the second half of the year. And we look forward to delivering value Thank you again for joining today. I will now turn the call over to our CFO, David Choi. Thank you, Wang. The strength of our brand products and global sales and marketing strategies served us well in the second quarter. Despite global uncertain times, the unit sales of both self branded products and the Mi Band rose to 8,900,000, increasing by 7.2% from the same period last year and leading to 9.5% revenue growth I'm especially pleased with that, especially pleased that we remain profitable despite the lower gross margin affected by our product mix. Second Quarter saw the continued prioritization of investment in R&D as well as sales and marketing infrastructure as product development and sales channel expansion remain critical components of revenue growth. While this cost impact the short term profitability, we are confident that continued strategic spend in these areas coupled with prudent cost control in other general operating expense categories. Will lead us to stronger profitability in the long term. Mindful of the length of this call, I will highlight the key financial measures for the second quarter 2020 and I encourage you to refer to our earnings press release for further details regarding our financial performance. Now here are some of the highlights for our second quarter our amounts are expressed in RMB unless otherwise stated. As previously mentioned, Revenues in the second quarter 2020 increased by 9.5 percent to RMB 1,137,000,000,000 from RMB 1,030,000,000 for the second quarter of 2019 Unit growth in the quarter was 7.2% and for the first quarter of 2020, was 18.7%. Gross profit decreased by 8.6% to RMB 253.4 million from RMB277.3 million in the second quarter of 2019. Our gross margin was 22.3%, compared with 26.7 percent a year ago. Gross margin can be affected by product mix as different products have different margin contributions. And this can change over the life of our product. In the second quarter of 2020, total gross margin was positively affected by a higher mix percentage of Huami branded products, offset by a higher mix of lower margin products shipped to Xiaomi. And by discount promotions, for some older products in the transition to the new Mi Band 5 Next want to discuss impact of COVID-nineteen on our business. The coronavirus continued to have a significant negative effect on retail sales in all areas of the world, and in most product categories through the second quarter. For example, although China recovered and opened many retail establishments midway through the second quarter. A number of Asia retailers reported that shoppers were slow to return, depricing second quarter results. In the Americas, and Europe continued or researching COVID infection rates kept many stores closed and also kept many shoppers out of the stores. Many retailers reduced inventories and our orders during the second quarter. This all affected our 2nd quarter results. Product delays due to the pandemic that slowed the manufacturer of products in the first quarter have been resolved with minimal lingering impacts in the second quarter. Looking forward, Huami is working with its channel partners flexibly as they reevaluate or change their market strategies, such as shifting focus to online sales and on demand retail models. While Huami has several direct online sales channels, the vast majority of our revenue flows through this retail partners channels. Before the pandemic hit, industry expectations were for strong demand and continued growth for smart health technology for many years. Aside from the disruption and resetting of consumer purchasing method choices, we see no evidence to indicate that major trends have been materially changed. Whether by personal choice or by encouragement from those who pay for our care, the world is increasingly focused on improving health. In the nearer term, with all the reports of people gaining weight during lockdowns, we think there may be upticks in demand for smart health technology in different geographies as people refocus on their health. In addition, The company is engaged in research and development related to the detection of COVID-nineteen infection through its internal R and D team as well as with some of its university research partnerships. Now moving to expenses. Research and development expenses increased to 25% to RMB117.2 million from RMB93.8 million for the second quarter last year. As a percentage of sales, R and D expense only increased 130 basis points to 10.3% in the 2nd quarter. We are striving for building up a top tier R and D team for our future growth. The increase was primarily due to an increase in the number of R and D staff otherwise in investment in healthcare related features, algorithms, cloud services, chip research and new products development as we carry out our mission. R and D was also up as we are aiming to launch a series of new products in the second half of twenty twenty to expand our customer base as we target different geographies and price points. Expenses increased by 76.6 percent to RMB71.3 million. From RMB40.4 million for the second quarter last year. Our percentage of sales basis Sales and marketing expense rose to 6.3 percent of revenue versus 3.9% in the year ago quarter. The increase was primarily due to expanding international markets outside of China for our Amazfit branded products, including increases in advertising and promotional expenses during holiday sales and promotional events and growth in personnel related expenses. In June, we organized our 1st AI Innovation Convention to present our current research results to the public and opened our first Amazfit offline retail store in Beijing to offer domestic consumers that are the opportunity to have a firsthand in person experience with our products and build our brands. We have a strategy to open a number of these locations globally. A number of these are as independent authorized dealers. 2nd quarter2020 General and administrative expenses increased 9% to RMB55.4 million from RMB51 million for the second quarter last year, reflecting primarily an increase in exchange rate fluctuations, professional fees for business management and depreciation and amortization expenses. Offset by the decrease of Our total operating expenses increased by 32 percent to RMB 244 1,000,000 from RMB185.2 million for the second quarter of 2019. Total operating expense represented 21.5 percent of revenue in the 2nd quarter 2020 compared to 17.8% in the year ago quarter and 20.6% in Q1 twenty twenty. Reflecting our strategy of consistent investment in R&D, with an emphasis on healthcare related product development and testing talent acquisition in addition to branding and marketing to enhance our company's long term returns. Operating income for the second quarter 2020 was rmb 9,400,000, down from RMB22.1 million in the year ago quarter driven primarily by the year over year increase of RMB31 million in sales and marketing expense and RMB23 million in RMB relating to cash as of June 30, 2020, the company had cash and cash equivalents of RMB 2,600,000,000 compared with RMB 1,800,000,000 as of December 31, 2019. Now let's turn expect net revenues to be between RMB2.1 1,000,000,000 RMB2.15 1,000,000,000 which would represent an increase of approximately 13% to 16% from the third quarter of 2019. The outlook is based on the current market conditions and reflects the company management's current and preliminary estimates of market and operating conditions and consumer demand, which are all subject to change. This concludes our prepared remarks. We will now open the call to questions. We will now begin the question and answer session. Our first question comes from for the benefit of all participants on today's call. To ask your question to the company's management in Chinese, please immediately repeat your question in English. Our first question comes from cloud Chung from Credit Suisse. Please go ahead. Hi, management. Thank you for taking my question. I have three small questions. The first being, the sales and marketing expenses, in the second quarter. You spoke about the expansion in channels. Can we on can you speak a little bit about where these expenses has gone into the channel expansion and if there is any specific updates on that My second question is on R and D. What kind of, expectation, what kind of level of R and D should we expect in the second half of 2020 ending 2021? And, lastly, what is the current status with the contract renewal with Xiaomi. Thank you very much. So thank you for your question, Clive. With respect to our sales and marketing expenses, we, we launched multiple products in the one half of twenty twenty. And then we attended CES at the beginning of this year. And we also hired multiple personnel in sales and marketing to to help us to build the channel in Europe, also in Southeast Asia, and we also add a few new stuff in the U. S. So, our strategy is to sell our products and also hopefully in future we expanded into the health care services into the global markets. So, even the pandemic is going away in those regions and we are sending out our stuff. And we're setting up new companies in those countries So, we're on our way to, for the future growth. So that's how we expanded our sales and marketing dollars. With, regarding our R and D expense again, so we spent money in adding new qualified R and D stuff. So we add new stuff a very quick in the later part of last year and first half of this year, we anticipated the R and D expense close will relatively moderate as compared to the earlier periods. So in the second half of this year and early 2021. So we will not see significant increase in our R and D expense, given that our revenue should pick up in Q3 and Q4. With respect to Xiaomi's contract, so what I can say right now is our relationship with Xiaomi is deeper than trust vendor relationship. This is, we all know, and they show me also has a significant ownership interest in Huami, right? And it's important to understand that the general contract we are talking about with Xiaomi is just about the planted terms and conditions associated with being a preferred vendor. So we negotiate a specific contractor for each product. We develop a further such as the new Mi Band 5. That's how we have done business with Xiaomi in the past and expect it to continue in the future. So although I have no additional update beyond that, that we are optimistic that we should be able to negotiate with Xiaomi to sign a similar, framework contract with Xiaomi and continue our strong relationship with Xiaomi along the way. Thank you. The next question comes from zedong Chen from CICC. Please go ahead. Hi, management. Thank you for taking my questions. I think you just start a new brand named Zet, which focus on the smart equipment for sports use I wonder what's the strategy for this product line. And my second question is I, I think you also called operate with Prudential insurance in PiHealth. Could you give me more information about this corporation? Thanks. Sure. I would try to I'm sorry. Is it Go ahead, sir. So, I'll maybe just to answer the first question regarding Zapp brand. And then I will leave the second question to Mike to answer. So that is a brand new brand we introduced to the market, and it is our digital health solution. Brand with variable technology in it. So we launched this new brand in that, we hope that we can speak to a little different audience. And American's feed right now is aimed more at every day. And Zapp aims a little dressier with style in terms of the product features and materials. So, we, and as you know, that we our mission is to connect the health with technology. So currently, we are launching new products under zed brand, but in future, we hope that we can build the set line, not just for the hardware, but also for providing health solutions globally. Mike? Yes. Thank you, David. Yeah, regarding the partnership with Prudential, actually, You probably, see the announcement, a press release earlier, you know, between the potential Asia and Thai, you know, which is again our Julio Subsidiary. Basically, it's a expensive partnership the press release that we released earlier talked about, potential incorporate Pice health, science backed activity metric algorithm into, the potential for digital health app, which is Pulse which is, right now, you know, have over 6,000,000 downloads, you know, in I think, 12 regions, all over Asia. And, that is the first, press releases about, but, we'll be also, I'm working with the potential to expand our partnership, in which will be announced in a second press release, very soon. And basically, we will, leverage, each other's products and services to cross sell, up sell. To each of our to each other's customers, and, you know, on both the health and SLC Wealth. Products and services, you know, for for for for for our joint users, consumers. And you'll hear more news this more expensive, partnership, again, very soon in the second press release, later this week. Thanks. The next question comes from Toni Zang from Haitong. Please go ahead. Hello management. Thanks for taking my call. So I have two questions. The first question the measurement is impacting quite strong sales in the third quarter. Can we give little more color where this stronger is coming from China or overseas market. And also, how about the sales recovery in overseas market, and in such a pandemic situation recently, So my second question is how about the gross margin outlook in the third quarter? Thank you. Okay. So we did provide a strong, a strong forecast for Q3. Because we do anticipate that a strong sales recovery overseas market and also in the domestic market. So, we will see more shipments of Mi Band Miban products, but we see even more stronger recovery for our branded own branded products. And that's why you can see sequentially that we doubled our for Q3. And similarly, we anticipated that Q4 should be also strong. So As a result of that, we should see a strong second half of twenty twenty. So our gross regarding our gross margin as you can see in Q2, our margin wasn't, that great because we because in June, we shipped, we launched Mi Band 5. So, also during this period, we provided the deeper discount on Mi Band 4, which dragged down our our gross margin. So in Q3 and Q4, we will see we will see the product mix change, meaning that we will sell more Mi Band 5 versus Mi Band 4. So that will see, show me me band's margin will climb. And also for our own branded margin we will see will remain strong. So, yeah, my best estimate is that we will see, we will see a little bit higher gross margin in The next question comes from Michelle Zhang from China Renaissance. Please go ahead. Thank you management for taking my questions. So I have two questions. The first one is, could you please give me more color like on the net income guidance like for the third quarter? And the second question is, could you please share more regarding the geographic sales distribution of Amazfit products and also an update of the current situation in Europe and in India? Thank you. So at this moment, I may not be able to provide an accurate net income guidance, but what I can see is that we will take an extreme measure on controlling our operating expenses in the second half and you will not see the same growth rate in operating expenses as compared to our revenue growth. So what I can see is that the net margin for second half will significantly improve as compared to the 1st half that's what I can comment. In terms of the geographic distribution, for Xiaomi's products. We don't have the exact number, but we know a large portion of Mi Band was shipped overseas. And for amazfit branded products, we shipped even more to overseas. So the geographic distribution will be primarily to European markets. And the second will be to the southeast Asia market and we sell our products to over too many countries and including North America. So the primary markets are European Markets And Southeast Asia market. And we see the pandemic situation improves. And remember that we do have roughly about half of our products were sold online in those markets. So we do see a lot of improvements in our sales, in global markets. Thank you. Thanks. The next question comes from Robert Chow from 86research. Please go ahead. Hi, management. Thanks for taking my question. I'd like to ask about pricing. So in the second quarter, I guess the blended average selling price was down a little bit year on year. And you mentioned some discounting related to BBAN4 in anticipation of the launch. How is the pricing on Mi Band 5 relative to previous generation and what kind of trend do you expect from pricing going forward? Well, in Q2, we shipped, let me see. In Q2, we shipped more mid band 4 than lib band 5. So we did provide deeper discount on lib band 4. So that's the reason to drag down the ASP in Q2. So in Q5, so we definitely shipped more we benefit 5 than we benefit 4. So I'm pretty sure that the ASP will climb. And the retail price, you know, for Mi Band 5 higher than Mi Band 4. And also as a new product, as a product new to the market, the we do not provide discount on Miban side. So I would say you get the regular price, if that's fine. So that's all I can say. Thank you. The next question comes from Andre Lynn from Citi. Please go ahead. Hi, management. Thank you for taking my question. I have one question. Regarding the next quarter's guidance, can you share the color on the product mix, how much contribution will come in from then? And that helps us a lot. Thank you. Yes. I would expect a similar product mix as euro, given that sales for both Xiaomi and self branded products are strong. And I would expect it at 7030 split. Thank you. And could you share a little bit about the life cycle pattern on the new generation of the product? Usually the product sales are peak during the 1st few quarters after launch and then they really decline. And could you share about your expectation on this generation? Thanks. Well, regarding Mi Band, we have We have a much shorter product cycle in terms of launching new products. Between Mi Band 3 to Mi Band 4, Mi Band 4 to Mi Band 5, it's about a year. We launched new products. And with respect to Amazfit products, Zest products, so we we will have a much quicker upgrades and we have a variety of older products and new products And we will maybe we have at least a year, we should have uplift on these products. And if not, we will launch new products. So it is much faster. And you will see a pipelines of new products under this new brands coming out. As there are no further questions now, I'd like to turn the call back over to the company for closing remarks. Thank you once again for joining us today. If you have further questions, please feel free contact Huami's Investor Relations department. This concludes this conference call. You may now disconnect your lines. Thank you.