Huami Corporation (HMI) Q3 2020 Earnings Call Transcript

Huami Corporation (NYSE: HMI) Q3 2020 earnings call dated Nov. 23, 2020

Corporate Participants:

Grace Zhang — Director of Investor Relations

Wang Huang — Chairman of the Board of Directors and Chief Executive Officer

Leon Deng — Chief Financial Officer

Mike Yan Yeung — Chief Operating Officer

Analysts:

Kyna Wong — Credit Suisse — Analyst

Joseph Hui — China Industrial Securities International Financial Group — Analyst

Michelle Zhang — China Renaissance Securities Ltd. — Analyst

Presentation:

Operator

Ladies and gentlemen, thank you for standing by for Huami Corporation’s Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a 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.

Grace Zhang — Director of Investor Relations

Hello everyone, and welcome to Huami Corporation’s third quarter 2020 earnings conference call. The company’s financial and operating results were issued in a press release via newswire services earlier today and are posted online. You can also view the earnings press release in the slide to which we will refer on this call by visiting the IR section of the company’s website at www.huami.com/investor. Participating in today’s call are Mr. Wang Huang, our Chairman of the Board of Directors and Chief Executive Officer; and Ms. Leon Deng, our Chief Financial Officer. The company’s management will begin with prepared remarks and the call will conclude with a Q&A session. Mr. Mike Yeung, our Chief Operating Officer, will join us for the Q&A session.

Before we continue, please note that today’s discussion will contain forward-looking statements made under the Safe Harbor provision of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, the company’s actual results may generally differ 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 U.S. Securities and Exchange Commission. The company does not assume any obligation 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 include 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 will now turn the call over to our CEO, Mr. Wang Huang. Please go ahead.

Wang Huang — Chairman of the Board of Directors and Chief Executive Officer

Hello everyone. Thank you for joining our earnings conference call today. We are pleased to report another quarter of solid financial results, highlighted by revenue growth of 20% year-over-year, that exceeded our expectations, despite supply issues due to the COVID-19, that partially dampened results.

Our top line results were complemented by bottom line growth visibility. Together, these testify to the resonance [Phonetic] of our portfolio of smart health products and services, as well as our efficient product development capability. We have launched five new smartwatch products in the third quarter. I am pleased with our development pace, through agile development processes, our teams executed according to plan, and our product portfolio is well positioned for the global [Indecipherable] a holiday rich season.

Innovation has always been the call of our DNA. It drives our R&D development, and supports our comprehensive health and fitness ecosystem. Reflecting this, we recorded a number of new product upgrades and launches in the third quarter. In September, we upgraded our most popular product line, the GTS and GDR smart watches. This numerous technology [Indecipherable] functionalities. Now, the upgraded version of Huami equipments, features better blood oxygen monitoring. Among other important applications, blood oxygen saturation data is an essential metric, used to monitor breathing quality.

Our classic and post variant of the Amazfit GTR 2, as well as other select smart wearables, are also upgraded with our newly launched BioTracker 2 PPG 24/7 heart-rate sensor. This sensor supports five logical data engine and is the most versatile and precise biosensor we have ever developed. We also launched our new app market Zepp brand, as previously announced in August. The Zepp line brings a more comprehensive and professional health and fitness measurement experience to users, leveraging our expertise of smart wearable technology. In the third quarter, we also extended our cooperation agreement with our strategic partner, Xiaomi. The Mi Band is an important product line to us and to the global value focus market, and we are pleased to continue to work with Xiaomi on that product line.

Now turning to our global expansion efforts. Our Amazfit product achieved strong market position in many of the international markets we serve. According to the IDC report, we have been positioned as number one market share in Spain and Indonesia for several quarters. In IDC’s second quarterly report, we experienced 323.7% growth in the Indian market, and 241.6% in the Western Europe market, contributed by our growing brand recognition, strengthening sales and market strategy, as well as distribution channels.

Our international shipments, as a percentage of total was 49.5% in the third quarter, with even our largest markets like Europe and SEA are still under the impact of COVID-19. Huami and Xiaomi device activation data further elucidates our globalization with a fourfold increase in the number of countries with sizable activations in the third quarter this year versus last year.

Starting in September, two of our most popular smartwatch lines, the Amazfit Bip S and the Amazfit GTS become available for purchase in America at over 2,800 Walmart retail stores. This is the first time that consumers can buy them at Walmart stores. We believe there is a strong fit between these value-priced lines and Walmart Target shoppers. We are pleased to have expanded our retail channel, distribution with this large partner, and we’ll keep exploring opportunities with other global large channels.

It’s worth remembering that the global megatrends of personal health awareness was well in place before the pandemic and the last 10 months has brought awareness to a compelling level. We also note that leading industry analysis are unified in their forecast for continued strong demand for smart wearables, well into the future. The variety of form factors keeps expanding, and we are expanding right along this way.

The global opportunity remains robust for Huami, especially with our product market positions, all representing exceptional value and feature set at every price point. These new products and services development as well as geographic expansion, are all part of our continued execution on our connect health with technology strategy. In addition, we are now doing academic research project, cooperated with more than 20 different hospitals, research institutes, and pharmaceutical companies, in both China and overseas, to help monitor users health condition, by using our smart wearable devices.

To name a few; we are now working with the first affiliate hospital of Guangzhou Medical College and Dr. Zhong Nanshan team, on chosen as an early warning project. We identified these as a key area of interest for our users, and are working with the Stanford Sleep Medicine Center in the U.S. and others to collect more data and perform analysis. [Indecipherable] made objective of these academic research projects will be to offer our users more dimensions of healthcare services, including pre-disease warning, and more comprehensive health condition, analysis in the future. Leveraging our devices are bridging together high quality data consistently from every model, regardless of price.

On a final topic. I want to note two key Huami team additions. At our Board meeting last Friday, we added a new independent director to Huami’s board. I am very pleased that Mr. Bing Xie, recently retired from leading worldwide sales at Texas Instruments, has agreed to join our Board. As an Independent Director, Bing, who served on the board audit compensation and nominating and Corporate Governance Committee.

Next, I want to formally introduce our new Chief Financial Officer, Mr. Leon Cheng Deng. Leon comes to Huami from Royal Philips. There he was most recently, Global Head of Finance for Phillip’s domestic appliance division. He brings to us 17 years of extensive experience in accounting, financial management, and manufacturing perspective on Europe and many other key international markets, and strategic transactional experience, that I believe will help Huami accelerate in our next phase of growth. Leon, welcome to your first Huami earnings call. We are glad to have you as part of our of our team and looking forward to your leadership, as we continue to execute and grow the business. The floor is yours.

Leon Deng — Chief Financial Officer

Thank you, Wang. I am excited to join the Huami family. I believe that with my global consumer health experience, I can help the company focus and manage its sustainable growth. Huami has grown very fast, and has many opportunities on both the health and fitness sector, and consumer industrial sites of healthcare. Building off my 17 years of strategic operational financial and accounting management experience at Phillips, I will be focusing on continuing to improve management processes, planning and financial controls, I anticipate looking at areas such as working capital management, cash flow and return on invested capital. I also look forward to leveraging my experience, to help manage the company’s global expansion in the future.

So let’s begin talking about third quarter results with sales. The COVID-19 virus continued to challenge companies and their business planning around the world. It both helped and hurt Huami in the third quarter. During the summer quarter, COVID cases abated in many regions, and has allowed local economies to open up more. People got outside to exercise and to live their lives. That was good for the industry, and Huami shipped 15.9 million units in the quarter, up 16.1% from a year ago third quarter, and driving our revenue increase of 20%. The largest portion of that increase was driven by the Xiaomi Mi Band 5, and we also began shipping a number of our own brand new products, as Wang just described.

Where the virus hurt us, was in some supply chain challenges, which left us a short of new Huami product inventory in a number of locations, and forced the delay of some of our new product launches, from the beginning to the end of the third quarter. I will have more to say on the impact of the virus, when I talk about the look ahead and guidance.

But first, I want to focus on just a few key numbers, including gross margin and operating expenses that I think are the most important for understanding what happened in the quarter, and that shaped our outlook. Gross margin can be affected by product mix, product launch timing and product lifecycles, including model upgrades. The 460 basis point decrease in gross margin from a year ago quarter, was predominantly driven by those effects.

In our specific case gross margin can be impacted by the proportion of split between products which we make, and sell to Xiaomi, and also the products we bring to market under our own brands. The split of products between Xiaomi and Huami was the same as in the year ago quarter, reflecting nearly identical patterns of old model winding down, and new model quality shipments for Xiaomi. In this year’s quarter, that was the new Xiaomi Mi Band 5.

Gross margin on Xiaomi products in 2020 third quarter was 400 basis points lower than the year ago quarter. This much larger volume of Xiaomi products versus our own branded products in the quarter, was primary driver of the overall lower gross margin.

Let me the next highlight operating expenses; as has been true all the year, sales and marketing, R&D and G&A expenses have been up year-over-year, quite significantly in some areas. As you saw in today’s press release, R&D was up 38.8% year-over-year and comprised 7.7% of the revenue, compared to 6.7% a year ago. Sales and marketing expenses was up 104.2% year-over-year, and comprised 5.2% of revenue compared to 3.0% a year ago. G&A increased 30.8% year-over-year, comprising 4.1% of the revenue compared to 3.7% a year ago. R&D has achieved a scale, which we believe, can continue to drive strong new product development going forward. Sales and marketing expenses vary with seasonality, and obviously it is important to support key selling seasons, such as the year-end holidays, and as we expand geographically. But we expect to apply some additional process prior to sales and marketing investments, with the highest sales impact and return on investment through the fourth quarter, and into the next year.

Total operating expenses in the third quarter 2020 was up 51.3% year-over-year comprising 17% of revenue compared to 13.5% in the year ago quarter. Given the uncertainties of the pandemic for the foreseeable future, we’re going to manage operating expenses to percentage of sales target at about where they are now in order to maintain profitability. The company’s cash position continued to be strong, finishing the third quarter with cash and cash equivalents of RMB2,556 million, up 42% from December 31, 2019.

As I said, the new resurgence of cases in our key markets of Europe and Russia, and in U.S. and increasingly other areas, caused us to temper our outlook for fourth quarter sales. How the impact of the virus will play out through the holidays is very uncertain. Retailers in several key geographies, after reopening during the summer, are facing new lockdowns are according to many recent media reports. Our guidance reflects this uncertainty for fourth quarter 2020, management currently expect net revenues to be between RMB1.95 billion and RMB2.15 billion. That outlook is based on the current market conditions, and reflects the company management’s current and preliminary estimates of market and operating conditions and customer demand, which are all subject to change.

This concludes our prepared remarks. We will now open the call to questions. Operator, please go ahead.

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. The first question today comes from Kyna Wong of Credit Suisse. Please go ahead.

Kyna Wong — Credit Suisse — Analyst

Thanks for taking my questions. I have like maybe two to three question. So the first one is actually wanted to address gross margin because I also — I heard that the overall product mix is the main reason. But do you think that — this is also more longlasting issue going into the full quarter and also the first half next year, because we also see the — we also see some industries pushing more — pushing harder for those promotion and also launching products in the IoT business. So I think they want to drive the recovery in the IoT business for the second half, and also next year. And so this becomes more longlasting, I mean into like coming quarters, in terms of things like Xiaomi product mix issue? And I also want to check if there is any impact from the currency, the foreign exchange in terms of the margin, because I — we also see the RMB appreciation in the past quarter. And going forward, any impact on this, that’s the first related to the gross margin, first question. The second one is about the — I would say, the sales — the overall patents, because we see these like sales and marketing and also the R&D expenses continue to increase, but the Amazfit sales is actually taking some time to pick up, and of course, some is due to the COVID-19. But how to like — how could we expect that the investment in the R&D and also sales and marketing can be sustained in the future? So yeah, just wanted to share this. Thanks.

Leon Deng — Chief Financial Officer

Thank you very much. Those are good questions. So let me try to answer the first question first, right. On the gross margin, I think you’re right that it is always Xiaomi’s goal to provide high quality, cost-effective products to the end customers, and we continue to also pack cutting edge functionalities and sensors into our product, right. That’s also why we keep on selling our products better always, than the next — the previous generation. Right? So, it is true that the gross margin from the Xiaomi Band 5 is actually lower than the previous generation last year. However, we are actually looking for scale and operating leverage from the Xiaomi products.

On the other hand you also noticed, that our own brand sales is also picking up, right. And our own brand sales is actually — carries a relatively high gross margin compared to the Xiaomi products. So in the end, with the effort of the product shipments of our own brands and also the continued growth of the Xiaomi products in the next year, we at least expect the gross margin to stay at the current level, if — and maybe in the second half of next year to expand a little bit.

I think that answers on the gross margin part. On the currency part, I think we’re more looking at a natural hedge situation, because in the end, we sell quite a bit of the products overseas, and we receive dollars and also most of our purchase also paid in dollars. So in this case, selling along the Chinese market, because that is not subject to currency fluctuation. On the foreign exchanges on the dollar impact, I think its relatively minimal to us. So I don’t see any off-base adverse currency impact coming out of dollars.

So I guess that concludes on the gross margin part. Coming back on your question on opex, right. I think we are always a long-term kind of thinking and we apply to that to our management and how we manage our business going forward. Right. So there is some saying, never waste a crisis, right. So in this time, we try to invest ahead of time and try to build the foundation for our product launches for next year, and also to build network of our distributions and channels overseas for next year. We believe that when the coronavirus is a little bit getting away, then it is good and probably is going to be in second half of next year. That will be the time that you will see a rebound of our performance.

Kyna Wong — Credit Suisse — Analyst

Thank you.

Operator

[Operator Instructions]. The next question comes from Joey Hui of Industrial Securities. Please go ahead.

Joseph Hui — China Industrial Securities International Financial Group — Analyst

Okay. Thanks for taking my question. My first question is, could the health monitor function turn smartwatches and smart bands into a more widely used device, like TWS earphone? And what are the core barriers of these two kinds of products? Do we have some medical certification that differentiate our products from others? And that is my first question. Thank you.

Leon Deng — Chief Financial Officer

I think probably I will be the person to answer your question again. Yes, we see consumers adopting more and more the usage of health monitoring functionalities of the smartwatch during the pandemic, right. So that’s why you see also our competitors and/or the usage of the data on the wrist, are picking up. Whether or not it will become a TWS market? I think it’s too early to tell. But as you see both Apple and other big brands, they are actually packing more and more functionalities like ECG, and stuff like SpO2 Max into their watches. I think it’s a good sign and also a trend of where the industry is moving, right? And yes, there is definitely a barrier to it, because you have the difference between health and fitness device, and a medical device, right. And then I think on the medical device part, we are on par, if not better than, our key competitors.

And with regard to, if there is any core barriers on the usage of such data. I think the FDA approval and the medical devices approval is going to set us apart between a casual health and fitness player and a serious health player, which we want to be in the future.

Joseph Hui — China Industrial Securities International Financial Group — Analyst

Okay. Okay, thank you. My second question is that, as the last analyst mentioned, R&D investments is irrelevantly [Phonetic] high in the past nine months this year. Could management give more color on what we invest in, and how can we improve the property of our device?

Leon Deng — Chief Financial Officer

So on the R&D actually there is a lot of information, which we could disclose a little bit more. And I would definitely refer you to the press releases, which we did at the beginning of this year, around April-May timeframe on what we have invested. I think we have invested in AI. We have invested in a lot of new functionalities, which will be used in our next generation products. And not to mention, that we have actually — maybe you don’t know, we almost refreshed all the product lines, which we currently have for our own brands. By the end of this year, we have launched so many products in the course of this quarter, which should set us apart and also lay great foundations for next year. I think that’s just because of a few R&D investments which we did and if you need to know more, please feel free to send a question to our IR contact, and then we’ll get back to you.

Joseph Hui — China Industrial Securities International Financial Group — Analyst

Okay. Okay, thank you. And I have one last question. We have heard that Huami have some cooperation with maybe insurance companies, to promote our healthcare solution. Could the management share more details on that?

Leon Deng — Chief Financial Officer

I think you have — okay, go ahead, Mike.

Mike Yan Yeung — Chief Operating Officer

Yeah. Okay, sorry Leon. So we — regarding the insurance companies, as you may have heard. We partner currently in Asia, with potential Asia, where they are, they have contributed to our pie technology algorithm into their pulse app, which is their consumer app, that will be launched in over 11 countries in Asia, and that’s just the beginning of our partnership with them. We will also partner with them on data analysis, and also cross-selling of products, and we are also working on similar type of deals models, not only in Asia, but in U.S. and North America, as well as for Europe. And you will see announcements soon, but we have not signed those deals yet.

Joseph Hui — China Industrial Securities International Financial Group — Analyst

Okay. Okay, thank you.

Operator

[Operator Instructions]. The next question is a follow-up from Kyna Wang of Credit Suisse. Please go ahead.

Kyna Wong — Credit Suisse — Analyst

Thanks for taking my follow-up questions. So I noticed that there is a pretty high EBITDA increase in the stock based compensation in the third quarter. Just wanted to get more idea about the pattern going forward. We also expect certain, I mean, sensing that there will be some large stock-based compensation expenses, even though it will not really affect the adjusted earnings, but still wanted to know the — I mean the pattern, I mean going forward. What should we expect on that? Thanks. And yeah will we expect — shall we expect these similar level in the fourth quarter as well?

Leon Deng — Chief Financial Officer

So I think the increase of this quarter is — as what we mentioned in the — it’s primarily due to that increase in share-based compensation, which we give to some key employees. Right. Whether or not it’s going to — the same level is going to continue into Q4. I think at this moment, my answer is no, because the previous one, which you saw, it’s pretty much a one-off, which are tied back to some incentive scheme, which we had. At this moment, to the best of my knowledge, I don’t see anything in Q4 popping up.

Kyna Wong — Credit Suisse — Analyst

Okay, thanks.

Operator

The next question comes from Michelle Zhang of China Renaissance. Please go ahead.

Michelle Zhang — China Renaissance Securities Ltd. — Analyst

Hi, thank you management for taking my questions. So I have two questions. The first one is, I want to know about the current development progress of the distribution channel expansion for Amazfit products? Yeah, this is my first question. Thank you.

Leon Deng — Chief Financial Officer

Excuse me. Can you repeat your first question?

Michelle Zhang — China Renaissance Securities Ltd. — Analyst

Yeah, sure. So. My first question is about the current status of the distribution channel expansion for Amazfit?

Leon Deng — Chief Financial Officer

Right. No, I get it. So we have actually very meaningful progress of the Amazfit products channel building in the third quarter. As we mentioned, our star products, the Bip S and GTS entered more than 2,800 Walmart stores in the third quarter, and we are also now serving more than 70 countries, and our sales team covering different regions. We have a strong presence in the universal large platforms like Amazon, Flipkart and AliExpress. We’re also cooperating with a lot of local partners, like Reliance in India, and Svyaznoy in Russia. These are only just a few examples of our strong overseas channels, and we will continue to strengthen our global distributions in the coming quarters.

Michelle Zhang — China Renaissance Securities Ltd. — Analyst

Okay, thank you. And my second question is about the management outlook for the shipment growth of Xiaomi bands and also Amazfit products for next year. Thank you.

Leon Deng — Chief Financial Officer

Normally, we don’t guide for the next year. But I can give you some flavor on what it is, right. I think on a higher level, the global band market is becoming a relatively mature market. So we would anticipate the Mi Band product, the Xiaomi Band product shipment and ASP to somehow stabilize a little bit or with moderate growth going forward. But on the other hand, you know, the ASP of our own products are much higher than those of the Xiaomi’. So I would expect that our own product shipment will continue to grow, alongside with the gross margin expansion. But however, I need to caution you that the COVID-19 virus still has an impact on the global market, and we don’t know, whenever that is going to stop. So therefore, there is still quite some certainties around that topic. I hope that answers your question, I gave you at least some flavor on what it is.

Michelle Zhang — China Renaissance Securities Ltd. — Analyst

Yeah. Yeah, sure. Thank you. Thank you so much.

Operator

As there are no further questions. Now I’d like to turn the call back over to the company for closing remarks.

Grace Zhang — Director of Investor Relations

Thank you once again for joining us today. If you have further questions, please feel free to contact Huami’s Investor Relations department. This concludes this conference call. You may now disconnect your lines. Thank you.