Viomi Technology Co., Ltd Q2 FY2020 Earnings Call

Hello, ladies and gentlemen. Thank you for standing by for Viomi Technology Company Limited Earnings Conference Call for the Second Quarter 2020. 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. Cecilia Li, the Senior IR Manager of the Company. Please go ahead, Cecilia.

Thank you, operator. Hello, everyone, and welcome to Viomi Technology Co., Ltd earnings conference call for the second quarter 2020. As a reminder, this conference is being recorded. The Company's financial and operating results were issued in a press release earlier today and are posted online. You can download the earnings press release and sign up for the Company's e-mail distribution list by visiting the IR section of the Company's website at ir.viomi.com. Participating in today's call are Mr. Xiaoping Chen, the Founder, Chairman of the Board of Directors and Chief Executive Officer; and Mr. Shun Jiang, the Chief Financial Officer. The Company's management will begin with prepared remarks, and the call will conclude with a Q&A session. Before we continue, please note 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, the Company's actual results may be materially different from the views expressed today. Further information regarding these and other risks and uncertainties is included in the Company's annual report on Form 20-F and other filings as filed with the U.S. Securities and Exchange Commission. The Company does not assume any obligation to update any forward-looking statements, except as required by law. Please also note, Viomi's earnings press release and this conference call also include discussions of unaudited GAAP financial information as well as unaudited non-GAAP financial measures. Viomi'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 Founder and CEO, Mr. Xiaoping Chen. Mr. Chen will deliver his remarks in Chinese, followed immediately by English translation. Mr. Chen, please go ahead.

Thank you, everyone, for joining our second quarter 2020 earnings conference call. We observed significant improvements in operating conditions during this quarter as the industry and overall economy continued to recover from the effects of COVID-19 earlier this year. The strong '618' sales season, along with successful new product launches like our air conditioning systems, contributed to our second quarter revenues exceeding RMB 1.68 billion, marking a 45.2% year-over-year increase, which was much stronger than anticipated. Despite the challenges in the first half of 2020, the recent '618' online shopping festival and associated promotions have shown encouraging signs of a broader industry recovery. We achieved our best-ever performance during the '618' sales season, more than doubling retail sales across our entire product range compared to last year. Products such as refrigerators, washing machines, and air conditioners ranked among the top 10 on certain online ecommerce platforms. This resilience illustrates our growing brand awareness and market presence, along with increasing consumer and sales channel interest in our offerings. Our ongoing growth is supported by continuous product innovation and new launches within our IoT @ Home strategy. We have successfully introduced new air conditioning systems and the 21Face Interactive Smart Screen TV, providing a comprehensive range of solutions tailored for home environments. We have also made significant progress with our 5G initiatives, with two models of our 21Face Interactive Smart Screen TVs already available in the market. We anticipate the mass production of our Wi-Fi 6 CPE and other exciting 5G products in the latter half of this year. With the increasing adoption of 5G networks, we see this as a crucial driver for industry growth moving forward. We believe that our unique product offerings and emphasis on technology research and development will position us as a leader in the evolving 5G and IoT landscape. We have made considerable advancements in developing content applications for our flagship 21Face large-screen refrigerators, recently upgrading the operating system to include features like video recommendations, gourmet recipes, and parenting workshops, along with enhancements in voice recognition. In July, we partnered with Kugou Music to deliver engaging music streaming content for our users. This collaboration aligns with our 5G IoT strategy and will enhance our offerings and interactivity across our large-screen products. We are also expanding our sales channels through new partnerships, such as our recent collaboration with Hunan Friendship & Apollo Commercial Co. Ltd., to promote our products and facilitate IoT @ Home solutions. In addition, we established a partnership with Zhejiang Zhengyuan Zhihui Technology Co. Ltd. to introduce Viomi-branded washing machines in various settings. These partnerships are evidence of the recognition of our value proposition and strengthen our brand and market presence. Looking to the second half of the year, with recovering market demand and the launch of new products like air conditioning systems and next-generation water purifiers, we are well-positioned to enhance our market standing and brand recognition. To support this, we implemented our share incentive plan in the second quarter to attract and retain talent, align employee interests with business success, and foster growth. Having navigated challenging conditions in the first half, we will maintain focus on dynamic practices, stable cash flows, and prudent risk management to achieve sustainable growth within our 5G IoT framework. We will also aim to improve operational efficiencies and create attractive incentives within our key business units. Lastly, we strive to create synergies across the Viomi Group to lay a strong foundation for future success. We are confident in reaching our long-term objectives and becoming a prominent leader in the IoT @ Home sector.

That concludes our founder's comments. I will now provide an operational update and discuss our financial performance in the second quarter of 2020. Despite the lingering impact of COVID-19, as well as ongoing macro uncertainties, we achieved revenues that significantly exceeded our expectations and again demonstrated the resilience of our business and our ability to identify and capture attractive growth opportunities. Our profitability remained relatively stable compared to the first quarter, as we continued the implementation of various cost and expense control initiatives during the quarter, mitigating the margin impact of promotional campaigns and sales events such as the ‘618’ online shopping festival. The number of Viomi offline stores remained at around 1,500 in the second quarter, relatively stable compared to the end of the first quarter. Our cumulative household users reached more than 4.2 million. Now, let's turn to the detailed financial review of our second quarter results as well as the outlook for the third quarter. As Xiaoping discussed, net revenues were RMB 1.6 billion, an increase of 45.2%, compared to the same period of last year. Revenues from IoT-enabled smart home products increased by 46.7% to RMB 1.3 billion from RMB 906 million for the second quarter of 2019, primarily due to the successful launch and continued rollout of certain new product categories. Within this category, revenues from our smart water purification systems decreased by 22.6% to RMB 266.8 million. The decline was mainly due to decreases in average selling prices, which offset continued year-on-year growth in sales volumes. Going forward, we expect the impact of like-for-like decline in average selling prices of water purifiers to be more moderate, and the category is likely to return to positive revenue growth in the second half, driven by continued volume growth of Xiaomi-branded products along with the ramp-up of newly launched next-generation Viomi-branded water purifiers. Revenues from smart kitchen and other products increased by 89.3% to RMB 1.06 billion. The revenue growth was primarily driven by the successful launch and continued rollout of certain products, in particular, the pilot launch of our air conditioning systems, which were particularly well-received by the market, as well as the strong performance of Xiaomi-branded sweeper robots. Revenues from consumable products increased by 24.6% to RMB 86.5 million, primarily due to the increased demand for our water purifier filter products. Revenues from value-added businesses increased by 45.5% to RMB 268.8 million from RMB 184.8 for the second quarter of 2019, primarily due to the new product introductions along with increased demand for our small appliances products. Please note that from the next quarter, we will update the naming of our various product categories as follows. Smart water purification systems will be renamed as Home Water Solutions; smart kitchen and other smart products will be renamed as IoT @ Home portfolio; consumable products will be renamed as Consumables, and value-added businesses will be renamed as Small Appliances and Others. And going forward, our revenue breakdown will comprise of the following categories in the following order: One, IoT @ Home portfolio; second, Home Water Solutions; three; Consumables; four, Small Appliances and Others. We believe these updates will provide investors with a clear understanding of our core businesses. There is no revenue reclassification associated with this particular update. Future category results will be directly comparable to their respective previously named categories. Moving on, gross profit was RMB 241 million and gross margin was 14.3%, compared to 26.6% for the second quarter of 2019. The decline in gross margin was primarily due to the shift in our business and product mix, including the pilot launch and related promotional campaigns of our air conditioning systems, together with decreases in average selling prices of certain product categories during the major sales season, including smart water purification systems in the quarter. The first half of this year was quite unique due to the unprecedented industry-wide impact of COVID-19. Based on the trends we're currently seeing, we do expect gross margin in the second quarter of 2020 to be a trough and expect to achieve a degree of gross margin uplift in the second half, driven by a recovery in overall industry conditions, general premiumization of our product portfolio and an increase in average selling prices compared to the first half. Total operating expenses increased by 13.3% to RMB 239.4 million, primarily due to the growth of our business and an increase in share-based compensation of RMB 20.9 million, which is partially offset by the continued implementation of expense control initiatives during the quarter. We incurred share-based compensation expenses of RMB 31.2 million in the second quarter of 2020, as compared to RMB 10.3 million in the second quarter of 2019. The increase in share-based compensation expenses was due to the implementation of our 2018 share incentive plan during the quarter from which we awarded approximately 15.6 million share options to certain employees, a small portion of which were immediately vested. In more detail for operating expenses, R&D expenses increased to RMB 60.7 million from RMB 59.6 million for the second quarter of 2019, primarily due to an increase in share-based compensation expenses of RMB 17.5 million to attract and retain research and development personnel, which is partially offset by the continued implementation of expense control initiatives during the quarter. Selling and marketing expenses increased by 25.2% to RMB 162.1 million, primarily due to an increase in logistics and promotional expenses as a result of the growth of the Company's business. G&A expenses decreased by 25% to RMB 16.7 million, primarily due to continued implementation of expense control initiatives during the quarter. Total operating expenses as a percentage of revenues was 14.2% compared to 18.2% for the second quarter of 2019. Excluding the impact of share-based compensation expenses, total operating expenses as a percentage of revenues was 12.4% as compared to 17.3% for the second quarter of 2019. The decline in expense ratio was predominantly due to greater economies of scale and operating efficiencies, as well as the continued implementation of our various expense control initiatives. Net income was RMB 10.3 million compared to RMB 88.9 million for the second quarter of 2019. Non-GAAP net income, which excludes the impact of share-based compensation expenses, was RMB 41.5 million compared to RMB 99.3 million for the second quarter of 2019. Additionally, our balance sheet remained healthy. As of June 30, 2020, we had cash and cash equivalents of RMB 634.2 million, restricted cash of RMB 45.4 million, short-term deposits of RMB 72.6 million and short-term investments of RMB 294.3 million, in total, over RMB 1 billion worth of liquid assets. Now, let's turn to our outlook. While future industry-wide uncertainties and challenges will be difficult to fully predict, based on our assessment of latest industry trends, we are cautiously optimistic that our financial strength, operational flexibility and strategic direction will allow us to continue delivering robust growth in the second half. For the third quarter of 2020, the Company currently expects net revenues to be between RMB 1.4 billion and RMB 1.45 billion, representing a year-over-year growth of approximately 30.8% to 35.5%. The above outlook is based on the current market conditions and reflects the Company'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 for Q&A. Operator, please go ahead.

The first question today comes from Hanli Fan of Morgan Stanley. Please proceed.

Thank you, management. This is Hanli Fan from Morgan Stanley. I have three questions. First, can you provide an update on recent business operations, particularly regarding the recovery pace in July and August? Additionally, could you discuss the offline recovery and the online channel? Second, in the small appliances sector, there are some newly launched niche products, such as yogurt machines and noodle makers, that sold well during the COVID-19 pandemic. How is Viomi preparing for these niche products, and what is your strategy for the small appliances market? Finally, regarding the net profit margin, the non-GAAP margin is 2.4% this quarter, mainly due to a decline in gross profit margin. Could you offer some outlook or guidance on future net profit margins in relation to gross profit margins and expense ratios? That's my question.

Yes. Thank you, Hanli. I'll take your questions one by one. So, the first question is on sales recovery and channel performance. Since the February lows, there has been a noticeable month-on-month recovery in sales performance across online, as well as offline channels. For online channels, the year-on-year recovery has been most evident since beginning around May where we started to enjoy very healthy double-digit year-on-year growth. For Viomi-branded products, the key drivers have been the various kitchen products, water purifiers, small appliances, as well as, of course, air conditioning systems. For offline channels, year-on-year growth has reemerged since around June and has continued to accelerate into July. Together with our offline channel partnerships, as well as new stores and points of sales, we're cautiously optimistic about the continued recovery of our offline sales channel performance going into the second half. We haven't really seen any slowdown in online channels heading into July or August either. I think that the Viomi-branded product sales through online channels, as discussed, more than doubled across the ‘618’ sales season and continued similar levels of strong performance heading into the third quarter, albeit off a relatively low base in 2019. If you look at our quarterly performance in 2019, it was more volatile and you should expect a smoother quarter-on-quarter performance this year. Nevertheless, I think, based on the current trends, we expect strong performance as we have guided for the third quarter, continuing deeper into the second half and into the Double 11 shopping festival towards the year-end. So, strong performance across both offline as well as online channels, based on current indicators in the third quarter so far. The second question was about small appliances. As you can see, from the performance of our value-added businesses, or soon to be renamed to small appliances and others category, small appliances have indeed performed very well in the second quarter, as well as the first half of 2020 in general, due to your aforementioned trends. The segment experienced close to 50% year-over-year growth in the quarter. Some of the key products within this category include fans, vacuum cleaners, water dispensers, blenders, kettles, and of course sweeper robots, so all quite popular products for the stay-at-home dynamic in the first half. Small appliances will be a key growth category for our Company going forward. We have formed a specialized team focusing on trendsetting small client product innovation and development. We believe there are significant growth and market opportunities to be captured in this space, and we'll be devoting the necessary resources to create the appropriate incentives to ensure this initiative will become a success. We look forward to sharing more progress with the market on this aspect in the quarters ahead. So, we're quite excited about small appliances’ potential going forward. In terms of your third question on net margins, I think that while a lot of uncertainties remain, I think we can definitely say that the performance trends in the second quarter as well as heading into the third quarter have been quite positive and ahead of expectations in the third quarter, not only from a revenue growth perspective, but I think also from a margin perspective. In terms of gross margins, as we've discussed earlier, we do expect gross margin in the second quarter of 2020 to be a trough and do expect a degree of gross margin uplift in the second half. The key drivers of this are recovering industry conditions, so less price competition, the general premiumization of our product portfolio, and an increase in selling prices compared to the first half. If you want to look at the overall net margin for the second half, while the exact uplift will be, I think it's a little bit too early to predict at the current time, you should expect some degree of uplift from what you saw in the second quarter of this year.

The key drivers of the margin uplift in the second half are recovering industry conditions leading to less price competition, the general premiumization of our product portfolio, and an increase in selling prices compared to the first half. While it may be too early to predict the exact uplift in overall net margin for the second half, you should expect some degree of improvement from what was observed in the second quarter of this year.

Mr. Chen would just like to supplement the response to the two questions. In terms of the small appliances, we have also noted that the industry is growing very quickly and especially for some of these niche products. We would like to reemphasize that small appliances will definitely be a key strategic focus for us. Our team is definitely focusing on growing our market presence and penetration within this category. I think, in terms of our core focus products, we will be focusing more on some of the mainstream small appliances category with the larger addressable markets to imprint our presence as well as our brands, in the near term, as a core focus rather than on some of the more niche categories as Hanli identified. And also, to supplement the response regarding margins and profitability, I think just to add, as you have seen with our growth performance in the second quarter as well as our guidance for the third quarter, top-line growth and market share gains will continue to remain our number one priority, at least for the near to medium term. Of course, we're also implementing various cost and expense control initiatives to ensure a healthy level of profitability and do expect a degree of margin uplift in the second half compared to the second quarter, but I think it needs to be emphasized that as a rapidly growing company with a quite differentiated value proposition compared to some of the more traditional peers in the market, our core focus will continue to be top-line growth for the near to medium term.

Thank you for taking my question. My first question is, what can we expect for your new product launch in your second half? Since your first half you have great success in your Viomi-branded air conditioner system and your 21Face Smart Screen TV, what can we expect for the second half? That's my first question. And my second question is, you have your collaboration agreement with Kugou Music, and could you give me more color about this collaboration? Thanks.

Yes. So, I'll answer the first question on the second half key growth drivers as well, and Mr. Chen will take the question on the Kugou Music partnership and some additional content collaboration opportunities. So, I think in the second half, you should expect several trends, right? One is the continued ramp-up of some of the new product categories we launched earlier in the first half, as you may have seen during our major product launch event in May. Some of the key products that we mentioned here are, of course, our air conditioning systems, a lot of new next-generation Viomi-branded water purification systems as well as an overall upgrade and premiumization of our entire product range. In the second half, across our key categories, such as refrigerators and washing machines, we will be more focused on higher ASP (average selling price) SKUs as well as additional specific use SKUs that will encompass higher margins compared to where we were initially focused when we first launched these categories, perhaps on some low ASP products to gain market share. So, in terms of new product launches, we do expect quite a number of new SKUs to come onto the market in the second half. In terms of key categories, we currently have a complete IoT @ Home portfolio across the major appliances categories within the market. I think there's ample room for expansion still in terms of brand and channel penetration, as well as SKU expansion optimization. Overall recovery and ramp-up of newly launched products will be the key drivers of growth.

We expect to introduce a significant number of new products in the second half of the year. Our IoT @ Home portfolio is fully developed across major appliance categories, and there is still plenty of opportunity for us to expand our brand presence and distribution channels, as well as optimize our product offerings. The overall recovery and ramp-up of our new products will be essential for driving growth.

Yes. So, I think the partnership with Kugou and other related partnerships, including live streaming and content partnerships, that we expect to announce shortly, aim to increase the content as well as enhance the user experience that our users can engage with our products like, for example, the 21Face large-screen refrigerators. Obviously, a key point of sale for these refrigerators is what they provide outside of the core refrigeration capabilities, in terms of content, data collection, control, entertainment, etc. The overall idea is to continue to increase engagement and smartification of these products within our overall IoT @ Home framework. Based on initial data collected, the engagement has been very positive. The trends are definitely encouraging, and we hope to continue to collect and improve some of the data metrics as we continue to adopt more of these content partnerships and user enhancements going forward. We will continue to collect such data and share with the market in the coming quarters once the data is a little bit more refined and mature. But we are very excited about these initiatives.

Thank you for taking the question, and congrats on the strong quarter. I have three questions. The first two are quite general questions; one is, in which product line the Company sees the most growth potential for the second half of 2020? And the second question is about how home appliance consumer demand will trend during the second half of 2020? And my third question is a follow-up on the refrigerator cooperation with other internet companies. If the users are, for example, watching advertisements or going to open their membership on IGE or KugoU, are we going to share revenue on these activities? Also, is it possible to share how we cooperate with fresh ecommerce companies? Are the customers ordering fresh food on refrigerator screens? What will kind of revenue sharing mechanism work?

Yes. Thanks, Vincent. I'll take your questions. The first question is regarding which product lines the Company sees most growth potential in the second half. I think, in terms of like-for-like growth versus last year, of course, air conditioners is a relatively large product category and as a new product introduced this year, it will be a significant contributor to the year-over-year growth. Nevertheless, based on the trends we are seeing in July and heading into August, growth is recovering across nearly the entirety of our product lines, especially for some categories that were lagging in previous months, such as refrigerators and washing machines. Additionally, as discussed, we're placing significant emphasis on the next generation of Viomi-branded water purifiers, along with various trendsetting small appliances products, and expect these categories to add a new layer of growth for the upcoming quarters as well. Regarding your second question on how home appliances consumer demand will trend during the second half, we see a generally positive trend, much better than earlier in the year during the worst impact of COVID-19. Although uncertainties and challenges will continue to remain in the second half, based on the current trends that we're seeing, we're cautiously confident in a continued and sustained rebound in overall consumption demand in the second half. Your third question on monetization opportunities for some of these internet services initiatives indicates various options, including revenue splits, advertising revenues, or other user engagement channels. The core focus for us is to enhance the user experience and build our user base. This will be our priority and connect to Mr. Chen's earlier point on maintaining top-line growth and market share, so we're focusing on growing our installed base. Once this phase matures, we can then explore monetization opportunities.

Our main goal is to improve the user experience and expand our user base. This aligns with Mr. Chen's earlier comment about sustaining revenue growth and market share, so we are concentrating on increasing our installed base. After this phase is complete, we can look into various monetization options.

Mr. Chen wanted to reiterate that small appliances will definitely be one of our key growth categories going forward, even in larger appliances. Given the impact of COVID-19, we're seeing a transformation in the industry where consumers are focusing more on enhancing their home living lifestyle and paying more attention to user experience of such products and engaging with the next-generation IoT capabilities. This presents a good opportunity for us and reflects the trends from the second quarter as we head into the second half. Regarding monetization opportunities, just to reiterate, our near-term focus will be building our installed base. There are several monetization avenues going forward, including advertising revenues, GMP, revenue sharing for subscriptions, etc. We will explore these down the line.

Hey, management. Thanks for taking the time. So, I wanted to ask about the share-based compensation in the second quarter. It looks like you all significantly stepped up the SBC there. And it makes sense, given the situation that we use share-based compensation as a way to retain some important members of the team. I guess, on this front, I want to ask if you can provide any more color on the structure of the grants that you all provided in the second quarter. So, the first would be about the number of participants, or if you could provide any more specificity as to which teams or departments are getting compensated with SBC. And then, also on vesting schedule and strike price, if you could provide any average strike price or color on either of those fronts, it would be helpful for us to better understand the incentive plan.

Thanks, Robert. As discussed, we issued around 15.6 million options to approximately 100 employees, predominantly from the R&D teams, as well as certain management personnel. In terms of the kind of the terms of these options or the incentive plan, as disclosed in our prospectus and the 20-F Annual Report, these have a five-year vesting period, with 40% of the amount maturing after two years. So, zero after one year, 40% up to three years, and then 20% for the next three years, accumulating for the entirety of the plan. The average strike price is around US$0.55 to US$1.1 per share, which translates into 1.65 to $3 per ADS. So, this represents relatively in-the-money options, with a small portion vested immediately. Just over 1.5 million were vested immediately, some backdated options to certain management employees that were hired a few years earlier. The overall impact on our share-based compensation expense line item, while outsized this quarter, should not be too different from our historical expenses. The historical SBC expense was predominantly due to the amortization of our 2015 share option plan which has now been largely fully amortized. So, now, this 2018 share option plan is essentially replacing the 2015 plan. In this quarter, the expense was slightly outsized due to the immediately amortized portion that was expensed on a one-off basis. You should expect around RMB 40 million of SBC expenses relating to the 2018 plan in the second half of this year, subject to exchange rates or any forfeitures, averaging around RMB 20 million per quarter and probably slightly decreasing over time, given the amortization schedule.

At this time, we show no further questions. And I would like to turn the conference back over to management for closing remarks.

Thank you once again for joining us today. If you have further questions, please feel free to contact Viomi's Investor Relations department through the contact information provided on our website. Thank you everyone. Have a good day and night.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.