Viomi Technology Co., Ltd Q2 FY2021 Earnings Call

Hello, ladies and gentlemen. Thank you for joining the Viomi Technology Co., Ltd Earnings Conference Call for the Second Quarter of 2021. Today's conference call is being recorded. I will now hand the call over to your host, Ms. Cecilia Li, the IR Director of the company. Please proceed, Cecilia.

Thank you, Operator. Hello, everyone, and welcome to Viomi Technology Co., Ltd Earnings Conference Call for the Second Quarter of 2021. As a reminder, this conference is being recorded. The company's financial and operating results were issued in a press release earlier today and 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, Mr. Xiaoping Chen, the Founder Chairman of the Board of Directors and Chief Executive Officer; and Mr. Wickham Thai, the Head of our Finance Department. 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 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. SEC. The company doesn't 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 includes discussions of unaudited GAAP financial information as well as unaudited non-GAAP financial measures. Viomi's press release contains a reconciliation of the audited 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.

Mr. Chen will now deliver his remarks in Chinese, followed immediately by an English translation. Please go ahead, Mr. Chen.

Thank you, Mr. Chen. I will quickly translate upon his remarks before discussing our financial performance for the second quarter of this year. Hello, everyone, thanks for joining our second quarter 2021 earnings conference call. During the second quarter, we optimized the product portfolio for certain categories and increased sales of new products with higher gross margin, further enhancing our business operations and improving the overall gross margin and profitability. Our second quarter net revenue reached RMB1.66 billion, with gross margin once again delivering both year-over-year and quarter-over-quarter increases reaching 21.2%. At the same time, non-GAAP net income attributable to ordinary shareholders of the company increased by 45% year-over-year, significantly improving the profitability. After years of hard work and enhanced exploration, we have developed a 5G IoT @ Home structure, which integrates the technology framework, AI algorithms, 5G IoT models, sensors, smart hardware, and cloud storage. This structure encourages further implementation of our one-stop IoT @ Home solution providing our users with smart home appliances, smart home devices, and software services across home scenarios. It enables intelligent interconnection from single products to the entire house forming an intelligent ecosystem for daily living and creating a complete smart home experience for users. To increase our product strategies appeal to younger users, we officially announced our changing technology branding strategy, which is underscored by our products, our channel operations, and the market team. First, with respect to our product offerings, we continue to focus on AI applications and innovation to support our AI household product strategy. Following the successful April launch for a series of new products, including the EROX mineral water purifier, the space all-direction air conditioner, the Alpha 2 premium water level monitor, and other products that can monitor female health data. We recently launched our SuperPro 1,100 da water purifier, our cost X1 AI-enabled rent, and other new AI products with technology upgrades. Many of these cutting-edge products are leading industry consumption trends. During the Chinese 618 e-commerce shopping festival, many of our products became some of the top 10 best sellers including the Alpha 2 Pro premier products, the Air Conditioner, and new smart washing dryer. In terms of sales channels, we implemented our largest store better merchant channel strategy. We have collaborated with high-quality merchants with strong door operation experience to offer larger experience stores and improved store image. These larger stores provide users with more comprehensive immersive, narrow-based experiences and services, enhancing our trending technology brand image. We have established 4 ads and 5 ads stores in comparison over 200 square meters and 300 square meters, respectively, to offer sales installation and after-sales services. Furthermore, this channel strategy promotes sales, decreases customer acquisition costs, and drives our overall market growth. According to the national residential market research report 2020, the total new development apartment transactions nationwide exceeded 150,000 square meters in 2020, which equals more than 10 million units based on our estimation, creating a huge potential source of growth for the smart home appliances market. We also increased our investment in branding and marketing, thereby reaching more diverse consumer groups with our omnichannel marketing tools and branding efforts. We invited one of China's top celebrities to become our product spokesperson, enhancing our brand recognition among younger generations. To target more consumers in cities, we collaborated with Focus Media and media leaders to advertise in around 100 major cities across the nation. As well as 3 top domestic airlines to increase our exposure to high-end consumers. Furthermore, we plan to advertise on television and other channels in the coming months. We also strengthened our new channel marketing on social media, including platforms through short-form videos and KOL live streaming. As in revenue innovation, optimization and strategies to strengthen our trending technology brand positioning as well as grow our customer base. We are also expanding our global market. Our overseas expansion of our silver business is progressing in line with our predictions. In addition to our previous coverage in more than 10 countries in Europe, Asia, and Australia. We began selling units in India, Saudi Arabia, Thailand, and North European countries in the second quarter. As we shared in our previous earnings call, our products were launched on U.S. Amazon in August, marking our official entry into the North American market. Although we will continue to expand globally and begin development of the self-operating mode in the second half of the year. Furthermore, our product pipeline includes a series of new wafer products for both domestic and overseas markets. In addition to our automated collection in UVs business technology, we are making a great drive with labor and optical inspection technology upgrades. We believe that there are 3 major drivers that will benefit the intelligent transformation and development of the smart home industry. First, the main consumer group in China and the younger generation has become a major consumption driver in China. According to research conducted by our third-party consultants, the younger generation prefers smart technology products and is more likely to demand and purchase smart home appliances. Secondly, the development of new energy vehicles over the past 2 years has created an emotional connection between customers and the smart products, and many other industries have also entered the intelligence era. Demand for smart products will drive the demand for the smart home industry, leading to an increase in consumer acceptance. Thirdly, China's 5G infrastructure has improved greatly over the past years. According to a report issued by the Ministry of Industry and Information Technology of the Chinese Government, the penetration rate of 5G will exceed 40%, and the average annual growth rate of 5G units will reach 200% by 2023. The ministry mentioned that Smart Life and Smart Home will be key components in promoting IoT applications. Our national policy support will also benefit the development of the IoT Smart Home industry. We are committed to becoming the leading one-stop IoT home solutions provider while developing our strong technology. Looking to the second half of the year, we will continue to improve our products through AI innovation, execute our larger store better merchant channel enhancement strategy, and strengthen our trending technology branding. With the ongoing development of home smart expansion in China, we remain confident in our ability to capitalize on opportunities and deliver long-term growth as well as contribute positively to our consumer core life and the industry-wide intelligence transformation. So, this concludes our founder's remarks. Let's now turn to the detailed financial review of the second quarter of this year as well as the outlook for the third quarter. Net revenues decreased slightly by 1.5% to RMB1.66 billion from RMB1.68 billion for the second quarter last year and increased by 43% compared to the same period of 2019. The slight year-over-year decrease was primarily due to decreased sales in water purifiers and smart appliances resulting from the product portfolio adjustments for margin expansion and second, a high base effect during the same period of last year due to promotional activities after the COVID-19 pandemic peak. Revenues from the IoT @ Home portfolio increased by 7.9% to RMB1.16 billion from RMB1.06 billion for the second quarter last year. The growth was primarily driven by sales increases in certain product series, particularly the Viomi-branded products and the washing machine. Sales from our home water solutions decreased by 18% to RMB218.9 million from RMB266.8 million for the second quarter of last year. The decline was primarily due to a decrease in sales of Xiaomi-branded water purifiers resulting from a product portfolio adjustment, though partially mitigated by sales increases in Viomi-branded water purifiers. Due to the product portfolio adjustment in Xiaomi-branded water purifiers, we achieved year-over-year and quarter-over-quarter increases in the overall gross margin of the home water solutions category. Revenues from consumables increased by 18.2% to RMB102.2 million from RMB86.4 million for the second quarter of 2020, primarily due to increased demand for our water purifier filter products. Revenues from small appliances and others decreased by 28.8% to RMB191.5 million from RMB268.8 million for the second quarter of 2020, primarily due to continued portfolio optimization for higher gross margin in this category. Gross profit increased by 46% to RMB351.8 million and gross margin was 21.2% compared to 14.3% for the second quarter last year. The year-over-year increase in gross margin was primarily driven by our efforts to shift the business and product mix towards higher gross margin products. This includes the increased revenue contribution from sales of new Viomi-branded water purifiers and cost control measures to optimize margins across our product lines. Total operating expenses increased by 29.4% to RMB309.7 million, primarily due to the increase in selling and marketing expenses. In more detail, R&D expenses increased by 9.1% to RMB66.2 million from RMB60.7 million for the same quarter of last year, primarily due to the increase in R&D expenses related to salaries and other expenses. Selling and marketing expenses increased by 32.5% to RMB214.8 million from RMB162.1 million a year ago, primarily attributable to the increase in advertising and marketing activities in order to enhance our branding and market recognition. G&A expenses increased by 72.6% to RMB28.8 million compared to RMB16.7 million for the second quarter of last year, primarily due to an increase in the estimated allowance for accounting receivables, along with a lower basis of lease expenses attributable to the lease exemption policies from the COVID-19 situation during the same period of last year. Net income attributable to ordinary shareholders of the company increased by 367.4% to RMB46.1 million, and net income attributable to all shareholders of the company increased by 44.9% to RMB59.5 million. Additionally, our balance sheet remains healthy. As of June 30, 2021, we had cash and cash equivalents of RMB667.6 million, restricted cash of RMB21.5 million, short-term deposits of RMB66.5 million, and short-term investments of RMB393.8 million. I would now like to turn to our outlook. For the third quarter of 2021, we currently expect net revenue to be between RMB1 billion and RMB1.1 billion. We expect the sales of Xiaomi-branded products to decrease in the third quarter, while our own brand business will achieve faster growth, which will become one of our main categories. The outlook is based on the current market conditions and reflects the company's current and preliminary happenings in the market and operating conditions and customer demand, which are all subject to change. Well, this concludes our prepared remarks, and we will now open the call for the Q&A session. The Head of our Finance Department, Mr. Wickham Thai will join the session and answer questions.

So the first question comes from Lillian Lou from Morgan Stanley.

I have three questions. First of all, can you give us a breakdown of the IoT @ Home product portfolio, in particular, how much the contribution came from the robot sweeper products in the second quarter? And also what kind of sales momentum are we seeing in July and August in the near term? That's the first one. Maybe I will just pause and I will ask the rest of the two questions later...

Okay. Thanks for your question. About the IoT @ Home portfolio, we have more than 10 small categories, including refrigerators, washing machines, water heaters, sweeping robots, and chargers. Among these, Viomi fairly contributed around 20% of revenues of IoT @ Home. Viomi-branded washing machines contributed around 10%, and Viomi-branded sweeper robots contribute around 10%. Viomi-branded sweeper robots were still the biggest driver for IoT @ Home sales due to a low base effect and fast-moving revenue contribution. The revenues from Viomi sweeper robots increased significantly compared to the second quarter of last year.

And any color on the near-term trend in terms of the growth momentum, including water solutions as well? Can we have a little bit of sense?

Yes, as we mentioned, we continue to execute quality and product optimization strategies in the second quarter. So we rolled out additional new products with higher margins and high average selling prices, particularly in some key categories, including water purifiers. In addition to introducing more high-end Viomi water purifiers, we also shifted the focus a bit more on supplying more large-sized Xiaomi water purifiers with better gross margins, thus improving the overall average selling price and gross margin, together with revenue contribution in the coming quarters.

My second question is regarding the average selling price and margin trends. Do you have any plans for price adjustments considering the increasing raw material costs? Additionally, I would like to know if we can expect a similar pattern of margin expansion in the second half, following the strong margin improvement we experienced in the second quarter due to product mix shifts and portfolio adjustments.

Yes, we observe that raw materials still decreased in the second quarter, albeit modestly compared to the previous month. This also contributes to the increase of average selling prices across the industry as well as for some of our products. Regarding margin, we have intensified our advertising and marketing activities since the second quarter to enhance our branding positioning and recognition. We will invest more in selling and marketing compared to last year, but in a prudent and reasonable way. We expect such expenses will slightly lower the margin, while as we have taken product optimization strategies, the overall gross margin has improved, and we're looking forward to continued improvement. We think this will mitigate some impact of the increased operating expenses on net profit margins. We don't foresee any material impact from increased raw material costs in the first quarter, as we have taken serious cost control measures.

Okay. My last question is on the new product strategy. I think Mr. Chen in the opening remarks mentioned quite a few new products being innovated and launched in the second quarter and the first half. So what kind of strategies in terms of how we actually make all these SKUs a more meaningful contribution to the revenue?

Yes, I am going to translate Mr. Chen's comment. So we have diversified our product offerings this year. The introduction of these new products can help us with margin expansion, which you can see from the second quarter and make our product portfolio more diverse. Some SKUs of this product such as sweeper robots, EROx water purifier, and all direction air conditioners can also help increase the revenue contribution in the respective categories. We believe these new SKUs and the margin expansion can help us to improve the overall gross margin of our business as well as drive overall growth.

Next question comes from Wei He from CICC.

And I have two questions here. The first is that we noticed the company has done a lot of promotion recently like cooperating with Focus Media, and we can also see the trend from the financial report. So do we expect a higher selling and marketing expense as a percentage of total expenses this year? Will it be higher in the second half of this year? Can you share with us the promotion plans or strategy in more detail?

I will quickly translate. Since last year and the first half of this year, among younger generations, we can see they are more likely to enroll and use Smart Home products, as Smart Home is a trending topic among them. Recently, we invited one of China's very popular celebrities for our product promotion, and we also engaged in a lot of advertising to increase brand recognition. Regarding the increase in selling and marketing expenses, we anticipate that such investment in advertising and marketing will indeed increase these expenses, but this will be partially mitigated by some of our sales structure optimization as well as some cost control measures. In the second half of this year, we will also continue to invest in related expenses on advertising, including television and other channels. From our internal data, we have noted that our brand recognition has increased across all of the marketing and advertising tools. We hope this will help improve our branding image.

Okay. And my second question is about the overseas market. Can you give us a more detailed update about the overseas distribution channel development, both online and offline, and are there any negative impacts due to the shortage of shipping containers?

Okay. I'll answer the question. In the first quarter of 2020 and the first quarter of this year, as we mentioned, we already entered into more than 10 countries in Europe, Asia, the Middle East, and Australia. In the past few months, we also expanded into additional 8 countries, including India and other European countries and the United States. Our exported products are sold through both online and offline channels most through our franchises. We sell our products to those franchisees and they handle the online sales as well. In the North American market, we just launched the U.S. store and are seeking cooperation opportunities for offline channels this year depending on the order selling conditions on Amazon. Regarding the shortage of shipping containers, yes, it did cause some impact leading to delays for some orders, but we have optimized the manufacturing and delivery timings, and plan to set up local warehouses to mitigate the impact. Generally, it hasn't caused any material impact on our overseas market.

Next question comes from Vincent Yu from Needham & Company.

So I have two questions that the analysts have mentioned, but I would like to discuss it a little bit more. The first one is that it looks like we missed our guidance range this quarter. Can management talk more about which segments didn't perform as expected? Did our portfolio optimization contribute to the top line miss as well?

So for your second question regarding raw material accounts, we have observed the pricing of raw materials stabilizing as we entered August. As the industry expects, we think the raw material cost is at a relatively high position but not likely to increase significantly. Regarding your first question about the guidance for the second quarter revenue and the third quarter guidance, we are shifting our focus on the product portfolio adjustments for the second quarter and the third quarter with two main points. First, we will increase sales of some new products with potential growth, which will take some time to increase contributions from these new products. Second, we plan to invest more R&D resources in our own branded products, particularly some high-end water purifiers and home devices. We believe that in the long term, these categories and products can drive overall growth. So overall, in the third quarter, we will be conservative about our selling and the guidance but remain focused on product portfolio improvements.

Thank you, management. Let me follow up with one more question. You mentioned that we are investing in new stores and hiring a spokesperson. Have these expenses already been incurred in the second quarter of 2021? Will we see selling and marketing expenses grow faster than total revenue growth on a year-over-year basis?

Okay. So regarding the selling and marketing expenses and impact on the operating expenses net margin, for the investment in the operating channel, we cooperate with the merchants to open offline stores, and merchants themselves take care of the store operations; this won't reflect in our operating expenses. For selling and marketing, we have indeed conducted advertising and invited the spokesperson in the second quarter, so we already incurred part of selling and marketing expenses there. In the second half of this year, we will have some ongoing expenses on this front. Compared to the first half of this year, expenses will increase. However, we are also seeing the effect of our internal data showing that these advertising activities have helped our sales both online and offline. So we believe this investment is effective, and we will continue our advertising activities in the second half.

Next question comes from Sue Boon from Blue Lodges.

Where international sales play an increasingly important role, is the management seeing any changes in the international segment with the easing of pandemic measures? Has international growth slowed a bit?

Okay. For the first half of the year, we have noted robust growth in the overseas market due to post-pandemic recovery in some countries. However, entering the second half of the year, we also see some changes regarding pandemic issues, and we are remaining conservative. Although sales performance remains in line with our expectations, we still note some uncertainties in the global market. We will be taking strict measures prudently on our promotion and marketing activities.

Is there any particular strategy for marketing in the U.S. market?

Thank you. In terms of the U.S. market, our products were just officially launched last week on our store. We will cooperate with local third-party operators to conduct our Amazon operations, as they understand operational guidelines on Amazon better and can help us connect more with American customers' culture. Additionally, we will engage in marketing and PR activities in the U.S. market, such as KOL recommendations, as well as other promotional activities to help boost sales in the U.S. market.

So as there are no further questions, I will turn the call back over to Cecilia Li for closing remarks.

Thank you once again for joining us today. If you have further questions, please feel free to contact us with the contact information on our website or via The Piacente Group, our Investor Relations consultant. Thank you all. Have a good one.

This concludes the conference call. You may disconnect your lines. Thank you.