Earnings Call Transcript - ZEPP Q1 2020

Operator, Operator

Hello, ladies and gentlemen. Thank you for standing by for Huami Corporation’s First 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.

Grace Zhang, Director of Investor Relations

Hello, everyone, and welcome to Huami Corporation's first 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 and the slides 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 Mr. David Cui, 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 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 year ended December 31, 2019, and other filings with the 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 the 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 and CEO

Hello, everyone. Thank you for joining our earnings conference call today. Our first quarter revenue continued the robust growth of 36.1% despite the unprecedented challenges created by the COVID-19 pandemic, driven by new product launches, increased brand recognition, successful sales and marketing strategies, as well as efficient supply chain management. At this year's CES, which took place in the first quarter, we launched the Amazfit T-Rex, a device with a military-certified body ideal for outdoor activity. This broadened our smartwatch portfolio to 7 product lines. We also introduced new product categories, including earbuds or hearables and interactive high-tech treadmills, both significant components in building a comprehensive health and fitness ecosystem as part of our ‘Connect Health with Technology’ aspirations. While we do not expect meaningful revenue contribution in the near term due to the time it takes to ramp up production and penetrate new market segments, new initiatives like these will create more opportunities for our Company's future growth. We feel confident in this growth opportunity because wearable technologies and health tech not only help people monitor and check their physical fitness and wellbeing but also potentially shape new behavior patterns and drive real changes in everyday life. While wearables and health tech offer nearly unlimited applications across a number of product verticals, we have only begun to scratch the surface. In the meantime, we continue to expand our footprint and have recently continued to make solid headway in international markets. We keenly focus on the market nuances of each key region and adopted a multichannel strategy, including both direct sales and third-party sales channels. We are now in more than 70 countries with 137 channel distributors and strong market share, showcasing the strength of our brand globally. According to the IDC fourth quarter 2019 report, we ranked number one in market share for India, Indonesia, and Spain under the smartwatch category; number three in Russia and Mainland China; and number six in the U.S. In terms of partnerships, our continued partnership with Xiaomi remains productive with the launch of the Mi-Band 5 scheduled later in 2020. Additionally, our close collaboration with Timex has yielded positive results with the first joint product launched in the first quarter. We should note that the sales of our Amazfit branded products are through independent channels which are explored by our own sales and marketing team. Next, let me further discuss our healthcare strategy and the solid progress we made this year in healthcare. From the inception of our Company, healthcare has been at the core of our mission. In 2020, we continue to build upon the strong foundation we have established by developing our cloud-based healthcare services through vertical operation with leading healthcare institutions. For example, we partnered with the respiratory disease team of Dr. Zhong Nanshan to jointly establish a laboratory for studies on monitoring respiratory diseases, using wearable devices. Dr. Zhong is a global leading epidemiologist and an academician of Chinese Academy of Engineering. He plays a significant role as an advisor in managing the COVID-19 epidemic crisis. The focus at this lab is on the early prediction of certain respiratory diseases, specifically COVID-19, and how our smart wearables, with our AI and big data advantages, can help establish a cloud service system to provide epidemic prediction and disease monitoring. As such, we look forward to realizing further potential of our wearable devices in the healthcare industry. On May 5th, we published a research article on infectious disease prediction based on data from wearable devices in journals of Discrete Dynamics in Nature and Society by Hindawi. The premise of the published article was that the popularity of wearable devices enables a new perspective for the precaution of infectious diseases. In this study, we proposed a framework which is based on the heart rate and sleep data collected from wearable devices to predict the epidemic trend of COVID-19 in different countries such as Spain and Italy, and different cities. The experiment's results indicated that the prediction model can be utilized to alert the outbreak of COVID-19 in advance, which can be the foundation for a health surveillance system with wearable devices. In addition, we signed a cooperation agreement with the China Athletic Association in March to become the official partner of China's national track and field team in the smart wearable industry. With our accumulated big data in both healthcare and our track record in smart hardware research and development, we look forward to helping the development of professional athletics. This collaboration also allows us to showcase the high quality of our products and help our marketing efforts, and we will continue to offer professional sports tracking services to all of our users. In summary, while we experienced some impact from the COVID-19 pandemic, we are confident the underlying demand for our products remains strong with our brand's rising popularity, our strengthening sales channels, new product innovations, and line extensions in the works. We believe that wearable technology will further shape the healthcare industry while helping people enjoy better healthcare services. We are excited about our unique positioning in connecting health with technology and the strong market potential in front of us. We will look to continue investing in R&D, and sales and marketing functions to deliver sustainable growth and healthy profitability once the impact from the pandemic eases. Thank you again for joining today. I will now turn the call over to our CFO, David Cui.

David Cui, CFO

Thank you, Wang. We are pleased with the resilience of our first quarter revenue growth during these uncertain times. We achieved solid unit sales of both self-branded products and the Mi-Band 4, shipping 7.6 million units in the first quarter, a 35.7% rise from the same period last year. Despite the impact of the COVID-19 pandemic that many other companies are also facing, we still kept our robust revenue growth of 36.1%, and we remained profitable in this challenging time period. This was driven by increasing brand awareness and adoption of our products by users both domestically and in overseas markets. During the first quarter, we continued to push investments in both R&D and sales and marketing, as product innovation and sales channel integrity are key components of our success. While we have seen some manufacturing shortage due to disruptions to our supply chain during the quarter, as we discussed during last quarter's earnings call, we are optimistic of stronger profitability in the longer term after the damage along with its impact runs its course. Mindful of the length of this call, I will highlight the key financial measures for the quarter 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 of our strong first quarter. All amounts are expressed in RMB, unless otherwise stated. As previously mentioned, revenues in the first quarter 2020 increased by 36.1% to RMB 1.1 billion from RMB 0.8 billion for the first quarter of 2019. Gross profit increased by 12.5% to RMB 244.6 million from RMB 217.5 million in the first quarter of 2019. Our gross margin was 22.5% compared with 27.2% a year ago. The gross margin decrease was attributable to the change of our product mix and sales promotions in previous product versions, especially for Mi-Band 4 in anticipation of the launch of a newer generation product. Moving to expenses. Total operating expenses increased by 60.2% to RMB 224.1 million from RMB 139.9 million for the first quarter of 2019, 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. Research and development expenses increased 63.5% to RMB 118.3 million from RMB 72.4 million for the first quarter last year. We are striving for building up a top-tier R&D team for our future growth. The increase was primarily due to an increase in the number of R&D staff and a rise in investment in healthcare-related features, algorithms, cloud services, chip research, and new products development as we carry out our mission. We aim to launch a series of new products in the upcoming quarters of this year. General and administrative expenses increased 12.3% to RMB 50.9 million from RMB 45.3 million for the first quarter last year. This was primarily due to an increase in personnel-related expenses and professional fees related to improving management operations, offset by a decrease in share-based compensation expense and foreign exchange rate fluctuation. Our selling and marketing expenses increased to RMB 54.8 million from RMB 22.2 million for the first quarter last year, primarily due to an increase in personnel-related expenses and an increase in advertising and promotional expenses for new market exploration and a series of new product releases. We hired more sales staff with heavy experience in overseas market expansion, starting 2019 and continue to carry out our plan during this year. In January 2020, we unveiled four new products spanning three verticals that go beyond smart bands and watches, including Amazfit Home Studio, a smart gym hub; Amazfit AirRun, a foldable next generation treadmill; Amazfit PowerBuds, true wireless stereo fitness earphones with Clip-to-Go design; and Amazfit ZenBuds, sleep-comfort and health monitoring earphones. Our income before income tax was RMB 20.3 million compared with RMB 85.6 million for the first quarter of 2019. Net income attributable to ordinary shareholders of the Company decreased to RMB 19.2 million. Next, for non-GAAP measures. Adjusted net income attributable to Huami Corporation decreased to RMB 25.5 million from RMB 95 million for Q1 2019. Relating to cash and cash equivalents, as of March 31, 2020, the Company had cash and cash equivalents of RMB 2.5 billion compared with RMB 1.8 billion as of December 31, 2019. Now, let's turn to our outlook. In the second quarter, as the COVID-19 outbreak continues to impact the global economy, we expect our overseas sales demand will be affected. With all things considered for the second quarter 2020, management currently expects net revenues to be between RMB 1 billion to RMB 1.05 billion. The above outlook is based on the current market conditions and reflects the Company's management's current and preliminary estimates of market and operating conditions and customer demand, which are all subject to change. So, this concludes our prepared remarks. We will now open the call to questions. Operator, please go ahead.

Operator, Operator

And today's first question comes from Kyna Wong with Credit Suisse. Please proceed.

Kyna Wong, Analyst

Good evening and good morning. Thank you for taking my questions. I have two questions regarding the 2020 outlook. We understand that COVID-19 has impacted the overseas market this quarter, along with some supply issues in the first quarter. What is the outlook for 2020? Will the company be able to manage and achieve its targets despite the uncertainties caused by COVID-19 in the overseas market? My second question is whether you could provide any targets for shipments of the smart band and smartwatch this year, particularly for the smartwatch, and if there will be any adjustments to your original expectations. Thank you.

David Cui, CFO

Thank you for your question. Regarding your first question, we provided guidance for the second quarter, which is near term and we can better estimate. In the longer term, in particular in the second half of this year, the impact of COVID-19, we cannot estimate with a certain accuracy. So, it really depends on how the situation develops. We couldn't estimate. But, we do see some positive signs that in Europe and in China, our primary markets, the situation is getting better. We would hope that sales of our products will pick up in the second half. And we do expect that we will release a number of new products during this year in anticipation of the market recovery for the rest of the year. So, regarding your second question, the shipment estimates for our smartwatch products, and again, this is really related to the first question. We couldn't really estimate; it really depends on the COVID-19 situation.

Kyna Wong, Analyst

May I ask if you see any signs that consumers are becoming more aware of healthcare to the point where they would consider purchasing a smartwatch or smart band to monitor their health? Yes, I believe that following the COVID-19 outbreak, there will be positive support for this, not just because the situation is improving, but also due to better management of COVID-19 developments. Do you notice that growing awareness around healthcare and well-being could benefit your product sales?

David Cui, CFO

Absolutely, absolutely. From the COVID-19 pandemic, we do see increased awareness globally, not just in the demand for our products in the future, but also the general awareness to increase the possibility that we could introduce future services also. As our CEO mentioned in the previous quotations, Huami does engage in a number of discussions, research, and work with top-tier scientists in China and also global partners to step into these opportunities because our mission is to connect health with technology. So this COVID-19 pandemic does introduce an opportunity for us.

Kyna Wong, Analyst

Got you. Thank you. I’ll come back then with another question later. Thanks.

David Cui, CFO

Sure. Thank you.

Operator, Operator

And our next question today comes from Arthur Lai with Citi. Please go ahead.

Arthur Lai, Analyst

Hi, management. Can you hear me clearly?

David Cui, CFO

Yes. Hi Arthur.

Arthur Lai, Analyst

Hi. Thank you. So, I have two questions. I would like to ask one by one. The first one is, we noticed that the Company actually had strong quarter one revenue, despite the virus outbreak. Can you share with us the underlying drivers? I guess, you mentioned one thing is, you do some promotion. And what else effort you do in order to maintain revenue? That's my first question. Thank you.

David Cui, CFO

Okay. So, two primary drivers for our revenue growth, despite the COVID-19 pandemic. Number one is, we continue to enjoy higher demand for Mi-Band products. So, the shipments of Mi-Band 4 continue to grow year-to-year. And this is number one. Number two is, we do see significant demand increase for our Amazfit smartwatch. So, we see an increase in that. So, the combination of these factors does offset the impact of the crisis.

Arthur Lai, Analyst

Yes. The second question concerns new products. You mentioned that you have already developed the chip business. Can you provide an update on any new business and the features we can expect in the future?

David Cui, CFO

You mean, the new product features, right?

Arthur Lai, Analyst

Yes, the new watch features and the IC features are significant. I believe, as mentioned last quarter, that Wang Huang talked about your second generation IC technology. Is there anything you would like to update the investors on?

David Cui, CFO

As of today, this year, we've already launched a couple of the new products, which have been released. And upcoming, we have more products, but we can't really disclose much of the details in terms of the technical specifications. But we do see some new products with the health-related features and of course the fitness and ECG features. Those are the old features, but we do have new features to add on.

Arthur Lai, Analyst

Got you…

David Cui, CFO

We mentioned earlier that we do have plans to release Mi-Band 5 this year.

Arthur Lai, Analyst

We understand that the coronavirus has a significant effect on people's blood oxygen levels. Do you believe that we can measure blood oxygen with our upcoming product?

David Cui, CFO

That's one of our near-term products. Thanks.

Operator, Operator

Our next question today comes from Robert Cowell with 86Research. Please go ahead.

Robert Cowell, Analyst

Hey, management. Thanks for taking my question. I would like to ask about the gross margin. So, what are the factors, kind of impacting the gross margin in 1Q, both on a year-on-year and quarter-on-quarter basis? And then, as we get into 2020, what do you expect in terms of trend on the gross margin? Thank you.

David Cui, CFO

The gross margin was mainly affected by the discount we offered on the Mi-Band to our channels during the quarter. The gross margin for Amazfit products remained relatively stable from this quarter to the previous one. The main factor was the Mi-Band 4, especially in light of the COVID-19 situation. Both Xiaomi and we chose to offer a larger discount to the channel since we will soon launch the Mi-Band 5. Looking ahead, we anticipate that new products will achieve better economies of scale later in the year and command higher retail prices. Based on our pricing strategy, we expect to maintain a reasonable margin on Xiaomi's products. For our new Amazfit products, we aim to preserve or even slightly enhance our margin.

Robert Cowell, Analyst

Thank you very much.

David Cui, CFO

Yes.

Operator, Operator

And our next question today comes from Xudong Chen with CICC. Please go ahead.

Xudong Chen, Analyst

Hi, management. Thank you for taking my questions. And David, you just said you see some recovery in the China market, and there are still some uncertainties outside of China. Can you give us more color on this, and especially in India and other like Western Europe, since there are some lockdowns in India and some store closings in those regions? And I will have a follow-up. Thanks.

David Cui, CFO

I want to emphasize that for Amazfit products, we mainly depend on our own independent sales channels for achieving sales, with overseas markets being our primary focus. Consequently, a significant portion of our products has been shipped internationally. Markets like Europe have affected our performance in the first and second quarters. However, we are noticing encouraging signs as countries such as Spain and Italy begin to reopen. We expect to see some consumer demand returning in the third quarter. Our domestic market is the second key area, where we are investing significantly in distribution channels, hoping to see a rebound in sales for our Amazfit products. As for the Indian market, it has been heavily impacted, but its sales account for a small percentage of our overall revenue, so we will monitor the situation there closely.

Xudong Chen, Analyst

Thank you. My second question is regarding the Mi-Band 5 release this year. Have you experienced any delays in your new product launches and R&D due to the impact of COVID-19? Thank you.

David Cui, CFO

No, we don't. Actually, right after Chinese New Year, our R&D staff and our supply chain staff were all back. So, our Shenzhen global hardware center, our R&D center in Hefei and Beijing are now fully operational. The R&D wasn't impacted. Therefore, we will release our products on time.

Xudong Chen, Analyst

That's great. Thanks.

Operator, Operator

Thank you. 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 Investor Relations department through the contact information provided on our website or the Piacente Group, the Company's Investor Relations consultant. This concludes the conference call. You may now disconnect your line. Thank you.