Zepp Health Corporation (ZEPP) Q2 2018 Earnings Call Transcript

Grace Zhang - Director, Investor Relations Wang Huang - Chairman and Chief Executive Officer David Cui - Chief Financial Officer Mike Yeung - Chief Operating Officer

Thompson Wu - Credit Suisse Arthur Lai - Citi Robert Cowell - 86 Research

Hello ladies and gentlemen. Thank you for standing by for Huami Corporation’s earnings conference call for the second quarter of 2018. At this time, all participants are in listen-only mode. Today’s conference call is being recorded. I will now turn the call over to your host, Ms. Grace Zhang, Director of Investor Relations for the Company. Please go ahead, Grace.

Hello everyone and welcome to Huami Corporation’s earnings conference call for the second quarter of 2018. The Company’s financial and operation results were issued in a press release via PRNewswire 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” 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 for the fiscal year ended December 31, 2017 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 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.

Hello everyone. Thank you for joining our earnings conference call today. We are excited to report to our shareholders another strong quarter, as revenue exceeded the top end of our guidance range by over 12%. Profitability was also stronger than we expected due to strong sales of our Amazfit branded products, successful launch of Mi Band 3, as well as efficient sell-through of Mi Band 2. In the first half of 2018, we sold about 1.4 million Amazfit branded products. This exceeds the about 1 million units we sold in the full year of 2017. Revenue generated from Amazfit branded products in the first half of 2018 was 523 million RMB and contributed 39% of our total revenue. This revenue amount is more than 4 times that of in the first half of 2017. In particular, shipments of our Amazfit sports smart watch product line reached 1 million units in the first half of 2018. Since the launch of this product line in late 2016, our total overseas shipments have now exceeded 1 million. We see increasingly strong interest for our products from overseas markets, which reflects huge overseas opportunities for our smart wearable devices. The diversity of our product portfolio, our cutting-edge product design and our proven success in meeting the needs of consumers，position us well to capitalize on this strong overseas interest. The success of our Amazfit products reflects our leading product development capabilities, our deep understanding of the consumers’ needs, as well as our winning precision marketing strategy. We expect that our Amazfit products will continue to grow rapidly: powered by our excellent existing products, innovative, desirable new products, and growing market recognition. During the second quarter, we also successfully launched the new generation Mi Band – Mi Band 3. The launch of Mi Band 3 met with huge demand. We sold over 1 million units in only 17 days after its wide release. We reached this one-million-unit milestone significantly faster than with the earlier generations of Mi Band 1 and Mi Band 2. This shows the power of the upgrade cycle as wearable technology becomes more widely adopted. The success of both self-branded and Xiaomi-branded products reflects our broad-based knowledge of both the markets we serve and our target customer base. It is this solid understanding that builds our confidence in our strategy as we continue to develop new and exciting products for consumers. We continue to make strategic investments in R&D, improving our AI technology in healthcare, sports, leisure, and IoT, to support our reputation for delivering cutting-edge products and great lifestyle service value to consumers. We are pleased to have a strong first half of the year. As of June 30, we had over 70 million registered users. This large and growing base of loyal users supports our growth, and we are confident in our ability to deliver strong results in the back half of the year. I will now turn the call over to our CFO, David Cui.

Thank you, Wang We delivered strong financial results in the quarter that exceeded our expectations supported by continued strong sales of our self-branded products and sales of the new Mi Band 3. Favorable revenue mix, with an increased penetration of higher- priced , and higher margin self-branded products, drove the increase of our gross profit in the quarter. I will now go over some of our financial results for the second quarter of 2018. Revenues increased by 54.8% to 760.1 million RMB year over year, primarily attributable to the strong sales of our self-branded products. Revenues from self-branded products and other were 319.0 million RMB, compared with 75.8 million RMB in the second quarter of 2017. In Q2, the sales of new Mi Band 3 was strong and Mi Band 2 continued to sells well. We are pleased with these results and expect continued solid sales of both self-branded and Xiaomi-branded products in the future. Gross profit increased by 55.0% to 196.9 million RMB year over year, while gross margin of 25.9% was on the same level as the second quarter of 2017. We were particularly pleased with our gross margin in the quarter. As we had previously described, we typically expect gross margin to be pressured following the launch of a new generation product since we would mark down older generation product to clear out the inventory. In this case, effective management of the manufacturing costs and joint sales efforts with Xiaomi helped minimize the end-of-life cycle process for Mi Band 2 and strong sales of higher margin self-branded products offset the margin impact to the quarter. Going forward, we expect the increasing penetration of our self-branded products to further support our gross margin. Total operating expenses increased by 42.2% to 97.9 million RMB from 68.8 million RMB in the second quarter of 2017 as we continue to invest in our R&D and marketing of our products. Research and development expenses increased by 35.1% to RMB44.4 million from RMB32.8 million for the second quarter of 2017, primarily due to an increase in personnel costs related to newly recruited and hired personnel, and costs related to application for intellectual property rights to strengthen our brand protection in overseas markets. General and administrative expenses increased by 23.3% to 32.8 million RMB from 26.6 million RMB for the second quarter of 2017, primarily due to an increase in personnel-related costs and professional services fees associated with business expansion and being a listed company. Selling and marketing expenses increased by 120.5% to 20.7 million RMB from 9.4 million RMB for the second quarter of 2017, primarily due to an increase in salary compensation and share-based compensation expenses to retain sales and marketing personnel, and an increase in advertisement promotion expenses for self-branded products. Operating income was 99.0 million RMB, which improved significantly from an operating income of 58.2 million RMB for the second quarter of 2017. Net income attributable to Huami Corporation totaled 85.5 million RMB compared with 49.7 million RMB for the second quarter of 2017. Adjusted net income attributable to Huami Corporation, which excludes share-based compensation expenses, increased by 57.8% to 101.6 million RMB from 64.3 million RMB for the second quarter of 2017. Adjusted Basic and diluted net income per ADS attributable to ordinary shareholders of Huami Corporation was 1.69 RMB and 1.61 RMB, respectively, compared 1.17 RMB and 1.12 RMB, respectively, for the second quarter of 2017. As of June 30, 2018, the Company had cash and cash equivalents of 893.9 million RMB, compared with 366.3 million RMB as of December 31, 2017. In summary, we are pleased to have delivered strong operational and financial results in the second quarter. Our success this quarter reinforces our proven ability to manage the entire product lifecycle – from product development and launch to end-of-lifecycle liquidation – and deliver strong results for shareholders. As we look to the future, we recently announced a partnership with PAI Health, which will accelerate our penetration in the healthcare sector. This is part of our early efforts to monetize our massive biometric database collected by our high quality smart wearable devices. With Huami’s powerful algorithms as well as PAI Health's developed software technology and marketing channels, we will collaborate with insurers, healthcare providers and employers to help address some of the health risks typically associated with an inactive lifestyle. In addition, we also recently announced the acquisition of the core assets of Zepp, a leading multi-sport sensor technology company. This acquisition will fast-track our entry into the premium sport products market and training analytics field. It also helps support our expansion into global markets by leveraging Zepp’s developed product marketing channels, such as the Apple Store. Importantly, we continue to make strategic investments in R&D to maintain our advanced product pipeline while expanding to serve new markets. This includes the thoughtful acquisition of industry peers who have capabilities that will accelerate our progress. We look forward to continuing to provide updates on our efforts. Outlook; Now, let’s turn to our outlook. For the third quarter of 2018, the Company’s management currently expects: Revenues to be between 820 million RMB and 840 million RMB, which would represent an increase of approximately 73.0% to 77.2% from 474.1 million RMB for the third quarter of 2017. This 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.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Thompson Wu of Credit Suisse. Please go ahead.

Hi, Wang, Mike and David. Congratulations on a very good quarter. First question, the upside in revenue this quarter, could you walk through where you saw that upside, was it because of stronger Amazfit demand in the quarter, was it a faster sell-through Mi Band 3, can you give us better color as to what drove the upside in the second quarter guidance, that’s my first question?

The revenue increase in Q2 was primarily driven by our strong sales of our Amazfit products. And in this quarter our home products revenue represents close to 40% of our total revenue. This in addition to the sales of Xiaomi’s products, so this is the main driver and in this quarter, we launched Mi Band 3. So we have two tasks, one is we need to sell, push Mi Band 2 to the channel and that, that was successful and then at the meantime this Mi Band 3 launched in late May. So on that product revenue, sales was also very strong. So that gives us the revenue increase.

And thank you, David. On the operating side, very good cost control this quarter, can we – how should we think about your OpEx to sales in the back half of the year?

Sorry, I didn’t hear you. You said OpEx expense, is that?

Yes. How should we think about your OpEx expense ratio going into the third quarter and fourth quarter?

Right, okay. Well, first of all, we do anticipate some increase in our OpEx expenditures in the third quarter and fourth quarter given that we will continue to invest in our R&D stuff and also we need to invest in our selling and marketing efforts. So, we would see some increase in the OpEx expense.

Okay. And then my final question – maybe just one more question for your guidance for third quarter, very strong outlook. Could you give us more color as to your expectations? I am little bit curious in your growth in the Amazfit brand? And I know you recently launched some new products in India, I believe it was the Amazfit and also the Amazfit stratus, can you talk a little bit about your guidance for third quarter and then your own brands growth in the third quarter? Thank you.

Right. All the watches, all the smart sports watches under our own brand are selling well. We expect that, that have strong some demand will continue into later in the year for sure. And in addition, we do invest into R&D with May launch will continue to launch a new product under our own brands.

Okay, thank you.

The next question comes from [indiscernible] Securities. Please go ahead.

Hi, management. This is [indiscernible] Securities. Thank you for taking my questions. Congrats on the solid quarter. The two quick questions regarding to expansion plan, the first one is regarding to your overseas expansion like what percentage of sales do you expect coming from overseas markets in the coming years, where there will be a target for that? And the second is about your domestic – can management share more in terms of growth plan for the domestic market, do you plan to open more customer experienced stores for something like that? Thank you.

Okay. So, in this quarter, in second quarter the sales generated from our own brand products has already exceeded 40%. So, in the first half of the year, it’s about 40%. So we will see revenue generated from own products will continue to grow in a faster pace. And meanwhile Xiaomi’s product revenue will also increase. So, we will see on an annual basis our own products – revenue from our own products we will be at 30% to 35% level, it all depends – it depends on the revenue mix. But this is going to be a much higher as compared to last year in terms of the percentage. In terms of the overseas sales, so currently our sales – our revenue coming from overseas sales continued to grow as percentage wise, it’s roughly above 40% also right now. So we will see in the future our massive, our overseas demand will continue to grow at faster pace as compared to domestic market demand. But those markets should continue to grow.

Alright. Thank you.

The next question comes from Arthur Lai of Citi. Please go ahead.

Hi, Huang Wang and also Mike and David. Congrats for the very good results. And this is Arthur Lai. Actually, I am quite surprised on the Amazfit products performance not only from the financial report, but also from daily life, I am actually quite focused on look at people’s willing and I saw quite a few they right now wear the Amazfit. So I think this is something I want to highlight. So I have two questions. The one is actually from this very strong revenue growth, David you just mentioned 40% from overseas, can you share with us what’s the currency we should model is based on the USD or based on the RMB? And later is how much cost of goods sold actually was nominated by the renminbi and how much is limited by the RMB? The reason I ask this question is because right now we understand there is depreciation from the renminbi, so we want to understand this sensitivity impact by the currency? Yes, that’s my first question. Thank you.

So, our primary operation is based in China. So our functional currency, our financial statements is renminbi. So the U.S. dollar translation is only for convenience of readers. So if you look at our financials, it’s only – we only translated before the last column of the financials for convenience. So basically whatever we have said here is based on renminbi. So our revenue, our cost of revenues were primarily renminbi denominated, so yes.

And how much percent the cost of goods sold use the USD as functional currency?

We do have some overseas procurement, but not that significant. Yes, it’s not that significant.

Okay. So net-net, if renminbi still in the depreciation trend actually to company’s gross margin, is it positive or negative impact?

We will say the impact will be very immaterial, because our cost also incurred in renminbi right parameter. So, the fluctuation of the foreign currency will not impact our gross margin percentage.

Okay, thank you. And second question is besides Xiaomi new product and Amazfit, can you share with us how is the internet video IP service is dynamic?

We still have the advertisement revenue. We will continue to grow that. And meanwhile historically we have some value-added programs working with the local business centers that revenue continue to exist. And in addition in our recent press release, I mentioned – we mentioned that we have a tool asset acquisition that we hopefully will lead to some future hardware revenues potentially in overseas market, not in China market. So, Mike, you want to add something on that or? Arthur?

Okay, thank you. And so that any new products or launch in the second half or like some IoT products company will also focus in this year or next year?

Well, we are always committed to launch new products everywhere. So, you will see that later in the year, yes.

Later in the year. Okay, thank you. Yes, no more questions. Thank you.

Thank you. The next question comes from Vivian Chui of GF Securities. Please go ahead.

Hi, management. Can you hear me?

Yes, please go ahead.

This is [indiscernible] Securities and congratulations on strong results. And I have two questions. The first one is about our self-brand products, because you have mentioned that the percentage of our self-brand product continued to increase in this year. So I want to ask do we have any expectation about the stable level of the percentage of our self-brand product in the future, maybe in 2 to 3 years in the future, so do we have any expectation of this percentage and will it just up our percentage – our gross margin to a extent, I mean, if it was our gross margin? Yes, this is my first question.

Right. So, first of all, the gross profit margin, our own product, self-branded products is higher than Xiaomi’s product. So while the percentage of the revenue generates from our own product will continue to grow. So the gross margins should be getting better and better. So, we are confident that the sales from our own product will continue to grow, maybe in absolute dollar amount will continue to grow, but in the meanwhile Xiaomi products is equally important. So even the Mi Band 3 is a successful product and in the near future we will launch an [NFC] version of the Mi Band 3. So we would expect that Xiaomi product sales will also increase. So given that Xiaomi, revenue from Xiaomi product is still at a large amount, so the basis is still high. So the percentage may not increase from current 40% on an annual basis, if Xiaomi’s revenue also increased a lot. But in the long run, we are committed to work on both product lines, Xiaomi product we will launch Mi Band 4 in future and then we may have watch product also with Xiaomi. And for our own product, we were focusing on sports, lifestyle, healthcare, so we will continue to deliver new product also. So also in addition, we may introduce some new product format beyond the wearable products and maybe some other type of sports products, so that we are looking 3 years or 4 years in future, that’s more what the picture looks like.

Do you have any expectations about the stable level in the future or it’s just – it’s very hard to say?

Well, I will say our own products you need a percentage or as a percentage of revenue, right?

Yes.

I would say like 40% to 50%, yes.

Okay, thank you. And my second question is about our recent acquisition of Zepp and Physical Enterprises, so we already made some progress in the cooperation with these two companies, can you just give us some further clue about how to produce synergies with two new companies? Yes, thank you.

Hi. This is Mike Yeung. So, yes, recently we acquired the assets of Zepp which we made the announcement hopefully and basically, the technology and the IP from Zepp can help us expand our strategy and our presence in sports training analytics field and strengthening our capabilities in [multi-sports center] technology. This acquisition was just done very, very recently. So, now we are integrating our technology into our products in order to monetize up a bit. And our partnership with PAI Health, that’s more a sales partnership and that is mostly help us to get a much better technology enabling us to serve into insurers, healthcare providers and as well as employers. So we are targeting people – how to improve people’s health due to their inactive lifestyle. So, this partnership is – we just signed recently and we expect to have some pilots soon from this partnership with insurance companies for example.

Okay, thank you very much. Thank you.

The next question comes from Ken [indiscernible] of Thailand Capital. Please go ahead.

Thank you for taking my question. Just a quick one. How many Mi Band 3 did you ship in the second quarter? Thank you.

1.9 million.

Okay. Thank you very much.

Only 1 month, sold.

[Operator Instructions] The next question comes from Robert Cowell of 86 Research. Please go ahead.

Hello. Congratulations on strong quarter, which is here you mentioned about the Mi Band 3 NFC version launch is going to have positive impacts on Xiaomi’s revenue. We are just wondering when do we expect to launch the NFC version of it and can you elaborate on what specific impact are expecting coming from it? Thank you.

So, NFC version will be fairly soon will be within this year, yes and then also our PD department is working with multiple cities to make sure that when we launch the product, so our payment feature will open with public transportation systems within those cities. Did I answer your question Robert?

Okay. Thank you.

As there are no further questions now, I would like to turn the call back over to the company for closing remarks.

Thank you once again for joining us today. If you have further questions, please feel free to contact Huami’s Investor Relations department through the contact information provided on our website or The Piacente Group, the company’s Investor Relations consultant.

This concludes this conference call. You may now disconnect your line. Thank you.