Logo of jester cap with thought bubble.

Image source: The Motley Fool.

Huami Corporation (NYSE:HMI)
Q2 2020 Earnings Call
Aug 18, 2020, 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Hello, ladies and gentlemen. Thank you for standing by for Huami Corporation's Second Quarter 2020 Earnings Conference Call. [Operator Instructions] 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 Yujia Zhang -- Director of Investor Relations

Hello, everyone, and welcome to Huami Corporation's Second 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 US 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 fiscal year ended December 31, 2019 and other filings as filed with the US 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'll now turn the call over to our CEO, Mr. Wang Huang. Please go ahead.

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

Hello, everyone. Thank you for joining our earnings conference call today. I want to start by highlighting four key takeaways from the quarter's financial and operating performance. First, in what was the difficult quarter for the industry, we delivered good revenue growth in the second quarter and first half, at or near the top of the industry growth. Second, we are well positioned with our latest new products and orders yet to come as we go into the fall run-up to the end to year-end holidays. Third, the consistent investments in R&D should continue our active development pace and innovation into 2021. Fourth, recent insurer bids [Phonetic] for our analytics offerings. Partnerships, such as the one announced yesterday with Aspen Imaging Healthcare and progress with our university research partners give me confidence in the future for the institutional side of our business.

Despite global disruptions caused by the COVID-19 pandemic, we delivered good growth on both revenue and product shipments. In particular, our Amazfit brand, smartwatch shipments grew 30% [Phonetic] year-over-year in the second quarter. This result is witnessed to our strong value proposition, recognition of our own Amazfit brand and expanding sales and marketing strategy. Another achievement in the second quarter was that we successfully shipped Xiaomi's Mi Band 5, the fifth generation in the popular product line. I hope everybody saw today's launch of our new Zepp brand, which is our healthcare services brand.

Today, we are kicking off with a premium tier of smart devices beginning with two new smartwatches. We are reintroducing then Zepp brand, which we acquired in 2018 with a broader smart ecosystem vision. As part of this, we are rebranding the consumer phone app to Zepp as well in the US. The first of the new Zepp models, the E, will be available in the next week on zepp.com and on Amazon. These new products are part of our continuous execution on our mission to Connect Health with Technology. In order to build a comprehensive health and fitness ecosystem, strong capability in hardware, big data analysis, algorithms and product certifications are all indispensable. To tackle these, many companies choose to find solutions from outside suppliers. We chose a road a few took developing the solutions ourselves. I firmly believe one cannot excel in software without expertise in hardware and vice versa, and people who are really serious about big data made their own sensors. We develop not only smart devices, but also AI chips, sensors, healthcare-related data and algorithms and now have a comprehensive AI-driven health management platform.

During our first AI Innovation convention in June, we launched RealBeats 2, an upgraded cardio health monitoring algorithm. This significantly improved the effective detection of atrial fibrillation at night and during the day by 87% and 564% respectively, compared to its predecessor. We also launched OxygenBeats, which enables near-medical-grade blood oxygen level measurement for our smart devices. Furthermore, in the second quarter, we launched the new generation of our biosensor, BioTracker 2, as well as completed the design phase for our self-developed AI chip, Huangshan 2. Huangshan 2 has more processing capability than its predecessor and enables more healthcare-related functionalities that will further differentiate our future smartwatch products. We plan to start volume production of Huangshan 2 in the fourth quarter of this year and by the first half of 2021, making it available to our users through our smartwatches.

In July, our wholly owned subsidiary, PAI Health, announced an agreement with Prudential Corporation Asia to incorporate PAI Health's science-backed activity metric into Prudential's digital health app, Pulse. Later this week, we will be announcing a follow-on expansion of our relationship with Prudential to co-develop new consumer solutions that may be made available to their users as well as Huami's. As you know, Huami's Connecting Health with Technology strategy is broad. While we have already achieved significant market share on the consumer side of health technology, we have mentioned industrial side of the business focusing on the insurance and medical institutional side of the industry can help us make devices smaller, portable, less expensive and allow us and care provider to aggregate more medical data for analytics services. PAI Health recent success is one example.

Yesterday, we announced a new venture with Aspen Imaging Healthcare, which is pioneering new X-Ray technology. We expect to leverage and combine engineering expertise of both companies in cooperative product development. We expect to leverage our broader international distribution capabilities for Aspen. And we explore potential investment in the company, Aspen which is based in Plano, Texas. It's creating some disruptive technology for medical imaging, which can open or expand new applications. Additionally, we are very pleased to have partnered with internationally renowned respiratory expert and a fellow of Chinese Academy of Engineering, Dr. Zhong Nanshan to establish the research laboratory facilities. The purpose of this lab is for the ongoing study of respiratory disease, rehabilitation management using wrist wearable devices that leverage our expertise in smart wearable technology, AI algorithms and big data biometric analysis.

While the first half of 2020 was a challenging period of -- for all of us, we are proud of our performance in smart wearable product shipments and the strong execution of our health service strategy. We are confident that our device shipment volume will continue to climb in the second half of the year, and we look forward to delivering value to all of our stakeholders.

Thank you again for joining today. I will now turn the call over to our CFO, David Cui.

David Cui -- Chief Financial Officer

Thank you, Wang. The strength of our brand, products and global sales and marketing strategies served us well in the second quarter despite global uncertain times. The unit sales of both self-branded products and the Mi Band rose to 8.9 million, increasing by 7.2% from the same period last year and leading to 9.5% revenue growth. I'm especially pleased with that -- especially pleased that we remain profitable despite the lower gross margin affected by our product mix. Second quarter saw the continued prioritization of investments in R&D, as well as sales and marketing infrastructure as product development and sales channel expansion remain critical components of revenue growth. While these costs impact short-term profitability, we are confident that continued strategic spend in these areas, coupled with prudent cost control in other general operating expense categories, will lead us to stronger profitability in the long term.

Mindful of the length of this call, I will highlight the key financial measures for the second quarter 2020, 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 second quarter. Our amounts are expressed in RMB unless otherwise stated.

As previously mentioned, revenues in the second quarter 2020 increased by 9.5% to RMB1.137 billion from RMB1.039 billion for the second quarter of 2019. Unit growth in the quarter was 7.2% and for the first quarter of 2020, was 18.7%. Gross profit decreased by 8.6% to RMB253.4 million from RMB277.3 million in the second quarter 2019. Our gross margin was 22.3% compared with 26.7% a year ago. Gross margin can be affected by product mix as different products have different margin contributions, and this can change over the life of our product. In the second quarter 2020, total gross margin was positively affected by a higher mix percentage of Huami-branded products, offset by a higher mix of a lower margin product shifted to Xiaomi and by discount promotions for some older products in the transition to the new Mi Band 5.

Next, I want to discuss impact of COVID-19 on our business. The coronavirus continued to have a significant negative effect on retail sales in all areas of the world and in most product categories through the second quarter. For example, although China recovered and opened many retail establishments midway through the second quarter, a number of Asian retailers reported that so far, they were slow to return depressing second quarter results. In the Americas and Europe, continued or resurging COVID infection risk kept many stores closed and also kept many shoppers out of the stores. Many retailers reduced inventories and our orders during the second quarter. This all affected our second quarter results.

Product delays due to the pandemic that slowed the manufacture of products in the first quarter have been resolved with minimal lingering impacts in the second quarter. Looking forward, Huami is working with its channel partners flexibly as they reevaluate or change their market strategies, such as shifting focus to online sales and on-demand retail models. While Huami has several direct online sales channels, the vast majority of our revenue flows through these retail partners' channels.

Before the pandemic hit, industry expectations were for strong demand and continued growth for smart health technology for many years. Aside from the disruption and resetting of consumer purchasing method choices, we see no evidence to indicate that megatrend has been materially changed. Whether by personal choice or by encouragement from those who pay for our care, the world is increasingly focused on improving health. In the nearer term, with all the reports of people gaining weight during lockdowns, we think there may be upticks in demand for smart health technology in different geographies as people refocus on their health.

In addition, the company is engaged in research and development related to the detection of COVID-19 infection through its internal R&D team, as well as with some of its university research partnerships.

Now moving to expenses, research and development expenses increased 25% to RMB117.2 million from RMB93.8 million for the second quarter last year. As a percentage of sales, R&D expense only increased 130 basis points to 10.3% in the second quarter. 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 product development as we carry out our mission. R&D was also up as we are aiming to launch a series of new products in the second half of 2020 to expand our customer base as we target different geographies and price points.

Our sales and marketing expenses increased by 76.6% to RMB71.3 million from RMB40.4 million for the second quarter last year. On a percentage of sales basis, sales and marketing expense rose to 6.3% of revenue versus 3.9% in the year ago quarter. The increase was primarily due to expanding international markets outside of China for our Amazfit-branded products, including increases in advertising and promotional expenses during holiday sales and promotional events and growth in personnel-related expenses. In June, we organized our first AI innovation convention to present our current research result to the public and opened our first Amazfit offline retail store in Beijing to offer domestic consumers the opportunity to have a first-hand, in-person experience with our products and build our brands. We have a strategy to open a number of these locations globally. A number of these are as independent authorized dealers.

Second quarter 2020 general and administrative expenses increased 9% to RMB55.4 million from RMB51 million for the second quarter last year, reflecting primarily an increase in exchange rate fluctuations, professional fees for business management, and depreciation and amortization expenses, offset by the decrease of share-based compensation.

Our total operating expenses increased by 32% to RMB244 million from RMB185.2 million for the second quarter of 2019. Total operating expense represented a 21.5% of revenue in the second quarter 2020 compared to 17.8% in the year ago quarter and 20.6% in Q1 2020, reflecting our strategy of consistent investment in R&D with an emphasize on healthcare-related product development and testing, talent acquisition in addition to branding and marketing to enhance our company's long-term returns.

Operating income for the second quarter 2020 was RMB9.4 million, down from RMB92.1 million in the year ago quarter, driven primarily by the year-over-year increase of RMB31 million in sales and marketing expense and RMB23 million in R&D.

Relating to cash, as of June 30, 2020, the company had cash and cash equivalents of RMB2.6 billion compared with RMB1.8 billion as of December 31, 2019.

Now, let's turn to our outlook. For the third quarter 2020, management currently expects net revenues to be between RMB2.1 billion and RMB2.15 billion, which would represent an increase of approximately 13% to 16% from the third quarter of 2019. The outlook is based on the current market conditions and reflects the company management's current and preliminary estimates of the market and operating conditions and consumer demand, which are all subject to change.

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

Questions and Answers:

Operator

Thank you. We will begin -- we will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Clive -- excuse me, [Operator Instructions] Our first question comes from Clive Cheung from Credit Suisse. Please go ahead.

Clive Cheung -- Credit Suisse -- Analyst

Hi, management. Thank you for taking my question. I have three small questions. The first being the sales and marketing expenses in second quarter, you spoke about the expansion in channels. Can we -- can you speak a little bit about where these expenses have gone into the channel expansion and if there is any specific updates on that? My second question is on R&D. What kind of expectation or what kind of level of R&D should we expect in the second half of 2020 and in 2021? And lastly, what is the current status with the contract renewal with Xiaomi? Thank you very much.

David Cui -- Chief Financial Officer

So thank you for your question, Clive. With respect to our sales and marketing expenses, we launched multiple products in the one half of 2020 and then we attended CES at the beginning of this year. And we also hired multiple personnel in sales and marketing to help us to build the channel in Europe, also in Southeast Asia. And we also had a few new staff in the US. So our strategy is to sell our products and also hopefully in future, we expand into the healthcare services into the global markets. So even the pandemic is going away in those regions and we are sending out our staff and we're setting up new companies in those countries, so we are on our way to further future growth. So that's how we spend it, our sales and marketing dollars.

With -- regarding our R&D expense, again, so we spend money in adding new qualified R&D stuff. So we add new staff fairly quick in the later part of the last year and first half of this year. We anticipated the R&D expense growth will relatively moderate as compared to the earlier periods. So in the second half of this year and early 2021, so we will not see a significant increase in our R&D expense given that our revenue should pick up in Q3 and Q4.

With respect to Xiaomi's contract, so what I can say right now is our relationship with Xiaomi is deeper than just a vendor relationship. This is we all know. And the Xiaomi also has a significant ownership interest in Huami, right? And it's important to understand that the general contract we are talking about with Xiaomi is just about the blanket terms and conditions associated with being a preferred vendor. So we negotiate specific contracts for each product we develop for them, such as the new Mi Band 5. That's how we have done business with Xiaomi in the past and expect it to continue in the future. So although I have no additional update beyond that, but we are optimistic that we should be able to negotiate with Xiaomi to sign a similar framework contract with Xiaomi and continue our strong relationship with Xiaomi along the way. Thank you.

Clive Cheung -- Credit Suisse -- Analyst

Thank you very much. Thank you very much, David.

David Cui -- Chief Financial Officer

Thanks.

Operator

The next question comes from Xudong Chen from CICC. Please go ahead.

Xudong Chen -- CICC -- Analyst

Hi, management. Thank you for taking my questions. I think you just start a new brand named Zepp, which focus on the smart equipment for sports use. I wonder what's your strategy for this product line? And my second question is I think you also cooperate with Prudential Insurance [Phonetic] in PAI Health. Could you give me more information about this cooperation? Thanks.

David Cui -- Chief Financial Officer

Sure.

Mike Yan Yeung -- Chief Operating Officer

Yeah, hi, this is...

David Cui -- Chief Financial Officer

I would try -- I'm sorry, is it...

Mike Yan Yeung -- Chief Operating Officer

Go ahead, David.

David Cui -- Chief Financial Officer

Sure. So I would maybe just try to answer the first question regarding Zepp brand and then, I will leave the second question to Mike to answer. So Zepp is a brand-new brand we introduced to the market. And it is our digital health solution brand with wearable technology in it. So we launched this new brand in that we hope that we can speak to a little different audience. And Amazfit right now is aimed more at every day and Zepp aims a little dressier with style in terms of the product features and materials. So we and -- as you know that we -- our mission is to Connect Health with Technology. So currently, we are launching new products under Zepp brand, but in future, we hope that we can build the third line, not just for the hardware, but also for providing health solutions globally. Mike?

Mike Yan Yeung -- Chief Operating Officer

Yes. Thank you, David. Yeah. Regarding the partnership with Prudential, actually, you've probably seen an announcement, a press release earlier between Prudential Asia and PAI, which is again our wholly owned subsidiary. Basically, the -- it's an extensive partnership.

The press release that we released earlier talked about Prudential incorporate PAI Health's science-backed activity metric algorithm into the Prudential's digital health app, which is Pulse, which right now have over 6 million downloads in, I think, 12 regions over Asia. And that is the first press releases is about, but we'll be also working with the Prudential to expand our partnership and -- which will be announced in a second press release very soon. And basically, we will leverage each other's products and services to cross-sell, upsell to each other's customers and -- on both the health and as well as the wealth products and services for our joint users, consumers. And you'll hear more news about this more extensive partnership again very soon in the second press release later this week. Yeah.

Xudong Chen -- CICC -- Analyst

Thanks.

Operator

The next question comes from Tony Zhang from Haitong. Please go ahead.

Tony Zhang -- Haitong International Research Ltd -- Analyst

Hello, management. Thanks for taking my call. So I have two questions. The first question is your -- the management is expecting a quite strong sales in the third quarter. Can you give a little more color where this strong growth come from, it's from China or overseas market? And also how about the sales recovery in overseas market amid such a pandemic situation recently? So my second question is how about gross margin outlook in the third quarter? Thank you.

David Cui -- Chief Financial Officer

Okay. So we did provide a strong forecast for Q3, because we do anticipate that a strong sales recovery, overseas market and also in domestic market. So we will see more shipments of Mi Band products, but we see even more stronger recovery for our branded -- own branded products. That's why you can see sequentially that we doubled our forecast for Q3. And similarly, we anticipated that Q4 should be also strong. So, as a result of that, we should see a strong second half of 2020.

So our gross margin -- regarding our gross margin, as you can see, in Q2, our margin wasn't that great, because we -- because in June, we shipped -- we launched Mi Band 5. So, also during this period that we provided the deeper discount on Mi Band 4, which dragged down our gross margin. So in Q3 and Q4, we will see the product mix change, meaning that we will sell more Mi Band 5 versus Mi Band 4, so that we'll see Xiaomi -- Mi Band's margin will climb. And also for our own branded margin, we will see -- we will remain strong. So my best estimate is that we will see a little bit higher gross margin in Q3. Thank you.

Operator

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

Michelle Zhang -- China Renaissance Securities Limited -- Analyst

Thank you management for taking my questions. So, I have two questions. The first one is, could you please give me more color like on the net income guidance, like for the third quarter? And the second question is, could you please share more regarding the geographic sales distribution of Amazfit products and also an update of the current situation in Europe and in India? Thank you.

David Cui -- Chief Financial Officer

So, at this moment, I may not be able to provide an accurate net income guidance, but what I can say is that we will take an extreme measure on controlling our operating expenses in the second half. And you will not see the same growth rate in operating expenses as compared to our revenue growth. So what I can say is that the net margin for second half will significantly improve as compared to the first half. That's what I can comment.

In terms of the geographic distribution for Xiaomi's products, we don't have the exact number, but we know a large portion of the Mi Band was shipped overseas. And for Amazfit-branded products, we shipped even more to overseas. So the geographic distribution will be primarily to European markets and the second would be to the Southeast Asia market. And we sell our products to over -- to many countries, including North America. So the primary markets are European markets and the Southeast Asia markets. And we see the pandemic situation improves. And remember that we do have roughly about half of our products were sold online in those markets. So we do see a lot of improvements in our sales in global markets.

Michelle Zhang -- China Renaissance Securities Limited -- Analyst

Thank you.

David Cui -- Chief Financial Officer

Thanks.

Operator

The next question comes from Robert Cowell from 86Research. Please go ahead.

Robert Cowell -- 86Research -- Analyst

Hi, management. Thanks for taking my questions. I'd like to ask about pricing. So in the second quarter, I guess the blended average selling price was down a little bit year-on-year. And you've mentioned some discounting related to Mi Band 4 in anticipation of the launch. How is the pricing on Mi Band 5 relative to previous generation? And what kind of trend do you expect in pricing going forward?

David Cui -- Chief Financial Officer

Well, in Q2, we shipped -- in Q2, we shipped -- let me see, in Q2, we shipped more Mi Band 4 than Mi Band 5. So, we did provide deeper discount on Mi Band 4. So that's the reason to drag down the ASP in Q2. So in Q5 [Phonetic], so we definitely should more -- Mi Band 5 than Mi Band 4. So I'm pretty sure that the ASP will climb. And the retail price for Mi Band 5 is higher than Mi Band 4. And also as a new product -- as a product new to the market, we do not provide discount on Mi Band 5. So, I will say you get the regular price on Mi Band 5. So, that's all I can say.

Robert Cowell -- 86Research -- Analyst

Thank you.

David Cui -- Chief Financial Officer

Thanks.

Operator

The next question comes from Andre Lin from Citi. Please go ahead.

Andre Lin -- Citigroup, Inc. -- Analyst

Hi, management. Thank you for taking my question. I have one question. Regarding the next quarter's guidance, can you share a little bit color on the product mix? How much contribution will come in from Mi Band? And I have a follow-up. Thank you.

David Cui -- Chief Financial Officer

Yeah. I would expect similar product mix as Europe [Phonetic] given that sales for both Xiaomi and self-branded products are strong. And I would expect it at 70-30 split.

Andre Lin -- Citigroup, Inc. -- Analyst

Thank you. And could you share a little bit about the life cycle pattern on the new generation of the product? Usually, the product sales are peak during the first few quarters after launch and then, they will decline. And could you share about the -- your expectations on this generation? Thanks.

David Cui -- Chief Financial Officer

Well, regarding Mi Band, we have a much shorter product cycle in terms of launching new products. And between Mi Band 3 to Mi Band 4, Mi Band 4 to Mi Band 5 is about a year we launched new products. And with respect to Amazfit products, Zepp products, so we will have much quicker upgrades and we have a variety of older products and new products. And we will -- maybe we have at least a year we should have upgrades on these products. And if not, we will launch new products. So it is much faster. And you will see pipelines of new products under these new brands coming out.

Operator

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

Grace Yujia Zhang -- Director of Investor Relations

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

Duration: 47 minutes

Call participants:

Grace Yujia Zhang -- Director of Investor Relations

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

David Cui -- Chief Financial Officer

Mike Yan Yeung -- Chief Operating Officer

Clive Cheung -- Credit Suisse -- Analyst

Xudong Chen -- CICC -- Analyst

Tony Zhang -- Haitong International Research Ltd -- Analyst

Michelle Zhang -- China Renaissance Securities Limited -- Analyst

Robert Cowell -- 86Research -- Analyst

Andre Lin -- Citigroup, Inc. -- Analyst

More HMI analysis

All earnings call transcripts

AlphaStreet Logo