Ladies and gentlemen, thank you for standing by for Huami Corporation's Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a 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 third 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. Huang Wang, our Chairman of the Board of Directors and Chief Executive Officer; and Ms. Leon Cheng Deng, 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 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, 2019, and other filings as filed with 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'll now turn the call over to our CEO, Mr. Huang Wang. Please, go ahead..

Hello, everyone. Thank you for joining our earnings conference call today. We are pleased to report another quarter of solid financial results, highlighted by revenue growth of 20% year-over-year that exceeded our expectation, despite supply issues due to the COVID-19, that's partially dampened result.

Our top line result were complemented by bottom line plus visibility, together this testifies to the resilience of our portfolio of smart health products and services, as well as our efficient product development capability. We have launched five new smartwatch products in the third quarter. I'm pleased with our development pace.

Through agile development processes, our teams executed according to plan. And our product portfolio is well positioned for the global history -- holiday this season. Innovation has always been the core of our DNA. It drives our R&D development and supports our comprehensive health and fitness ecosystem.

Reflecting this, we recorded a number of new product upgrades and launches in the third quarter. In September, we upgraded our most popular product line, the GTS and GTR smart watches, with numerous technology enriched functionalities.

Now, the upgraded versions are fully equipped with features that support blood oxygen monitoring among other important applications, blood oxygen saturation data is an essential metric used to monitor breathing quality.

Our classic and sports variant of the Amazfit GTR 2 as well as other select smart variables are also upgraded with our newly launched BioTracker 2 PPG 24/7 heart-rate sensor. This sensor supports five biological data engine and it's the most versatile and precise bio sensor, we have ever developed.

We also launched our new app market Zepp brand, as previously announced in August. The Zepp line brings more comprehensive and professional health and fitness management experience to users, leveraging our expertise of smart wearable technology. In the third quarter, we also extended our cooperation agreement with our strategic partner Xiaomi.

The Mi Band is an important product line to us and to the global value-focused market and we are pleased to continue to work with Xiaomi on that product line. Now turning to our global expansion effort. Our Amazfit product achieved strong market position in many of the international markets we serve.

According to the IDC report, we have been positioned as number one market share in Spain and Indonesia for several quarters. In IDC's second quarter report, we experienced a 323.7% growth in the Indian market.

And 241.6% in the Western Europe market contribute by our growing brand recognition strengthening sales and market strategies as well as distribution channels. Our international shipments as a percentage of total was 49.5% in the third quarter. With even our largest market like Europe and FEA are still under the impact of COVID-19.

Huami and Xiaomi device activation data further -- it illustrates our globalization with the third world increase in the number of countries with sizable activations in the third quarter this year versus last year.

Starting in September, two of our most popular smartwatch lines, the Amazfit Bip S and the Amazfit GTS become available for purchase in America at over 2,800 Walmart retail stores. This is the first time that consumers can buy them at Walmart stores. We believe there's a strong fit between these value-priced lines and Walmart target shoppers.

We are pleased to have expanded our retail channel distribution this large partner and will keep exploring the opportunities with other global large channels. It's worth remembering that the global mega-trend of personal health awareness was well in place before the pandemic. And the last 10 months has brought awareness to a compelling level.

We also note that leading industry analysts are unified in their forecast for continued strong demand for smart wearables well into the future. The variety of form factors keeps expanding and we are expanding right along with this.

The global opportunity remains robust for Huami, especially with our product market positions all representing exceptional value and feature sets at every price point. These new products and services development as well as geographic expansion are all part of our continuous execution on our connect health with technology strategy.

In addition, we are now doing academic research project cooperated with more than 20 different hospitals, search institutes and pharmaceutical companies in both China and overseas to help monitor users' health conditions by using our smart wearable devices.

To name a few, we are now working with the first affiliated hospital of Guangzhou Medical College and Dr. Zhong Nanshan's team on a chosen asthma early warning project. We identified sleep as a key area of interest for our users. And are working with the Sample Sleep medicine center in the U.S. and others to collect more data and perform analysis.

The ultimate objective of these academic research projects will be to offer our users more dimensions of healthcare services including pre-disease warning and more comprehensive health condition analysis in the future leveraging our devices ability to gather high-quality data consistently from every model regardless of price.

On a final topic, I want to note two key Huami team additions. At our Board meeting last Friday, we added a new independent director to Huami Board. I'm very pleased that Mr. Bing Xie recently retired from leading worldwide sales at Texas Instruments has agreed to join our board.

As an independent director, Bing will serve on the boards’ Audit, Compensation and Nominating and Corporate Governance Committees. Next, I want to formally introduce our new Chief Financial Officer, Mr. Leon Cheng Deng. Leon comes to Huami from Royal Philips where he was most recently Global Head of Finance for Philips Domestic Appliances Division.

He brings to us 17 years of extensive experience in accounting financial management and manufacturing perspective on Europe and many other key international markets and strategic transaction experience that I believe will help Huami accelerate in our next phase of growth. Leon welcome to your first Huami earnings call.

We are glad to have you as part of our team and looking forward to your leadership as we continue to execute and grow the business. The floor is yours..

Thank you, Wang. I'm excited to join the Huami family. I believe that with my global consumer health experience, I can help the company focus and manage its sustainable growth. Huami has grown very fast and has many opportunities on both the health and fitness sector and consumer industrial side of healthcare.

Building off my 17 years of strategic operational financial and accounting management experience at Philips, I will be focusing on continuing to improve management processes, planning and financial controls, I anticipate looking at areas such as working capital management, cash flow and return on invested capital.

I also look forward to leveraging my experience to help manage the company's global expansion in the future. So let's begin talking about third quarter results with sales. The COVID-19 virus continued to challenge companies and their business planning around the world. It both helped and hurt Huami in the third quarter.

During the summer quarter, COVID cases abated in many regions and allowed local economies to open up more. People got outside to exercise and to live their lives. That was good for the industry and Huami shipped 15.9 million units in the quarter, up 16.1% from the year ago third quarter and driving a revenue increase of 20%.

The largest portion of that increase was driven by the Xiaomi Mi-Band 5 and we also began shipping a number of our own brand new products as Wang just described.

Where the virus hurt us was in some supply chain challenges, which left us a short of new Huami product inventory in a number of locations and forced the delay of some of our new product launches from the beginning to the end of the third quarter. I will have more to say on the impact of the virus, when I talk about the look ahead and guidance.

But first, I want to focus on just a few key numbers including gross margin and operating expenses that I think are the most important for understanding what happened in the quarter and that shape our outlook. Gross margin can be affected by product mix, product launch timing and product life cycles including model upgrades.

The 460 basis point decrease in gross margin from a year ago quarter was predominantly driven by those effects. In our specific case, gross margin can be impacted by the proportional split between products which we make and sell to Xiaomi and also the products we bring to market under our own brands.

The split of products between Xiaomi and Huami was the same as in the year ago quarter, reflecting nearly identical patterns of old model winding down and new model quantity shipments for Xiaomi. In this year's quarter that was the new Xiaomi Mi-Band 5.

Gross margin on Xiaomi products in 2020 third quarter was 400 basis points lower than the year ago quarter. This much larger volume of Xiaomi products versus our own branded products in the quarter was primary driver of the overall lower gross margin. Let me next highlight operating expenses.

As has been true all the year sales and marketing, R&D and G&A expenses have been up year-over-year quite significantly in some areas. As you saw in today's press release, R&D was up 38.8% year-over-year and comprised 7.7% of the revenue compared to 6.7% a year ago.

Sales and marketing expenses was up 104.2% year-over-year and comprised 5.2% of revenue compared to 3% a year ago. G&A increased 30.8% year-over-year comprising 4.1% of the revenue compared to 3.7% a year ago. R&D has achieved a scale which we believe can continue to drive strong new product development going forward.

Sales and marketing expenses vary with seasonality. And obviously it is important to support key selling seasons such as the year-end holidays and as we expand geographically.

But we expect to apply some additional process to prioritize sales and marketing investments with the highest sales impact and return on investment through the fourth quarter and into the next year. Total operating expenses in the third quarter 2020 was up 51.3% year-over-year comprising 17% of revenue compared to 13.5% in the year ago quarter.

Given the uncertainties of the pandemic for the foreseeable future, we're going to manage operating expenses to a percentage of sales target at about where they are now in order to maintain profitability.

The company's cash position continued to be strong finishing the third quarter with cash and cash equivalents of RMB 2,556 million up 42% from December 31st, 2019. As I said, the new resurgence of cases in our key markets of Europe and Russia and the U.S.

are increasingly -- and increasingly other areas caused us to temper our outlook for fourth quarter sales. How the impact of the virus will play out through the holidays is very uncertain. Retailers in several key geographies after reopening during the summer are facing new lockdowns according to many recent media reports.

Our guidance reflects this uncertainty. For fourth quarter 2020, management currently expects net revenues to be between RMB1.95 billion and RMB2.15 billion.

That 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..

Thank you. We’ll now begin the question-and-answer session. [Operator Instructions] The first question today comes from Kyna Wong of Credit Suisse. Please go ahead..

Thanks. Thanks for taking my questions. I have like maybe two to three questions. So, the first one is actually wanted to ask just in the gross margin. Because I also -- I heard that the overall product mix is the main reason.

But do you think that this is also more long lasting issue going into fourth quarter, and also the first half next year? Because we also see some industry pushing more -- pushing harder to the -- for those promotions and also launching product in the IoT business.

So, I think they want to drive the recovery in the IoT business for the second half and also next year.

And so, would this becomes more like long lasting, I mean into coming quarters in terms of these like Xiaomi product mix issue? And I also want to check if there's any impact from the currency, the ForEx change in terms of the margin, because we also see the RMB appreciation in the past quarter.

And going forward, any impact on this? That's the first related to the gross margin first question. The second one is about the -- I would say the sales -- the overall -- because I -- we see this sales and marketing and also the R&D expenses continue to increase.

But the -- a mess is out is that tradetaking some time to pick up, and of course, some is due to the COVID-19. But how to like -- how could we expect that the investment in the R&D and also sales and marketing can be harvesting in the future? So, yeah, I just wanted to check this. Thanks..

Okay. Thank you very much. Those are good questions.

So let me try to answer the first question first, right? On the gross margin, I think, you're right that it is always Xiaomi's goal to provide high-quality cost-effective products to the end customers and we continue to also pack cutting-edge functionalities and sensors into our products, right? That's also why we keep on selling our products better always than the next -- the previous generation, right? So, it is true that the gross margin from the Xiaomi Band 5 is actually lower than the previous generation last year.

However, we're actually looking for scale and operating leverage from the Xiaomi products.

Right? On the other hand, you also noticed that our own brand sales, is also picking up, right? And our own brand sales is actually -- carries a relatively high gross margin compared to Xiaomi product, right? So in the end, with the effort of the product shipments of our own brands and also the continued growth of the Xiaomi product in the next year, we, at least, expect the gross margin to stay at the current level if -- and maybe in the second half of next year to expand a little bit.

I think that answers on the gross margin part. On the currency part, I think we're more looking at a natural hedge situation because in the end, we sell quite a bit of the products overseas and we receive dollars. And also most of our purchase are also paid in dollars.

So in this case, setting along the Chinese market because that is not subject to currency fluctuation on the foreign exchanges of the dollar impact, I think it's relatively minimal to us. So I don't see any big adverse currency impact coming out of dollars. So I guess that concludes on the gross margin part.

To coming back on your question on OpEx, right? I think we are always a long-term kind of thinking and we apply to that to our management and how we manage our business going forward, right? So there's some saying says never waste a crisis, right? So in this time we try to invest ahead of time and try to build that foundation for our product launches for next year and also to build network of our distributions and channels overseas for next year.

We believe that when the coronavirus is little bit getting away then it is good – and that probably is going to be in second half of next year that will be the time that we will see a rebound of our performance..

Thank you. [Operator Instructions] The next question comes from Joe Hui of Industrial Securities. Please go ahead..

Okay. Thanks for taking my question. My first question is could the health monitor function turn smartwatches and smart bands into a more widely used device like TWS earphone? And what are the core barriers of these two kinds of products? Do we have some medical certification that differentiate our products from others? And that is my first question.

Thank you..

I think, probably I will be the person to answer your question again.

Yes, we see adopting – consumers adopting more and more the usage of health monitoring functionalities of a smartwatch during the pandemic, right? So that's why you see also our competitors and all the usage of the data of the wrist are picking up, right? Whether or not they will become a TWS market? I think it's too early to tell.

But as you see both Apple and other big brands, they are actually packing more and more functionalities like ECG and stuff like StO2 meds into their watches.

I think it's a good sign and then also a trend on where the industry is moving, right? And yes, there's definitely a barrier to it because you have the difference between health and fitness device and medical device, right? And then I think on the medical device part we're on par if not better than our key competitors, right? And with regard to if there's any core barriers on the usage of such a data, I think the FDA approval and the medical devices approval is going to set us apart between a cash – health and fitness player and a serious health player which we want to be in the future..

Okay. Okay, thank you.

My second question is that as the last analyst mentioned, the R&D investments is relatively high in the past nine months this year, could management give more color on what we invest in and how can we improve the property of our device?.

Okay. Now so on the R&D actually, there's a lot of information which we could disclose a little bit more.

And I would definitely refer you to the press releases which we did at the beginning of this year around April-May timeframe on, what we have invested I think, we have invested in AI, we have invested in a lot of new functionalities, which will be used in our next-generation products.

And not to mention, that we have actually -- maybe you don't know, we almost refreshed all the product lines which we currently have for our own brands, by the end of this year. We have launched so many products in the course of this quarter, which should set us apart and also laid a great foundation for next year.

I think that's just because of a few R&D investments which we did. And if you need to know more, please feel free to send a question to our IR contact. And then, we'll get back to you..

Okay, okay. Thank you. And then, I have one last question. We've heard that, Huami have some cooperation with, maybe insurance company to promote our health care solution.

Could the management share more details on that?.

I think we update….

Oh! Yes. Hi. This is....

Okay, go ahead Mike..

Yeah. Okay. Sorry, Leon yeah. So, yes, so we -- regarding the insurance companies as you may have heard, we partner currently in Asia with Prudential Asia, where they are -- they contributed our Pie technology algorithm, into their Pulse app which is their consumer app, that will be launched in over 11 countries in Asia.

And that's just the beginning of our partnership with them. We will also partner with them on data analysis and also cross-selling of products. And we are also working on, similar type of deals models, not only in Asia, but in U.S. and North America as well as Europe. And you will see announcements, soon that we have signed those deals yeah..

Okay, okay. Thank you. And that’s all my questions..

[Operator Instructions] The next question is a follow-up from Kyna Wong of Crédit Suisse. Please go ahead..

Hi. Thanks for taking my follow-up questions.

So I noticed that there is a pretty high EBITDA large increase in the stock-based compensation in the third quarter just wanted to get more idea about the pattern going forward? We also expect certain -- I mean time thing that there will be some large stock-based compensation expenses, even though it will not really affect the adjusted earnings, but still wanted to know the -- I mean the pattern, I mean going forward? What should we expect on that end? And -- yeah and, will we -- shall we expect these similar levels in the fourth quarter as well?.

So I think the increase of this quarter is as what we mentioned in the press release, it's primarily due to the increase in share-based compensation which we give to a few key -- to some key employees', right? Whether or not, it's going to -- the same level is going to continue into Q4, I think at this moment, my answer is no, because the previous one which you saw, it's pretty much a one-off, which tied back to some incentive scheme which we had.

At this moment to the best of my knowledge, I don't see anything in Q4 popping up..

Okay. Thanks..

Next question comes from Michelle Zhang of China Renaissance. Please go ahead..

Hi. Thank you, management for taking my questions. I have two questions. The first one is, I want to know about the current development progress of the distribution channel expansion for Amazfit product? And that is my first question. Thank you..

Excuse me can you repeat your first question?.

Yes. Sure.

Sir, my first question is about the current status of the distribution channel expansion for Amazfit product?.

Okay. Now, I get it. So, we have actually very meaningful progress of the Amazfit product channel building in the third quarter. As we mentioned, our star products Bip S and GTS entered more than 2,800 Walmart stores in the third quarter. And we're also now serving more than 70 countries and our sales team covering different regions.

We have a strong presence in the universal large platforms like Amazon, Flipkart and Ali Express, where we also cooperated with a lot of local partners like Reliance in India and Svyaznoy in Russia. These are only just a few examples of our strong overseas channels. And we'll continue to strengthen our global distributions in the coming quarters..

Okay. Thank you. And my second question is about the management outlook for the shipment growth of Xiaomi Band and also Amazfit products for next years? Thank you..

Normally, we don't guide for the next year. But I can give you some flavor on what it is, right? I think, on a higher level, the global band market is becoming a relatively mature market. So we would anticipate the Mi Band product, the Xiaomi Band product shipment and ASP to somehow stabilize a little bit with moderate growth going forward.

But on the other hand, you know the ASP of our own products, are much higher than those of the Xiaomi's. So, I would expect that our own product shipment will continue to grow, alongside with the gross margin expansion.

So -- but however, I need to caution you that, the COVID-19 virus still has the impact on the global market and we don't know whenever that is going to stop. So therefore, there's still quite some uncertainties around that topic. I hope that answers your question. I'll give you at least some flavor on what it is..

Yes, yes sure. Thank you, so much..

As there are no further questions, now I'd 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. This concludes this conference call. You may now disconnect your lines. Thank you..