F-1 1 d410987df1.htm FORM F-1 Form F-1
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As filed with the Securities and Exchange Commission on January 12, 2018

Registration No. 333-                

 

 

 

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM F-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

Huami Corporation

(Exact name of Registrant as specified in its charter)

Not Applicable

(Translation of Registrant’s name into English)

 

 

 

Cayman Islands   3571   Not Applicable

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

Building H8, No. 2800, Chuangxin Road

Hefei, 230088

People’s Republic of China

+86 551-65837200

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)

Law Debenture Corporate Services Inc.

801 2nd Avenue, Suite 403

New York, New York 10017

+1 212-750-6474

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

 

Z. Julie Gao, Esq.

Will H. Cai, Esq.

Skadden, Arps, Slate, Meagher & Flom LLP

c/o 42/F, Edinburgh Tower, The Landmark

15 Queen’s Road Central

Hong Kong

+852 3740-4700

 

David Zhang, Esq.

Steve Lin, Esq.

Kirkland & Ellis International LLP

c/o 26/F, Gloucester Tower, The Landmark

15 Queen’s Road Central

Hong Kong

+852 3761-3300

 

 

Approximate date of commencement of proposed sale to the public: as soon as practicable after the effective date of this registration statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ☐

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933.

Emerging growth company  ☒

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 7(a)(2)(B) of the Securities Act.  ☒

† The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of each class of

securities to be registered(1)(2)

 

Proposed maximum aggregate

offering price(2)(3)

 

Amount of

registration fee

Class A Ordinary Shares, par value US$0.0001 per share

  US$150,000,000   US$18,675

 

 

Notes:

(1) American depositary shares issuable upon deposit of class A ordinary shares registered hereby will be registered under a separate registration statement on Form F-6 (Registration No. 333-                ). Each American depositary share represents                class A ordinary shares.
(2) Includes class A ordinary shares that are issuable upon the exercise of the underwriters’ over-allotment option. Also includes class A ordinary shares initially offered and sold outside the United States that may be resold from time to time in the United States either as part of their distribution or within 40 days after the later of the effective date of this registration statement and the date the shares are first bona fide offered to the public. These class A ordinary shares are not being registered for the purpose of sales outside the United States.
(3) Estimated solely for the purpose of determining the amount of registration fee in accordance with Rule 457(o) under the Securities Act of 1933.

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. We and the selling shareholders may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and we are not soliciting offers to buy these securities in any state where the offer or sale is not permitted.

 

PROSPECTUS (Subject to Completion) Issued                 , 2018.

American Depositary Shares

 

LOGO

Huami Corporation

Representing                 Class A Ordinary Shares

 

 

Huami Corporation is offering                  American depositary shares, or ADSs. This is our initial public offering and no public market currently exists for our ADSs or class A ordinary shares. Each ADS represents                  of our class A ordinary shares, par value US$0.0001 per share. It is currently estimated that the initial public offering price per ADS will be between US$                 and US$                .

 

 

We intend to apply for the listing of our ADSs on the Nasdaq Global Market under the symbol “HMI.”

We are an “emerging growth company” under applicable U.S. federal securities laws and are eligible for reduced public company reporting requirements.

Investing in our ADSs involves risks. See “Risk Factors” beginning on page 14.

 

 

PRICE US$                 PER ADS

 

 

 

    Price to
Public
  Underwriting
Discounts and
Commissions
  Proceeds
to us

Per ADS

  US$               US$               US$            

Total

  US$               US$               US$            

We and the selling shareholders identified in this prospectus have granted the underwriters the right to purchase up to an additional                 ADSs to cover over-allotments.

Neither the United States Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities, or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

Upon completion of this offering, we will have a dual class ordinary share structure. Our ordinary shares will be divided into class A ordinary shares and class B ordinary shares. Holders of class A ordinary shares are entitled to one vote per share, while holders of class B ordinary shares are entitled to ten votes per share. Holders of class A and class B ordinary shares will vote together as one class on all matters that require a shareholders’ vote. Each class B ordinary share is convertible into one class A ordinary share at any time by the holder thereof, while class A ordinary shares are not convertible into class B ordinary shares under any circumstance. All shares held by our existing shareholders will be converted to class B ordinary shares immediately before the completion of this offering. Upon the completion of this offering, they will own an aggregate of 197,736,467 class B ordinary shares, which will represent             % of the then total outstanding shares and             % of total voting power of our outstanding shares.

The underwriters expect to deliver the ADSs to purchasers on                , 2018.

 

Credit Suisse   Citigroup   China Renaissance

                    , 2018.


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TABLE OF CONTENTS

 

PROSPECTUS SUMMARY

     1  

RISK FACTORS

     14  

SPECIAL NOTE REGARDING FORWARD -LOOKING STATEMENTS

     46  

USE OF PROCEEDS

     47  

DIVIDEND POLICY

     48  

CAPITALIZATION

     49  

DILUTION

     51  

EXCHANGE RATE INFORMATION

     53  

ENFORCEABILITY OF CIVIL LIABILITIES

     54  

CORPORATE HISTORY AND STRUCTURE

     56  

SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA

     61  

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     65  

BUSINESS

     92  

REGULATION

     113  

MANAGEMENT

     125  

PRINCIPAL AND SELLING SHAREHOLDERS

     134  

RELATED PARTY TRANSACTIONS

     137  

DESCRIPTION OF SHARE CAPITAL

     140  

DESCRIPTION OF AMERICAN DEPOSITARY SHARES

     151  

SHARES ELIGIBLE FOR FUTURE SALE

     161  

TAXATION

     163  

UNDERWRITING

     170  

EXPENSES RELATED TO THIS OFFERING

     180  

LEGAL MATTERS

     181  

EXPERTS

     182  

WHERE YOU CAN FIND ADDITIONAL INFORMATION

     183  

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

     F-1  

 

 

You should rely only on the information contained in this prospectus or in any related free writing prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus or in any related free writing prospectus. We are offering to sell, and seeking offers to buy the ADSs, only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or any sale of the ADSs.

We have not taken any action to permit a public offering of the ADSs outside the United States or to permit the possession or distribution of this prospectus outside the United States. Persons outside the United States who come into possession of this prospectus must inform themselves about and observe any restrictions relating to the offering of the ADSs and the distribution of the prospectus outside the United States.

Until                     , 2018 (the 25th day after the date of this prospectus), all dealers that buy, sell or trade ADSs, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

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PROSPECTUS SUMMARY

The following summary is qualified in its entirety by, and should be read in conjunction with, the more detailed information and financial statements appearing elsewhere in this prospectus. In addition to this summary, we urge you to read the entire prospectus carefully, especially the risks of investing in our ADSs discussed under “Risk Factors,” before deciding whether to invest in our ADSs. This prospectus contains information from an industry report, dated December 19, 2017, commissioned by us and prepared by Frost & Sullivan, an independent research firm, to provide information regarding our industry and our market position in China and globally. We refer to this report as the “Frost & Sullivan Report.”

Our Mission

We are transforming the way individuals connect with the Internet and with each other through smart wearable technology and data-driven innovations. Our mission is to make the world more connected.

Our Global Market Leadership

We are a biometric and activity data-driven company with significant expertise in smart wearable technology. We shipped 11.6 million units of smart wearable devices in the first nine months of 2017, more than any other company in the world, according to the Frost & Sullivan Report. As of September 30, 2017, we had shipped a total of 45.3 million devices since our inception in 2013, quickly establishing our global market position and recognition.

We believe we have one of the largest biometric and activity databases in the global smart wearables industry. Our mobile apps, Mi Fit and Amazfit, work hand in hand with our smart wearable devices and provide users with a comprehensive view and analysis of their biometric and activity data. As of September 30, 2017, our mobile apps had 49.6 million registered users, from whom we collect over 10 dimensions of measurement that include heart rate, ECG, weight, body fat compositions, GPS running track, steps, sleeping duration, etc. With a wide range of biometric and activity data from a large number of users, we are well-positioned to develop new application scenarios for smart wearable technology and drive innovation.

We have been the sole partner of Xiaomi Corporation, or Xiaomi, a mobile Internet company and global consumer electronics brand, to design and manufacture Xiaomi-branded smart bands, watches (excluding children watches and quartz watches), scales and associated accessories, or Xiaomi Wearable Products. Our strategic cooperation agreement with Xiaomi grants us the most-preferred-partner status globally to develop future Xiaomi Wearable Products and provides us with significant business demand, allowing us to quickly commercially launch our products and ramp up our business. This large and visible demand, combined with our technological expertise, in turn enhances our control over our supply chain and drives our efficiency. Meanwhile, our strong research and development capabilities and innovative products enrich Xiaomi’s suite of offerings and enhance user loyalty, resulting in a mutually beneficial relationship between Xiaomi and us. As of September 30, 2017, we had sold 40.0 million Mi Band series of smart band products since its launch in July 2014. In addition to Xiaomi Wearable Products, we also leverage Xiaomi’s established distribution network to promote smart bands and watches under our own brand, Amazfit. Our cooperation with Xiaomi has been a major driver for our growth. Xiaomi is the sole customer and distribution channel for all of our Xiaomi Wearable Products, and sales of Xiaomi Wearable Products contributed 97.1%, 92.1% and 82.4% of our total revenues for 2015 and 2016 and the nine months ended September 30, 2017, respectively. See “Risk Factors—Risks Related to Our Business and Industry—Xiaomi is our most important customer and distribution channel. Any deterioration of our relationship with Xiaomi or reduction of sales of Xiaomi Wearable Products could have a material adverse effect on our operating results.” for more discussion on our dependence on Xiaomi.

We have achieved significant growth since our inception. Our revenues increased by 73.6% from RMB896.5 million in the year ended December 31, 2015 to RMB1,556.5 million (US$233.9 million) in the year

 

 

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ended December 31, 2016, and increased by 37.4% from RMB943.5 million for the nine months ended September 30, 2016 to RMB1,296.2 million (US$194.8 million) for the same period of 2017. We recorded a net loss of RMB37.9 million in the year ended December 31, 2015, which improved to a net income of RMB23.9 million (US$3.6 million) in December 31, 2016. For the nine months ended September 30, 2017, we had a net income of RMB95.1 million (US$14.3 million), compared to a net loss of RMB19.0 million for the nine months ended September 30, 2016. Our adjusted net income, which excludes share-based compensation expenses, increased from RMB18.1 million in the year ended December 31, 2015 to RMB81.7 million (US$12.3 million) in the year ended December 31, 2016, and increased from RMB24.3 million for the nine months ended September 30, 2016 to RMB143.7 million (US$21.6 million) for the same period of 2017. See “—Summary Consolidated Financial and Operating Data—Non-GAAP Measures” for a reconciliation of adjusted net income to net income.

Market Opportunity and Powerful Trends

The global smart wearables market has been growing rapidly and the momentum is expected to continue in the near future. According to the Frost & Sullivan Report, between 2014 and 2016, the global smart wearables market size increased from US$1.7 billion in 2014 to US$16.0 billion in 2016, and shipment volume increased from 29.3 million devices in 2014 to 102.9 million devices in 2016. By 2021, the global smart wearables market size is expected to reach US$46.2 billion, representing a five-year compound annual growth rate, or CAGR, of 23.6% from 2016 to 2021, with shipment volume of 281.9 million devices, representing a CAGR of 22.3% for the same period, according to the Frost & Sullivan Report. In 2015, China surpassed the U.S. to become the largest smart wearables market in terms of shipment volume and is expected to continue to experience the highest growth rate among major markets, according to the same source.

We believe smart wearable technology and biometric application scenarios, including those for sports and fitness, are redefining the way individuals connect with devices, the Internet and each other. The seamless manner in which smart wearable technology enables interaction with and data collection from users makes the aggregation and analytics of a broader and more diversified set of biometric and activity data possible, driving innovation. Rapidly-expanding application scenarios, powered by continually-refined algorithms and AI technology, are in turn driving the creation of next-generation products. Furthermore, the exponential growth in data collected by smart wearable technology companies is driving new business models and monetization opportunities.

We believe the following are the key trends driving the demand for smart wearable technology:

 

    growing consciousness for health and fitness products and services;

 

    increasing applications in healthcare and medical fields;

 

    emergence and adoption of Internet-of-Things (IoT) devices; and

 

    quality products with increasingly attractive prices.

Competitive Strengths

We believe the following competitive strengths contribute to our success and differentiate us from our competitors:

 

    massive database and powerful algorithms;

 

    strong research and development capability;

 

    broad range of application scenarios;

 

 

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    efficient supply chain management; and

 

    mutually beneficial relationship with Xiaomi.

Our Strategies

We plan to pursue the following strategies to achieve our mission:

 

    strengthen our data insights and technology;

 

    enhance our brand recognition;

 

    expand domestically and internationally;

 

    broaden application scenarios and build our ecosystem; and

 

    pursue strategic partnerships and acquisitions.

Our Challenges

Our ability to achieve our mission and execute our strategies is subject to risks and uncertainties, including those relating to our ability to:

 

    continue to maintain our comprehensive cooperation with Xiaomi;

 

    develop and commercialize new products, services and technologies;

 

    compete successfully in the relevant markets;

 

    anticipate and satisfy consumer preferences in a timely manner;

 

    promote our brands, including Amazfit, to enhance brand recognition;

 

    continue to provide accurate measurement, data and recommendation to our users;

 

    efficiently manage our contract manufacturers and component suppliers; and

 

    protect our intellectual property and proprietary rights.

Recent Developments

The following sets forth our selected unaudited financial data for the two months ended November 30, 2017 and certain operating data for the fourth quarter of 2017.

 

    Revenues. Our revenues for the two months ended November 30, 2017 were RMB476.7 million (US$71.6 million), consisting of RMB345.0 million (US$51.9 million) of Xiaomi Wearable Products segment revenues and RMB131.7 million (US$19.8 million) of self-branded products and others segment revenues.

 

    Gross profit. Our gross profit for the two months ended November 30, 2017 was RMB121.3 million (US$18.2 million).

 

    Net income. Our net income for the two months ended November 30, 2017 was RMB52.2 million (US$7.9 million).

 

    Adjusted net income. Our adjusted net income, which excludes share-based compensation expenses, was RMB61.9 million (US$9.3 million) for the two months ended November 30, 2017.

 

    Shipment volume. We shipped 6.5 million units of smart wearable devices in the fourth quarter of 2017.

 

 

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Our selected unaudited financial data for the two months ended November 30, 2017 and certain operating data for the fourth quarter of 2017 may not be indicative of our financial results for future interim periods or for the full year ended December 31, 2017. Please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus for information regarding trends and other factors that may affect our results of operations.

The table below sets forth a reconciliation of our adjusted net income to net income for the period indicated. See “—Summary Consolidated Financial and Operating Data—Non-GAAP Measures” for further explanation.

 

     For the Two Months Ended November 30, 2017  
     RMB      US$  
     (in thousands)  

Net income

     52,227        7,850  

Add:

     

Share-based compensation expenses

     9,687        1,456  
  

 

 

    

 

 

 

Adjusted net income

     61,914        9,306  
  

 

 

    

 

 

 

Corporate History and Structure

We commenced operations in December 2013 through Anhui Huami Information Technology Co., Ltd., or Anhui Huami, to develop, manufacture and sell smart wearable devices. In July 2014, we incorporated Huami (Beijing) Information Technology Co., Ltd., or Beijing Huami, to expand our operation.

In December 2014, we incorporated Huami Corporation in Cayman Islands as our offshore holding company to facilitate financing and offshore listing. Shortly following its incorporation, Huami Corporation established a wholly-owned Hong Kong subsidiary, Huami HK Limited. From December 2014 to April 2015, our Cayman holding company Huami Corporation issued ordinary shares and preferred shares to the holding vehicles of the then shareholders of Anhui Huami, in proportion to these shareholders’ then respective equity interest percentages in Anhui Huami.

In February 2015, Huami HK Limited established a wholly-owned subsidiary in China, Beijing Shunyuan Kaihua Technology Co., Ltd., which we refer to as Shunyuan Kaihua or our WFOE in this prospectus. Our WFOE later entered into a series of contractual arrangements with Anhui Huami, Beijing Huami, which two entities we collectively refer to as our VIEs in this prospectus, and their respective shareholders. These contractual arrangements enable us to (i) exercise effective control over our VIEs, (ii) receive substantially all of the economic benefits of our VIEs, and (iii) have an exclusive option to purchase all or part of the equity interests in and assets of them when and to the extent permitted by PRC law. For more details, please see “Corporate History and Structure—Contractual Arrangements with the VIEs and Their Respective Shareholders.”

As a result of our direct ownership in our WFOE and the VIE contractual arrangements, we are regarded as the primary beneficiary of our VIEs, and we treat them and their subsidiaries as our consolidated affiliated entities under U.S. GAAP. We have consolidated the financial results of our VIEs and their respective subsidiaries in our consolidated financial statements in accordance with U.S. GAAP.

Currently, our officers, directors and principal shareholders collectively hold 89.1% of the total voting power in our Company. They will continue to have a substantial control of us and hold             % of total voting power immediately after this offering.

 

 

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The chart below summarizes our corporate structure and identifies our subsidiaries, our VIEs and their subsidiaries, as of the date of this prospectus:

 

LOGO

 

 

 

Notes:

(1) Messrs. Wang Huang, Yunfen Lu, Meihui Fan, Bin Fan, Yi Zhang and Xiaojun Zhang are beneficial owners of the shares of our company and hold 45.8%, 2.1%, 2.1%, 2.1% 2.1% and 1.4% equity interests in Beijing Huami, respectively. They are directors and/or employees of our company. De Liu and Bin Yue, who are also our directors, hold 17.7% and 5.9% equity interests in Beijing Huami, respectively. The remaining 20.7% equity interests in Beijing Huami are held by Liping Cao and Lhassa Multi-Industry Investment Management Co. Ltd., who are employee and affiliate of our shareholders, respectively.
(2) Messrs. Wang Huang and Yunfen Lu are beneficial owners of the shares of our company and hold 54.9% and 0.3% equity interests in Anhui Huami, respectively. They are also directors of our company. De Liu and Bin Yue, who are also our directors, hold 17.9% and 6.0% equity interests in Anhui Huami, respectively. The remaining 20.9% equity interests in Anhui Huami are held by Liping Cao and Lhassa Multi-Industry Investment Management Co. Ltd., who are employee and affiliate of our shareholders, respectively.

Implication of Being an Emerging Growth Company

As a company with less than US$1.07 billion in revenue for our last fiscal year, we qualify as an “emerging growth company” pursuant to the Jumpstart Our Business Startups Act of 2012, as amended, or the JOBS Act. An emerging growth company may take advantage of specified reduced reporting and other requirements

 

 

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compared to those that are otherwise applicable generally to public companies. These provisions include exemption from the auditor attestation requirement under Section 404 of the Sarbanes-Oxley Act of 2002 in the assessment of the emerging growth company’s internal control over financial reporting. The JOBS Act also provides that an emerging growth company does not need to comply with any new or revised financial accounting standards until such date that a private company is otherwise required to comply with such new or revised accounting standards. However, we have elected to “opt out” of this provision and, as a result, we will comply with new or revised accounting standards as required when they are adopted for public companies. This decision to opt out of the extended transition period under the JOBS Act is irrevocable.

We will remain an emerging growth company until the earliest of (a) the last day of the fiscal year during which we have total annual gross revenues of at least US$1.07 billion; (b) the last day of our fiscal year following the fifth anniversary of the completion of this offering; (c) the date on which we have, during the preceding three-year period, issued more than US$1.07 billion in non-convertible debt; or (d) the date on which we are deemed to be a “large accelerated filer” under the Securities Exchange Act of 1934, as amended, or the Exchange Act, which would occur if the market value of our ADSs that are held by non-affiliates exceeds US$700 million as of the last business day of our most recently completed second fiscal quarter. Once we cease to be an emerging growth company, we will not be entitled to the exemptions provided in the JOBS Act discussed above.

Corporate Information

Our principal executive offices are located at Building H8, No. 2800, Chuangxin Road, Hefei, 230088, People’s Republic of China. Our telephone number at this address is +86 551-65837200. Our registered office in the Cayman Islands is located at offices of Maples Corporate Services Limited at PO Box 309 Ugland House, Grand Cayman, KY1-1104, Cayman Islands.

Investors should submit any inquiries to the address and telephone number of our principal executive offices. Our main website is www.huami.com. The information contained on our website is not a part of this prospectus. Our agent for service of process in the United States is Law Debenture Corporate Services Inc., located at 801 2nd Avenue, Suite 403, New York, New York 10017.

Conventions that Apply to this Prospectus

Unless otherwise indicated or the context otherwise requires, references in this prospectus to:

 

    “ADSs” are to our American depositary shares, each of which represents                 class A ordinary shares;

 

    “ADRs” are to the American depositary receipts that evidence our ADSs;

 

    “China” or the “PRC” are to the People’s Republic of China, excluding, for the purposes of this prospectus only, Hong Kong, Macau and Taiwan;

 

    “Huami,” “we,” “us,” “our company” and “our” are to Huami Corporation, our Cayman Islands holding company and its subsidiaries, its consolidated variable interest entities and the subsidiaries of the consolidated variable interest entities.

 

    “Our platform” is to the products and mobile apps that we provide to users and platform partners;

 

    “Mobile App MAUs” are to monthly active users of our mobile apps, which are represented by the number of accounts that have been logged into on our mobile apps during a given calendar month. The numbers of our Mobile App MAUs are calculated using internal company data that have not been independently verified. It is possible that some users may have set up more than one account;

 

 

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    “class A ordinary shares” are to our class A ordinary shares, par value US$0.0001 per share;

 

    “class B ordinary shares” are to our class B ordinary shares, par value US$0.0001 per share;

 

    “ordinary shares” are to our class A ordinary shares and class B ordinary shares, par value US$0.0001 per share;

 

    “RMB” and “Renminbi” are to the legal currency of China;

 

    “US$,” “U.S. dollars,” “$,” and “dollars” are to the legal currency of the United States; and

 

    “Xiaomi Wearable Products” are to Xiaomi-branded smart bands, watches (excluding children watches and quartz watches), scales and associated accessories, which we design and manufacture for Xiaomi.

All shipment volume and devices sold data include sales of smart bands, watches and scales, net of any return, and exclude sales of accessories. Unless the context indicates otherwise, all information in this prospectus assumes no exercise by the underwriters of their over-allotment option.

 

 

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THE OFFERING

 

Offering price

We currently estimate that the initial public offering price will be between US$             and US$             per ADS.

 

ADSs offered by us

             ADSs (or             ADSs if the underwriters exercise their over-allotment option in full).

 

ADSs offered by the selling shareholders

            ADSs if the underwriters exercise their over-allotment option in full).

 

ADSs outstanding immediately after this offering

             ADSs (or              ADSs if the underwriters exercise their over-allotment option in full)

 

Ordinary shares outstanding immediately after this offering

             class A ordinary shares and 197,736,467 class B ordinary shares (or              class A ordinary shares and              class B ordinary shares if the underwriters exercise their over-allotment option in full).

 

The ADSs

Each ADS represents              class A ordinary shares, par value US$0.0001 per share.

 

  The depositary will hold class A ordinary shares underlying your ADSs. You will have rights as provided in the deposit agreement among us, the depositary and holders and beneficial owners of ADSs from time to time.

 

  We do not expect to pay dividends in the foreseeable future. If, however, we declare dividends on our class A ordinary shares, the depositary will pay you the cash dividends and other distributions it receives on our class A ordinary shares after deducting its fees and expenses in accordance with the terms set forth in the deposit agreement.

 

  You may surrender your ADSs to the depositary in exchange for class A ordinary shares. The depositary will charge you fees for any exchange.

 

  We may amend or terminate the deposit agreement without your consent. If you continue to hold your ADSs after an amendment to the deposit agreement, you agree to be bound by the deposit agreement as amended.

 

  To better understand the terms of the ADSs, you should carefully read the “Description of American Depositary Shares” section of this prospectus. You should also read the deposit agreement, which is filed as an exhibit to the registration statement that includes this prospectus.

 

 

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Over-allotment option

We and the selling shareholders have granted to the underwriters an option, exercisable within 30 days from the date of this prospectus, to purchase up to an aggregate of                  additional ADSs.

 

Use of proceeds

We expect that we will receive net proceeds of approximately US$            million from this offering, assuming an initial public offering price of US$            per ADS, which is the midpoint of the estimated range of the initial public offering price, after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

 

  We intend to use the net proceeds from this offering for (i) research and development of products, services and technologies, (ii) selling and marketing, and (iii) general corporate purposes and working capital and potential strategic investments and acquisitions. See “Use of Proceeds” for more information.

 

  We will not receive any of the proceeds from the sale of ADSs by the selling shareholders.

 

Lock-up

We, our directors, executive officers, all of our existing shareholders and [all] holders of share-based awards have agreed with the underwriters not to sell, transfer or dispose of any ADSs, ordinary shares or similar securities for a period of 180 days after the date of this prospectus. See “Shares Eligible for Future Sale” and “Underwriting.”

 

Directed Share Program

At our request, the underwriters have reserved for sale, at the initial public offering price, up to an aggregate of            ADSs offered in this offering to some of our directors, officers, employees, business associates and related persons through a directed share program.

 

Listing

We intend to apply to have the ADSs listed on the Nasdaq Global Market under the symbol “HMI.” Our ADSs and shares will not be listed on any other stock exchange or traded on any automated quotation system.

 

Payment and settlement

The underwriters expect to deliver the ADSs against payment therefor through the facilities of the Depositary Trust Company on             , 2018.

Depositary

The number of ordinary shares that will be outstanding immediately after this offering:

 

    assumes the underwriters will not exercise the over-allotment option;

 

    is based on 185,671,642 ordinary shares outstanding as of the date of this prospectus; and

 

    excludes 2,942,165 vested restricted shares and all shares reserved under our share incentive plan.

 

 

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SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA

The following summary consolidated statements of operating data for the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2017, summary consolidated balance sheet data as of December 31, 2015 and 2016 and September 30, 2017 and summary consolidated cash flow data for the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2017 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The following summary consolidated statements of operating data for the nine months ended September 30, 2016 and summary consolidated cash flow data for the nine months ended September 30, 2016 are derived from our unaudited consolidated financial statements included elsewhere in this prospectus. Our consolidated financial statements are prepared and presented in accordance with accounting principles generally accepted in the United States of America, or U.S. GAAP. Our historical results are not necessarily indicative of results expected for future periods. You should read this Summary Consolidated Financial and Operating Data section together with our consolidated financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

 

     For the Year Ended December 31,     For the Nine Months
Ended September 30,
 
     2015     2016     2016     2017  
     RMB     RMB     US$     RMB     RMB     US$  
     (in thousands, except for per share data)  

Summary Consolidated Statements of Operating Data:

            

Revenues(1)

     896,458       1,556,476       233,940       943,511       1,296,248       194,828  

Cost of revenues(2)

     785,867       1,280,324       192,434       791,212       968,369       145,547  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     110,591       276,152       41,506       152,299       327,879       49,281  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

            

Research and development expenses(3)

     61,553       132,304       19,885       98,008       108,590       16,321  

General and administrative expenses(3)

     69,984       102,644       15,428       69,043       82,474       12,396  

Selling and marketing expenses

     19,168       27,821       4,181       14,801       29,680       4,461  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     150,705       262,769       39,494       181,852       220,744       33,178  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating (loss)/income

     (40,114     13,383       2,012       (29,553     107,135       16,103  

Other income and expenses:

            

Realized gain from investments

                             2,335       351  

Interest income

     255       754       113       646       1,463       220  

Other income

     1,109       14,726       2,213       7,287       1,066       160  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss)/income before income tax

     (38,750     28,863       4,338       (21,620     111,999       16,834  

Income tax benefit/(expense)

     897       (3,088     (464     3,731       (15,462     (2,324
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss)/income before loss from equity method investments

     (37,853     25,775       3,874       (17,889     96,537       14,510  

Loss from equity method investments

     —         (1,829     (275     (1,156     (1,422     (214
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss)/income

     (37,853     23,946       3,599       (19,045     95,115       14,296  

Less: net loss attributable to non-controlling interest

     —         —         —         —         (263     (39
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss)/income attributable to Huami Corporation

     (37,853     23,946       3,599       (19,045     95,378       14,335  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss)/income per share attributable to Huami Corporation:

            

Basic (loss)/income per ordinary share

     (1.22     (0.22     (0.03     (0.84     0.35       0.05  

Diluted (loss)/income per ordinary share

     (1.22     (0.22     (0.03     (0.84     0.33       0.05  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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Notes:

(1)   Includes RMB876.7 million, RMB1,449.9 million (US$217.9 million), RMB879.6 million and RMB1,124.8 million (US$169.1 million) with related parties for the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2016 and 2017, respectively.
(2)   Includes RMB762.9 million and RMB1,198.3 million (US$180.1 million), RMB742.1 million and RMB853.3 million (US$128.3 million) with related parties for the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2016 and 2017, respectively.
(3)   Share-based compensation expenses were allocated in operating expenses as follows. Our share-based compensation expenses were the result of (i) our grants of options, restricted shares and restricted share units under our share incentive plans to our employees, and (ii) the share restriction agreements entered into among our founders and our preferred shareholders in relation to our private financing transactions in January 2014 and April 2015. For the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2017, we recorded share-based compensation expenses of RMB37.2 million, RMB50.8 million and RMB38.9 million, respectively, in relation to the vesting of the restricted shares of our founders under the share restriction agreements.

 

     For the Year Ended December 31,      For the Nine Months Ended
September 30,
 
     2015      2016      2016      2017  
     RMB      RMB      US$      RMB      RMB      US$  
     (in thousands)  

Research and development expenses

     2,588        2,626        395        1,970        6,428        966  

General and administrative expenses

     53,403        55,109        8,283        41,393        42,147        6,335  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     55,991        57,735        8,678        43,363        48,575        7,301  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     As of December 31,      As of September 30,  
     2015      2016      2017  
     RMB      RMB      US$      RMB      US$  
     (in thousands)  

Summary Consolidated Balance Sheet Data:

              

Current assets:

              

Cash and cash equivalents

     219,987        153,152        23,019        504,388        75,810  

Accounts receivable (net of allowance of nil, nil and nil as of December 31, 2015 and 2016 and September 30, 2017, respectively)

     21,924        19,707        2,962        28,655        4,307  

Amount due from related parties

     172,966        476,698        71,648        171,575        25,788  

Inventories

     89,946        192,372        28,914        191,101        28,723  

Non-current assets:

              

Property, plant and equipment, net

     2,926        10,801        1,623        10,665        1,603  

Total assets

     529,079        972,896        146,227        1,090,430        163,892  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Current liabilities:

              

Accounts payable

     252,073        524,072        78,769        435,270        65,422  

Bank borrowings

     —          10,000        1,503        40,000        6,012  

Total liabilities

     277,823        634,370        95,347        607,730        91,341  

Total liabilities, mezzanine equity and equity

     529,079        972,896        146,227        1,090,430        163,892  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

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     For the Year Ended
December 31,
    For the Nine Months Ended
September 30,
 
     2015     2016     2016     2017  
     RMB     RMB     US$     RMB     RMB     US$  
     (in thousands)  

Summary Consolidated Cash Flow Data:

      

Net cash (used in)/provided by operating activities

     (6,767     17,266       2,595       59,769       336,216       50,533  

Net cash used in investing activities

     (4,911     (99,387     (14,938     (45,256     (5,507     (827

Net cash provided by financing activities

     214,063       10,024       1,507       —         30,089       4,522  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase/(decrease) in cash and cash equivalents

     202,385       (72,097     (10,836     14,513       360,798       54,228  

Exchange rate effect on cash and cash equivalents

     10,226       5,262       791       2,568       (2,635     (396

Cash, cash equivalents and restricted cash at beginning of the period

     7,376       219,987       33,064       219,987       153,152       23,019  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash, cash equivalents and restricted cash at end of the period

     219,987       153,152       23,019       237,068       511,315       76,851  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The following table presents certain of our operating data for the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2017.

 

     For the Year Ended
December 31,
     For the Nine
Months Ended
September 30,
 
     2015      2016      2017  
     (in millions)  

Units shipped(1)

     14.4        17.8        11.6  
  

 

 

    

 

 

    

 

 

 

 

Note:

(1)   Numbers of units shipped represent the numbers of smart bands, watches and scales shipped during the relevant periods, net of any return.

Non-GAAP Measures

We use adjusted net income, a non-GAAP financial measure, in evaluating our operating results and for financial and operational decision-making purposes. Adjusted net income represents net income excluding share-based compensation expenses, and such adjustment has no impacts on income tax.

We believe that adjusted net income helps identify underlying trends in our business that could otherwise be distorted by the effect of certain expenses that we include in net income. We believe that adjusted net income provides useful information about our operating results, enhance the overall understanding of our past performance and future prospects and allow for greater visibility with respect to key metrics used by our management in its financial and operational decision-making.

Adjusted net income should not be considered in isolation or construed as an alternative to net income or any other measure of performance or as an indicator of our operating performance. Investors are encouraged to review the historical non-GAAP financial measures to the most directly comparable GAAP measures. Adjusted net income presented here may not be comparable to similarly titled measures presented by other companies. Other companies may calculate similarly titled measures differently, limiting their usefulness as comparative measures to our data. We encourage investors and others to review our financial information in its entirety and not rely on a single financial measure.

 

 

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The table below sets forth a reconciliation of our adjusted net income to net (loss)/income for the periods indicated.

 

     For the Year Ended December 31,      For the Nine Months Ended September 30,  
     2015     2016      2016     2017  
     RMB     RMB      US$      RMB     RMB      US$  
     (in thousands)  

Net (loss)/income

     (37,853     23,946        3,599        (19,045     95,115        14,296  

Add:

               

Share-based compensation expenses

     55,991       57,735        8,678        43,363       48,575        7,301  
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Adjusted net income

     18,138       81,681        12,277        24,318       143,690        21,597  
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

 

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RISK FACTORS

An investment in our ADSs involves significant risks. You should consider carefully all of the information in this prospectus, including the risks and uncertainties described below, before making an investment in our ADSs. Any of the following risks could have a material and adverse effect on our business, financial condition and results of operations. In any such case, the market price of our ADSs could decline, and you may lose all or part of your investment.

Risks Related to Our Business and Industry

Xiaomi is our most important customer and distribution channel. Any deterioration of our relationship with Xiaomi or reduction of sales of Xiaomi Wearable Products could have a material adverse effect on our operating results.

Xiaomi is the sole customer and distribution channel for all Xiaomi Wearable Products, and it currently holds 19.3% of our total outstanding shares. For the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2017, sales of Xiaomi Wearable Products contributed 97.1%, 92.1% and 82.4% of our revenues, respectively.

We entered into a strategic cooperation agreement with Xiaomi in October 2017, which grants us the most-preferred-partner status globally to develop future Xiaomi Wearable Products. This strategic cooperation agreement can be terminated by Xiaomi and we can therefore lose the most-preferred-partner status if we fail to meet the various requirements set out in the agreement, such as requirements on product launching timetable, product quality and annual sales target of Xiaomi Wearable Products. In addition, Xiaomi has the option to develop by itself or engage other companies to develop similar and competing products, if such companies can offer better terms and services than we do—for example such companies may ask for less profit sharing or less intellectual property rights from their cooperation with Xiaomi. The strategic cooperation agreement will expire in October 2020; we cannot assure you that we will be able to renew this agreement upon its expiry or on the same terms. If for any reason, we cannot maintain our cooperation relationship with Xiaomi, our business and operation results may be materially adversely affected. For more details of the strategic cooperation agreement with Xiaomi, including under what circumstances it can be early terminated, please see “Related Party Transaction—Our Relationship with Xiaomi—Strategic Cooperation Agreement.”

Xiaomi is also an important distribution channel for our self-branded products. If Xiaomi is not successful in selling our products, which in turn can be due to various reasons, including lower demand, market competition and decreasing efficiency of distribution network, our revenue may decrease. Furthermore, negative publicity related to Xiaomi, including products offered by Xiaomi, the celebrities Xiaomi is associated with, or even the labor policies of any of Xiaomi’s suppliers or manufacturers may have a material adverse effect on the sales of our products.

In addition, Xiaomi sells a broad spectrum of electronic products through its online and offline channels. We cannot assure you that our products can always receive the same level of attention and promotion efforts from Xiaomi as they have been so far receiving. In the event that Xiaomi dedicates less resources in promoting and selling our products, our revenue may decrease as well. If we lose Xiaomi as our customer or distribution channel for any reason, we will need to build a larger distribution network on our own, which can be time and resource consuming, and there is no assurance that we can achieve that in an effective and efficient manner, or at all.

When exercising its rights as our shareholder, Xiaomi may take into account not only the interests of our company and our shareholders but also its interests and the interests of its other affiliates. The interests of our company and our shareholders may at times conflict with the interests of Xiaomi and its affiliates. Such conflicts may result in lost corporate opportunities for our company, including opportunities to enter into lines of business that may overlap with those pursued by Xiaomi and/or the companies within its ecosystem.

 

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If we fail to successfully and timely develop and commercialize new products, services and technologies, our operating results may be materially adversely affected.

Historically, sales of smart bands and watches contributed a significant majority of our revenues and our growth has been influenced by our product launches and product cycle. In particular, sales of our smart band products (including Mi Bands and Amazfit Bands) contributed 81.7%, 85.8% and 73.2% of our total revenues in the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2017, respectively. Our future growth depends on whether we can continually develop and introduce new generations of our existing product lines and new forms of smart wearable technology with enhanced functionalities and value-added services in a timely manner. This is particularly important in the current industry landscape where technology and consumer preference evolve constantly and rapidly, which may cause our existing products to reach the end of their lifecycles prematurely and require us to introduce new products with enhanced functionalities to sustain our growth. Our capability to roll out new or enhanced products and services in turn depend on a number of factors, including timely and successful research and development efforts by us as well as our suppliers to bring cutting-edge technologies to the market and quality control of service provision and product manufacturing and our distribution channels. Pursuant to our strategic cooperation agreement with Xiaomi, we are also required to consult Xiaomi regarding the product launch timetable for Xiaomi Wearable Products. If we are unable to commercialize appealing new products, functionalities, services or innovative technologies leveraging our data in a timely manner and introduce them to consumers at attractive price points compared to our existing products and competing products, or our new products, services or technologies are not accepted or adopted by consumers, our competitors may increase their market share, which could adversely impact our operating results. In addition, the research and development of new or enhanced products and services can be complex and costly. Given the complexity, we could experience delays in completing the development and introduction of new and enhanced services and products in the future. Our research and development effort may not yield the benefits we expect to achieve at all after we dedicate our time and resources into it.

We are endeavoring to apply our products in more scenarios, and medical use is one area that we put in significant efforts. Some of our existing products monitor users’ cardiac cycle, which have significant potential for medical application. For example, a doctor may use our products to monitor the cardiac cycle of his or her patients. In such applications, our products may be deemed as medical devices, and we may be required to obtain the relevant medical device registration certificate. See “Regulation—Regulation on Medical Device.” We are in the process of applying for medical device registration certificate for these products so that they can be advertised and sold as medical devices, possibly through prescription by physicians. The process of obtaining regulatory clearances or approvals to market a medical device, however, can be costly and time consuming. We may not be able to obtain these clearances or approvals on a timely basis, or at all, in order to extend our business into medical use wearable device market. Moreover, even if we successfully obtain the required approvals for our products, given the complex and stringent nature of regulation on medical devices, failure to comply with applicable China Food and Drug Administration (CFDA) regulations will subject us to enforcement actions such as fines, civil penalties or recalls of products, which could harm our reputation and operating results.

We operate in highly competitive markets and the scale and resources of some of our competitors may allow them to compete more effectively than we can, which could result in a loss of our market share and a decrease in our revenue and profitability.

We offer a number of products and services and compete with a variety of competitors. For example, the smart wearables market has a multitude of participants, including consumer electronics companies specialized in smart wearable technology, such as Fitbit and Garmin; large, broad-based consumer electronics companies that either compete in our market or adjacent markets, or have announced plans to do so, such as Huawei, Apple and Samsung; traditional health and fitness companies and traditional watch companies. We also face competition from local providers of similar products in the various regions and countries where our products are distributed. Intensified competition may result in pricing pressures and reduced profit margins and may impede our ability to

 

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continue to increase the sales of our products or cause us to lose market share, any of which could substantially harm our results of operations.

Many of our existing and potential competitors enjoy substantial competitive advantages, such as: (i) longer operating history, (ii) the capacity to leverage their sales efforts and marketing expenditures across a broader portfolio of products, (iii) more established relationships with a larger number of suppliers, contract manufacturers and channel partners, (iv) access to larger and broader user bases, (v) greater brand recognition, (vi) greater financial, research and development, marketing, distribution and other resources, (vii) more resources to make investments and acquisitions, (viii) larger intellectual property portfolios, and (ix) the ability to bundle competitive offerings with other products and services.

If we are unable to anticipate and satisfy consumer preferences in a timely manner or technological innovation renders existing smart wearable technology non-competitive or obsolete, our business may be materially and adversely affected.

Consumer preferences in smart wearable devices are changing rapidly and difficult to predict. Consumers may decide not to purchase our products and services as their preferences shift to different types or designs of smart wearable devices, or even move away from these categories of products and services altogether. In particular, new technologies might bring about industry-wide impacts and make the category of smart bands and watches less appealing or obsolete. In addition, our new products and services with additional features have higher prices than many of our earlier products, which may not appeal to as large a consumer base. Accordingly, if we fail to anticipate and satisfy consumer preferences in a timely manner, or if it is perceived that our future products and services will not satisfy consumer preferences, our business may be adversely affected.

In addition, as the smart wearable technology continues to develop, the functions of smart bands and smart watches may converge, which in turn may cause our smart band product lines to compete with our smart watch product lines and inhibit our future growth.

Our future success depends on our ability to promote our own brands and protect our reputation. The failure to establish and promote our brands, including Amazfit, and any damage to our reputation will hinder our growth.

Since September 2015, we have begun to use the brand, “Amazfit,” to sell our products that are not designed and manufactured for Xiaomi to address the middle to high-end market. Prior to that, all of our products were Xiaomi Wearable Products. We believe the strategy to establish and promote our own brand is crucial to our future success as it expands our addressable market and gives us more flexibility in terms of pricing, distribution and marketing compared to our cooperation with Xiaomi on Xiaomi Wearable Products. We have invested, and will need to continue to dedicate, significant time, efforts and resources to build our own brand recognition. Shipments of our self-branded products have increased from approximately 129,000 units in the first nine months of 2016 to approximately 464,000 units in the first nine months of 2017. For the nine months ended September 30, 2016 and 2017, revenues from our self-branded products and others segment, substantially all of which was from the sales of our self-branded products, were RMB70.3 million and RMB227.8 million (US$34.2 million), representing 7.5% and 17.6% of our total revenues, respectively. However, we cannot guarantee that the shipment of our self-branded products will continue to grow, or that our promotion efforts will ultimately be successful, as it involves numerous factors including the effectiveness of our marketing efforts, our ability to provide consistent, high quality products and services, and our consumers’ satisfaction with the technical support and software updates we provide.

In addition, negative publicity related to our brand, products, contract manufacturers, component suppliers, distributors, strategic partners and the celebrities we are associated with could damage and offset our effort to promote our own brands. For example, our company name in Chinese character, “ LOGO ”, has been preempted as a trademark by a company unaffiliated to us under certain trademark categories in China. This company currently

 

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manufactures and sells products and service lines similar to ours using this trademark. As a result, consumers may be confused and associate any quality issue on the products and services they provide with us, which will have an adverse impact on our brand image.

We do not have internal manufacturing capabilities and rely on several contract manufacturers to produce our products. If we encounter issues with these contract manufacturers, our business, brand and results of operations could be harmed.

We do not maintain our own manufacturing capabilities and rely on contract manufactures to produce our products. We assign the production of Mi Band series and Mi Smart Scale series to a number of manufacturers while each of our self-branded product lines is assigned to a corresponding manufacturer. We may experience operational difficulties with our manufacturers, including reductions in the availability of production capacity, failures to comply with product specifications, insufficient quality control, failures to meet production deadlines, increases in manufacturing costs and longer lead time required. Our manufacturers may experience disruptions in their manufacturing operations due to equipment breakdowns, labor strikes or shortages, natural disasters, component or material shortages, cost increases or other similar problems. In addition, we may not be able to renew contracts with our contract manufacturers or identify manufacturers who are capable of producing new products we target to launch in the future.

We are susceptible to supply shortages, long lead time for raw materials and components, and supply changes, any of which could disrupt our supply chain and have a material adverse impact on our results of operation because some of the key components of our products, such as Bluetooth Low Energy (BLE) system-on-chip and sensors, come from a limited number or a single source of supply.

All of the components and raw materials used to produce our products are sourced from third-party suppliers, and some of these components are sourced from a limited number of or a single supplier. Therefore, we are subject to risks of shortages or discontinuation in supply, long lead time, cost increases and quality control issues with the limited sources of suppliers. In addition, some of our suppliers may have more established relationships with our competitors, and as a result of such relationships, such suppliers may choose to limit or terminate their relationship with us or prioritize our competitors’ orders in the case of supply shortages. We have in the past experienced and may in the future experience component shortages. For example, we have experienced component shortages and longer lead time for components such as PPG (photoplethysmography) sensors and gravity sensors, most recently in the third quarter of 2017 due to higher than expected demand for Xiaomi Wearable Products and our smart watches product lines. In addition, as many of electronics component suppliers are concentrated in East and Southeast Asia, there have been industry-wide conditions, natural disasters and global events in the past that have caused material shortages for components, such as a shortage of flash memory in 2011 in aftermath of the tragic earthquake and tsunami in Japan. While component shortages have historically been immaterial, they could be material in the future.

In the event of a component shortage or supply interruption from suppliers of key components, we will need to identify alternate sources of supply, which can be time-consuming, difficult and costly. We may not be able to source these components on terms that are acceptable to us, or at all, which may undermine our ability to meet our production requirements or to fill our orders in a timely manner. This could cause delays in shipment of our products, harm our relationships with our customers, distributors and users, and adversely affect our results of operations.

Our operating results could be materially harmed if we or Xiaomi is unable to accurately forecast consumer demand for our products and services or manage our inventory.

To ensure adequate inventory supply for our products, we procure raw materials and components based on sales and production forecasts. The ability to accurately forecast demand for our products and services could be affected by many factors, including changes in customer demand for our products and services or our

 

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competitors’, sales promotions by us or our competitors, sales channel inventory levels, and unanticipated changes in general market and economic conditions. In addition, as we continue to introduce new products and services, we may also face challenges managing the production plan of our existing products, which may in turn affect the inventory management for our existing products. If we or our customers fail to accurately forecast customer demand, we may experience excess inventory levels or a shortage of products available for sale. Inventory levels in excess of customer demand may result in inventory write-downs or write-offs and the sale of excess inventory at discounted prices, which may cause our gross margin to suffer and could impair the strength of our brand. On the other hand, in the case we experience shortage of products, we may be unable to meet the demand for our products, and our business and operating results could be adversely affected. We expect that it will become more difficult to forecast demand as we introduce and develop a more diverse product portfolio and as market competition for similar products intensifies.

Our intellectual property and proprietary rights may not adequately protect our products, and our business may suffer if it is alleged or determined that our technologies, products, or other aspects of our business infringe third party intellectual property or if third parties infringe our rights.

We may fail to own or apply for key trademarks or patents on important products, services, technologies or designs in a timely fashion, or at all. For example, our company name in Chinese characters, “ LOGO ”, has been registered as a trademark by a company unaffiliated to us in certain trademark categories in China. As such, we currently cannot use the “ LOGO ” trademark in certain categories of products and our self-branded products are sold under the brand name of “Amazfit.” In addition, this company currently manufactures and sells products and service lines similar to ours under the “ LOGO ” trademark. As a result, consumers may be confused and associate any quality issue on the products and services they provide with us, which will have an adverse impact on our brand image. Furthermore, the “ LOGO ” trademark in several other trademark categories—which is contractually owned jointly by Xiaomi and us—is currently registered under the name of Xiaomi alone. Xiaomi is in the process of transferring its title to us pursuant to the relevant agreement. However, in the event that the transfer process is not completed as planned, we will not be able to use “ LOGO ” as a trademark in these additional categories as well. We have registered “Amazfit” as our trademarks in China in several categories and in the U.S., and we are in the process of registering it in additional categories or in combination with logo. There can be no assurance, however, that we will be able to register the trademark of “Amazfit” in all categories or all format as we desire.

Various other issues may arise with respect to our intellectual property portfolio. We and Xiaomi are co-owners of certain patents, certain other intellectual properties and user data related to Xiaomi Wearable Products. There is a possibility that Xiaomi may use these intellectual properties and user data to develop and manufacture competing products on its own or engage other companies leveraging such resources to do so. In addition, we may not have sufficient intellectual property rights in all countries and regions where unauthorized third-party copying or use of our proprietary technology may occur and the scope of our intellectual property might be more limited in certain countries and regions. Our existing and future patents may not be sufficient to protect our products, services, technologies or designs and/or may not prevent others from developing competing products, services, technologies or designs. We cannot predict the validity and enforceability of our patents and other intellectual property with certainty.

Litigation may be necessary to enforce our intellectual property rights. Initiating infringement proceedings against third parties can be expensive and time-consuming, and divert management’s attention from other business concerns. We may not prevail in litigation to enforce our intellectual property against unauthorized use.

Additionally, we receive from time to time letters alleging infringement of patents, trademarks or other intellectual property rights by us.

 

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We collect, store, process and use personal information and other user data, which subjects us to governmental regulations and other legal obligations related to privacy, information security, and data protection, and any security breaches or our actual or perceived failure to comply with such legal obligations could harm our brand and business.

Exploring growth opportunities with our wealth of data is one of our key strategies. Due to the volume and sensitivity of the personal information and biometric data we collect and manage and the nature of our products, the security features of our enterprise platform and information systems are critical.

We have adopted security policies and measures, including encryption technology, to protect our proprietary data and user information. However, our enterprise platform and information systems may be targets of attacks, such as viruses, malware or phishing attempts by cyber criminals or other wrongdoers seeking to steal our user data for financial gain or to harm our business operations or reputation. The loss, misuse or compromise of such information may result in costly investigations, remediation efforts and notification to affected users. If such content is accessed by unauthorized third parties or deleted inadvertently by us or third parties, our brand and reputation could be adversely affected. Cyber-attacks could also adversely affect our operating results, consume internal resources, and result in litigation or potential liability for us and otherwise harm our business. In addition, according to our cooperation agreement with Xiaomi, both Xiaomi and we have access and can collect and use user data of Xiaomi Wearable Products. Consequently, any leak or abuse of user data by Xiaomi may be perceived by consumers as a result of the compromise of our information security system. Any failure or perceived failure by us to prevent information security breaches or to comply with privacy policies or privacy-related legal obligations, or any compromise of security that results in the unauthorized release or transfer of personally identifiable information or other customer data, could cause our users to lose trust in us and could expose us to legal claims.

A growing number of legislative and regulatory bodies have adopted consumer notification requirements in the event of unauthorized access to or acquisition of certain types of personal data. Such breach notification laws continue to evolve and may be inconsistent from one jurisdiction to another, which might become a particular concern as we accelerate our international expansion. Complying with these obligations could cause us to incur substantial costs and could increase negative publicity surrounding any incident that compromises user data. Any failure to comply with applicable regulations could also result in regulatory enforcement actions against us.

If we continue to grow, we may not be able to effectively manage our growth and the increased complexity of our business, which could negatively impact our brand and financial performance.

Since our founding in December 2013, our company has experienced rapid growth. Continued growth of our business requires us to expand our product development, sales and marketing, and distribution functions, to upgrade our management information systems and other processes and technology, and to secure more space for our expanding workforce. Such expansion could increase the strain on our resources, and we could experience serious operating difficulties, including difficulties in hiring, training, and managing an increasing number of employees.

As we only have a limited history of operating our business at its current scale, it is difficult to evaluate our current business and future prospects, including our ability to plan for and model future growth. Our limited operating experience at this scale, combined with the rapidly evolving nature of the market in which we sell our products and services, substantial uncertainty concerning how these markets may develop, and other economic factors beyond our control, reduces our ability to accurately forecast quarterly or annual revenue. As such, any predictions about our future revenue and expenses may not be as accurate as they would be if we had a longer operating history or operated in a more developed and predictable market. Failure to manage our future growth effectively could have an adverse effect on our business, which, in turn, could have an adverse impact on our operating results and financial condition.

 

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We are subject to a variety of costs and risks due to our continued expansion internationally that may not be successful and could adversely affect our profitability and operating results.

Our products have international versions that are manufactured for sales and distribution in overseas markets. The shipment volume of international versions of our products, as a percentage of our total shipment volume, increased from 7.9% in 2015 to 12.8% in 2016 and further to 18.9% in the first nine months of 2017. International expansion represents a large opportunity to further grow our business and enhance our competitive position, and is one of our core strategies.

We may enter into new geographic markets where we have limited or no experience in marketing, selling, and localizing and deploying our products. International expansion has required and will continue to require us to invest significant capital and other resources and our efforts may not be successful. International sales and operations may be subject to risks such as:

 

    limited brand recognition (compared with our home market in China);

 

    costs associated with establishing new distribution networks;

 

    foreign consumers’ preferences and customs;

 

    difficulties in staffing and managing foreign operations;

 

    burdens of complying with a wide variety of local laws and regulations, including packaging and labeling;

 

    adverse tax effects and foreign exchange controls making it difficult to repatriate earnings and cash;

 

    political and economic instability;

 

    trade restrictions;

 

    differing employment practices and laws and labor disruptions;

 

    the imposition of government controls;

 

    lesser degrees of intellectual property protection;

 

    tariffs and customs duties and the classifications of our goods by applicable governmental bodies; and

 

    a legal system subject to undue influence or corruption.

The occurrence of any of these risks could negatively affect our international business and consequently our business and operating results. In addition, the concern over these risks may also prevent us from entering into or releasing certain of our products in certain markets.

Our current international expansion efforts primarily depend on Xiaomi’s brand recognition and distribution channels in markets outside China. If we are unable to leverage such advantage in the future, such as in the event that the brand recognition of Xiaomi deteriorates or Xiaomi fails to establish its global distribution network, our expansion efforts will be hindered.

We cooperate with a wide range of strategic partners to enable diversified application scenarios. If we fail to expand or maintain the pool of our strategic partners, the number of application scenarios of our products may not grow as quickly, or at all, which may reduce the attractiveness of our products. Any underperformance or negative publicity of our strategic partners may also adversely affect our operating results.

It requires resources and contributions from a variety of market players to capitalize on the data and user base that we have accumulated so far. We have been actively seeking strategic cooperation opportunities on this front to create diverse application scenarios of our products. If we fail to expand or maintain the pool of our partners, the growth of application scenarios of our products may slow down or even wither, which in turn may affect the willingness of our users to purchase our products.

 

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As in any cooperation relationship, the success of our initiatives to extend the application scenarios of our products together with our strategic partners involves many factors beyond our control. Additionally, there can be no assurances that our choices of strategic partners can always deliver satisfactory performance to our users, that our strategic partners would not replace us with any of our competitors, and that our current strategic partners would not leave the market. Further, as we associate ourselves with these strategic partners in providing services, any negative publicity on them may also have adverse impact on our own reputation.

Our future success depends on the continuing efforts of our key employees, including our founder Mr. Wang Huang, and on our ability to attract and retain highly skilled personnel and senior management.

Our future success depends, in part, on our ability to continue to attract and retain highly skilled personnel. In particular, we are highly dependent on the contributions of our founder Mr. Wang Huang, as well as other members of our senior management team. The loss of any key personnel could be disruptive to our operations and research and development activities, reduce our employee retention and revenue, and impair our ability to compete.

Certain director may have conflicts of interest.

One of our directors Mr. De Liu is also a co-founder and a senior vice president of Xiaomi. Such association may give rise to potential conflicts of interest, especially with regarding to our business cooperation with Xiaomi. Directors of our Company are required by law to act honestly and in good faith with a view to the best of our interests and to disclose any interest that they may have in any of our projects or opportunities. In addition, we will adopt a code of ethics and an audit committee charter, both of which will become effective upon the effectiveness of the registration statement to which this prospectus is a part. The code of ethics will provide that an interested director needs to refrain from participating in any discussion among senior officers of our Company relating to an interested business and may not be involved in any proposed transaction with such interested business. Furthermore, the audit committee charter will provide that most related party transactions must be pre-approved by the audit committee, which will consist of only independent directors. Our audit committee charter, however, will exempt the pre-approval requirement for related party transactions that are immaterial to us or not unusual by nature. In the event of such transactions with Xiaomi, Mr. Liu will still be entitled to vote on our board meeting, and we cannot assure you that Mr. Liu’s decision will not be impacted by any potential conflict of interest rising from his association with Xiaomi.

We have granted, and may continue to grant, options and other types of awards under our share incentive plan, which may result in increased share-based compensation expenses.

We adopted a share incentive plan in 2015 and 2018, which we refer to as the 2015 Plan and the 2018 Plan, respectively, in this prospectus, for the purpose of granting share-based compensation awards to employees, directors and consultants to incentivize their performance and align their interests with ours. We recognize expenses in our consolidated statement of income in accordance with U.S. GAAP. Under our two share incentive plans, we are authorized to grant options and other types of awards. The maximum aggregate number of shares which may be issued pursuant to all awards under the 2015 Plan and the 2018 Plan is 14,328,358 class A ordinary shares and              ordinary shares, respectively. As of the date of this prospectus, awards to purchase 14,111,029 class A ordinary shares under the 2015 Plan have been granted and outstanding, excluding awards that were forfeited or cancelled after the relevant grant dates. No award has been granted under the 2018 Plan. Some of our outstanding awards set the completion of an initial public offering of our ordinary shares as performance condition for vesting. As a result, a number of awards will become vested once we complete this offering, and we will then record a significant share-based compensation expense on the completion date of this offering. As of September 30, 2017, our unrecognized share-based compensation expenses amounted to RMB80.1 million (US$12.0 million).

We believe the granting of share-based awards is of significant importance to our ability to attract and retain key personnel and employees, and we will continue to grant share-based compensation to employees in the

 

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future. As a result, our expenses associated with share-based compensation may increase, which may have an adverse effect on our results of operations.

Competition for highly skilled personnel is often intense and we may incur significant costs or not successful in attracting, integrating, or retaining qualified personnel to fulfill our current or future needs. We have, from time to time, experienced, and we expect to continue to experience, difficulty in hiring and retaining highly skilled employees with appropriate qualifications. In addition, if any of our senior management or key personnel joins a competitor or forms a competing company, we may lose knowhow, trade secrets, business partners and key personnel. Furthermore, perspective candidates and existing employees often consider the value of the equity awards they receive in connection with their employment. Thus, our ability to attract or retain highly skilled employees may be adversely affected by declines in the perceived value of our equity or equity awards. Furthermore, there are no assurances that the number of shares reserved for issuance under our share incentive plans will be sufficient to grant equity awards adequate to recruit new employees and to compensate existing employees.

Higher labor costs and inflation may adversely affect our business and our profitability.

Labor costs in China have risen in recent years as a result of the enactment of new labor laws and social development. Given our contract manufacturers are currently all located in China, rising labor costs in China will increase their costs, which in turn may be reflected in the manufacturing fees charged by these contract manufacturers to us.

In addition, we have witnessed growing inflation rates in many areas of the world, and particularly in Asia where we procure most of our raw materials, which adversely affects us and our suppliers alike.

The rising costs as a result of higher labor cost of our contract manufacturers and increasing raw material price, on the other hand, cannot be easily passed to end consumers in the form of higher retail sale prices due to severe competition in the smart wearable device market. Our profitability therefore may be adversely affected if labor cost and inflation continue to rise in the future.

Our business is subject to seasonal fluctuations and if our sales fall below our forecasts, our overall financial conditions and results of operations could be adversely affected.

Our business is subject to seasonal fluctuations, which may be caused by product launches and various promotional events hosted by our distributors. Our revenues have been higher in the fourth quarter each year primarily as a result of promotional events organized by TMall and other e-commerce platforms. Accordingly, any shortfall in expected fourth quarter revenue would adversely affect our annual operating results.

Furthermore, our rapid growth may obscure the extent to which seasonality trends have affected our business. Accordingly, yearly or quarterly comparisons of our operating results may not be useful and our results in any particular period will not necessarily be indicative of the results to be expected for any future period.

You should not rely on our Mobile App MAU or number of registered users metrics as indicators of future retention of users, continual user engagement or other revenue opportunities.

Our MAU metric tracks the number of the accounts that have been logged into on our mobile apps during a given calendar month. Our number of registered users metric tracks the number of users who have completed the registration process on our mobile apps as of a specified date. They do not fully capture the frequency and duration that users engage with our devices as users may not sign in or stay logged in on our mobile apps when using our devices. The Mobile App MAU and the number of registered users metrics only represent the potential size or growth of our user community and are not necessarily indicators of the actual size and growth of our user community. In addition, most of the services provided on our mobile apps currently are offered to users for free

 

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once they have purchased our smart wearable devices. Therefore, our Mobile App MAU metric should not be relied upon as an indicator of the level of retention of individual users in the future or continual user engagement, nor the potential size and growth of our user community as an indicator for other revenue opportunities.

We may engage in acquisition and investment activities, which could require significant management attention, disrupt our business, dilute shareholder value, and adversely affect our operating results.

As part of our business strategy, we may acquire or make investments in other companies, products, or technologies to enhance the features and functionality of our devices, and accelerate the expansion of our platform and network of strategic partners. We may not be able to find suitable acquisition or investment candidates and we may not be able to complete acquisition and investment on favorable terms, if at all. If we do complete acquisition and investment as we expect, we may not ultimately strengthen our competitive position or achieve our goals; and any acquisition and investment we complete could be viewed negatively by users or investors. In addition, if we fail to successfully integrate such acquisitions, or the technologies associated with such acquisitions, into our company, the revenue and operating results of the combined company could be adversely affected.

Acquisitions and investments may disrupt our ongoing operations, divert management from their primary responsibilities, subject us to additional liabilities, increase our expenses, and adversely impact our business, financial condition, operating results, and cash flows. We may not accurately forecast the financial impact of an acquisition or investment transaction, including accounting charges. We would have to pay cash, incur debt, or issue equity securities to pay for any such acquisition and investment, each of which may affect our financial condition or the value of our capital stock and could result in dilution to our shareholders. We had RMB78.8 million (US$11.8 million) of short-term and long-term investments as of September 30, 2017. Most of our investee companies are in their early stages and may not be able to achieve profitability or generate positive operating cash flows in the near future. A partial or complete loss of our investments in these investee companies is possible.

Additionally, we may receive indications of interest from other parties interested in acquiring some or all of our business. The time required to evaluate such indications of interest could require significant attention from management, disrupt the ordinary functioning of our business, and adversely affect our operating results.

An economic downturn or economic uncertainty may adversely affect consumer discretionary spending and demand for our products and services.

Our products and services may be considered discretionary items for consumers. Factors affecting the level of consumer spending for such discretionary items include general economic conditions, and other factors, such as consumer confidence in future economic conditions, fears of recession, the availability and cost of consumer credit, levels of unemployment, and tax rates. As global economic uncertainty remains, trends in consumer discretionary spending also remain unpredictable and subject to reductions. Unfavorable economic conditions may lead consumers to delay or reduce purchases of our products and services and consumer demand for our products and services may not grow as we expect. Our sensitivity to economic cycles and any related fluctuation in consumer demand for our products and services may have an adverse effect on our operating results and financial condition.

We are subject to governmental economic sanctions laws that could subject us to liability and impair our ability to compete in international markets.

Exports of our products must be made in compliance with various economic and trade sanctions laws in different jurisdictions. For example, U.S. economic sanctions prohibit the provision of products and services to countries, governments, and persons targeted by U.S. sanctions. Even though we take precautions to prevent our products from being provided to targets of U.S. sanctions, our products, including our firmware updates, could be

 

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provided to those targets through independent distributors despite such precautions. Any such provision could have negative consequences, including government investigations, penalties and reputational harm. We could be subject to future enforcement action with respect to compliance with governmental economic sanctions laws that result in penalties and costs that could have a material effect on our business and operating results.

Any significant cybersecurity incident or disruption of our information technology systems or those of third-party partners could materially damage user relationships and subject us to significant reputational, financial, legal and operation consequences.

We depend on our information technology systems, as well as those of third parties, to develop new products and services, operate our platform, host and manage our services, store data, process transactions, respond to user inquiries, and manage inventory and our supply chain. Any material disruption or slowdown of our systems or those of third parties whom we depend upon, including a disruption or slowdown caused by our failure to successfully manage significant increases in user volume, could cause outages or delays in our services, particularly in the form of interruption of services delivered by our mobile applications, which could harm our brand and adversely affect our operating results. We rely on cloud servers maintained by cloud service providers to store our data, and the majority of the data we collected are hosted at Xiaomi’s cloud servers. Problems with our cloud service providers or the telecommunications network providers with whom they contract could adversely affect the experience of our users. Our cloud service providers could decide to cease providing us services without adequate notice. Any change in service levels at our cloud servers or any errors, defects, disruptions, or other performance problems with our platform could harm our brand and may damage the data of our users. If changes in technology cause our information systems, or those of third parties whom we depend upon, to become obsolete, or if our or their information systems are inadequate to handle our growth, we could lose users and our business and operating results could be adversely affected.

Our use of open source software could negatively affect our ability to sell our products and subject us to possible litigation.

A portion of the technologies we use incorporates open source software, and we may incorporate open source software in the future. Such open source software is generally licensed by its authors or other third parties under open source licenses. These licenses may subject us to certain unfavorable conditions, including requirements that we offer our products and services that incorporate the open source software for no cost, that we make publicly available source code for modifications or derivative works we create based upon, incorporating, or using the open source software, or that we license such modifications or derivative works under the terms of the particular open source license. Additionally, if a third-party software provider has incorporated open source software into software that we license from such provider, we could be required to disclose or provide at no cost any of our source code that incorporates or is a modification of such licensed software. If an author or other third party that distributes open source software that we use or license were to allege that we had not complied with the conditions of the applicable license, we could be required to incur significant legal expenses defending against such allegations and could be subject to significant damages and enjoined from the sale of our products and services that contained the open source software. Any of the foregoing could disrupt the distribution and sale of our products and services and harm our business.

We are exposed to potential liabilities arising from the products we sell, and costs related to defective products could have a material adverse impact on us.

Contractual disputes over warranties of our products can arise in the ordinary course of business. In extreme situations, we may be exposed to potential injury liabilities as a result of misuse or quality defects of the products we sell. There can be no assurance that we will not experience material product liability losses in the future, or that we will be able to defend such claims at a contained level of cost. We currently do not have product liability insurance, and we cannot assure you that we would be able to obtain insurance coverage with sufficient coverage at an acceptable cost in the future. A successful claim brought against us in excess of our available insurance

 

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coverage may have a material adverse effect on our business. Although we had insignificant volume of product replacements or product returns historically, the cost of product replacements or product returns may be substantial, and we could incur substantial costs to implement modifications to fix defects.

In addition, due to the nature of some of our smart wearable devices, some users have had in the past and may in the future experience skin irritations or other biocompatibility issues not uncommon with jewelry or other wearable products that stay in contact with skin for extended periods of time. There have been a limited number of reports from some users of certain of our devices experiencing skin irritations. This negative publicity could harm sales of our products and also adversely affect our relationships with distributors and retailers that sell our products, including causing them to be reluctant to continue to sell our products. If large numbers of users experience these problems, we could be subject to enforcement actions or the imposition of significant monetary fines or other penalties by regulatory agencies, and face personal injury or class action litigation, any of which could have a material adverse impact on our business, financial condition and operating results.

We also rely on the accuracy of sensors and our algorithms to ensure that our products can offer high measurement accuracy. Additionally, usages of our products in different physical environment or by different type of users may require delicate modification of our sensors and algorithms. There is, however, no assurance that functionality of sensors from our suppliers or our algorithms can progress as much and quickly to meet demand of our users. Although we have not received significant claims of inaccuracy of measurements by our products in the past, these claims may occur from time to time. Such claims may further bring warranty claims, regulatory investigations and litigation. In that case, our brand may suffer from negative publicity, which may then result in loss of consumer confidence and reduction of sales in our products.

We do not maintain insurance coverage which could expose us to significant costs and business disruption.

We do not maintain liability insurance coverage for our products and business operation. A successful liability claim against us due to injuries suffered by our users could materially and adversely affect our financial conditions, results of operations and reputation. In addition, we do not have any business disruption insurance. Any business disruption event could result in substantial cost to us and diversion of our resources.

If we fail to implement and maintain an effective system of internal controls, we may be unable to accurately or timely report our results of operations or prevent fraud, and investor confidence and the market price of our ADSs may be materially and adversely affected.

Prior to this offering, we were a private company with limited accounting personnel and other resources with which to address our internal controls and procedures. Our management has not completed an assessment of the effectiveness of our internal control over financial reporting, and our independent registered public accounting firm has not conducted an audit of our internal control over financial reporting. In the course of auditing our consolidated financial statements for the fiscal year ended December 31, 2016, we and our independent registered public accounting firm identified two material weaknesses in our internal control over financial reporting as well as other control deficiencies as of December 31, 2016, in accordance with the standards established by the Public Company Accounting Oversight Board of the United States.

The material weaknesses identified related to (i) our lack of accounting personnel with appropriate knowledge of U.S. GAAP and (ii) our lack of comprehensive accounting policies and procedures manual in accordance with U.S. GAAP.

Upon the completion of this offering, we will become a public company in the United States subject to the Sarbanes-Oxley Act of 2002. Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, will require that we include a report of management on our internal control over financial reporting in our annual report on Form 20-F beginning with our annual report for the fiscal year ending December 31, 2018. In addition, once we cease to be an “emerging growth company” as such term is defined in the JOBS Act, our independent registered

 

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public accounting firm must attest to and report on the effectiveness of our internal control over financial reporting. Our management may conclude that our internal control over financial reporting is not effective. Moreover, even if our management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm, after conducting its own independent testing, may issue a report that is qualified if it is not satisfied with our internal controls or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us. In addition, after we become a public company, our reporting obligations may place a significant strain on our management, operational and financial resources and systems for the foreseeable future. We may be unable to timely complete our evaluation testing and any required remediation.

During the course of documenting and testing our internal control procedures, in order to satisfy the requirements of Section 404, we may identify other weaknesses and deficiencies in our internal control over financial reporting. In addition, if we fail to maintain the adequacy of our internal control over financial reporting, as these standards are modified, supplemented or amended from time to time, we may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404. Generally speaking, if we fail to achieve and maintain an effective internal control environment, we could suffer material misstatements in our financial statements and fail to meet our reporting obligations, which would likely cause investors to lose confidence in our reported financial information. This could in turn limit our access to capital markets, harm our results of operations, and lead to a decline in the trading price of our ADSs. Additionally, ineffective internal control over financial reporting could expose us to increased risk of fraud or misuse of corporate assets and subject us to potential delisting from the stock exchange on which we list, regulatory investigations and civil or criminal sanctions.

Risks Related to Our Corporate Structure

If the PRC government finds that the agreements that establish the structure for operating some of our operations in China do not comply with PRC regulations relating to the relevant industries, or if these regulations or the interpretation of existing regulations change in the future, we could be subject to severe penalties or be forced to relinquish our interests in those operations.

Our WFOE has entered into a series of contractual arrangements with our VIEs and their respective shareholders, respectively, which enable us to (i) exercise effective control over our VIEs, (ii) receive substantially all of the economic benefits of our VIEs, and (iii) have an exclusive option to purchase all or part of the equity interests and assets in our VIEs when and to the extent permitted by PRC law. As a result of these contractual arrangements, we have control over and are the primary beneficiary of our VIEs and hence consolidate their financial results into our consolidated financial statements under U.S. GAAP. See “Corporate History and Structure” for further details.

In the opinion of Zhong Lun Law Firm, our PRC legal counsel, (i) the ownership structures of our VIEs in China and our WFOE, both currently and immediately after giving effect to this offering, comply with all existing PRC laws and regulations; and (ii) the contractual arrangements between our WFOE, our VIEs and their respective shareholders governed by PRC law are valid, binding and enforceable, and will not result in any violation of PRC laws or regulations currently in effect. However, our PRC legal counsel has also advised us that there are substantial uncertainties regarding the interpretation and application of current and future PRC laws, regulations and rules. Accordingly, the PRC regulatory authorities may take a view that is contrary to the opinion of our PRC legal counsel. It is uncertain whether any new PRC laws or regulations relating to variable interest entity structures will be adopted or if adopted, what they would provide. If we or any of our VIEs are found to be in violation of any existing or future PRC laws or regulations, or fail to obtain or maintain any of the required permits or approvals, the relevant PRC regulatory authorities would have broad discretion to take action in dealing with such violations or failures, including:

 

    discontinuing or placing restrictions or onerous conditions on our operations through any transactions between our WFOE and our VIEs;

 

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    imposing fines, confiscating the income from our WFOE or our VIEs, or imposing other requirements with which we or our VIEs may not be able to comply;

 

    requiring us to restructure our ownership structure or operations, including terminating the contractual arrangements with our VIEs and deregistering the equity pledges of our VIEs, which in turn would affect our ability to consolidate, derive economic interests from, or exert effective control over our VIEs; or

 

    restricting or prohibiting our use of the proceeds of this offering to finance our business and operations in China.

The imposition of any of these penalties would result in a material and adverse effect on our ability to conduct our business. In addition, it is unclear what impact the PRC government actions would have on us and on our ability to consolidate the financial results of our VIEs in our consolidated financial statements, if the PRC government authorities were to find our legal structure and contractual arrangements to be in violation of PRC laws and regulations. If the imposition of any of these government actions causes us to lose our right to direct the activities of our VIEs or our right to receive substantially all the economic benefits and residual returns from our VIEs and we are not able to restructure our ownership structure and operations in a satisfactory manner, we would no longer be able to consolidate the financial results of our VIEs in our consolidated financial statements. Either of these results, or any other significant penalties that might be imposed on us in this event, would have a material adverse effect on our financial condition and results of operations.

We rely on contractual arrangements with our VIEs and their shareholders for a large portion of our business operations, which may not be as effective as direct ownership in providing operational control.

We have relied and expect to continue to rely on contractual arrangements with our VIEs and their shareholders to conduct certain of our key businesses. These contractual arrangements may not be as effective as direct ownership in providing us with control over our VIEs. For example, our VIEs and their shareholders could breach their contractual arrangements with us by, among other things, failing to conduct their operations in an acceptable manner or taking other actions that are detrimental to our interests.

If we had direct ownership of our VIEs, we would be able to exercise our rights as a shareholder to effect changes in the board of directors of our VIEs, which in turn could implement changes, subject to any applicable fiduciary obligations, at the management and operational level. However, under the current contractual arrangements, we rely on the performance by our VIEs and their respective shareholders of their obligations under the contracts to exercise control over our VIEs. However, the shareholders of our consolidated VIEs may not act in the best interests of our company or may not perform their obligations under these contracts. Such risks exist throughout the period in which we intend to operate certain portions of our business through the contractual arrangements with our VIEs. If any disputes relating to these contracts remains unresolved, we will have to enforce our rights under these contracts through the operations of PRC law and arbitration, litigation and other legal proceedings and therefore will be subject to uncertainties in the PRC legal system. See “—Any failure by our VIEs or their shareholders to perform their obligations under our contractual arrangements with them would have a material and adverse effect on our business.” Therefore, our contractual arrangements with our VIEs may not be as effective in ensuring our control over the relevant portion of our business operations as direct ownership would be.

Any failure by our VIEs or their shareholders to perform their obligations under our contractual arrangements with them would have a material and adverse effect on our business.

We refer to the shareholders of each of our VIEs as its nominee shareholders because although they remain the holders of equity interests on record in each of our VIEs, pursuant to the terms of the relevant power of attorney, each such shareholder has irrevocably authorized our WFOE to exercise his, her or its rights as a shareholder of the relevant VIE. However, if our VIEs or their shareholders fail to perform their respective obligations under the contractual arrangements, we may have to incur substantial costs and expend additional

 

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resources to enforce such arrangements. We may also have to rely on legal remedies under PRC law, including seeking specific performance or injunctive relief, and claiming damages, which we cannot assure will be effective under PRC law. For example, if the shareholders of our VIEs refuse to transfer their equity interest in our VIEs to us or our designee if we exercise the purchase option pursuant to these contractual arrangements, or if they otherwise act in bad faith toward us, then we may have to take legal actions to compel them to perform their contractual obligations.

All of the agreements under our contractual arrangements are governed by PRC law and provide for the resolution of disputes through arbitration in China. Accordingly, these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. The legal system in the PRC is not as developed as in some other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements. See “—Risks Related to Doing Business in China—Uncertainties with respect to the PRC legal system and changes in laws and regulations in China could adversely affect us.” Meanwhile, there are very few precedents and little formal guidance as to how contractual arrangements in the context of a VIE should be interpreted or enforced under PRC law. There remain significant uncertainties regarding the ultimate outcome of such arbitration should legal action become necessary. In addition, under PRC law, rulings by arbitrators are final, parties cannot appeal the arbitration results in courts, and if the losing parties fail to carry out the arbitration awards within a prescribed time limit, the prevailing parties may only enforce the arbitration awards in PRC courts through arbitration award recognition proceedings, which would require additional expenses and delay. In the event we are unable to enforce these contractual arrangements, or if we suffer significant delays or other obstacles in the process of enforcing these contractual arrangements, we may not be able to exert effective control over our VIEs, and our ability to conduct our business may be negatively affected.

The shareholders of our VIEs may have potential conflicts of interest with us, which may materially and adversely affect our business and financial condition.

The shareholders of our VIEs may have potential conflicts of interest with us. These shareholders may breach, or cause our VIEs to breach, or refuse to renew, the existing contractual arrangements we have with them and our VIEs, which would have a material and adverse effect on our ability to effectively control our VIEs and receive economic benefits from them. For example, the shareholders may be able to cause our agreements with our VIEs to be performed in a manner adverse to us by, among other things, failing to remit payments due under the contractual arrangements to us on a timely basis. We cannot assure you that when conflicts of interest arise any or all of these shareholders will act in the best interests of our company or such conflicts will be resolved in our favor. Currently, we do not have any arrangements to address potential conflicts of interest between these shareholders and our company. If we cannot resolve any conflict of interest or dispute between us and these shareholders, we would have to rely on legal proceedings, which could result in disruption of our business and subject us to substantial uncertainty as to the outcome of any such legal proceedings.

Contractual arrangements in relation to our VIEs may be subject to scrutiny by the PRC tax authorities and they may determine that we or our PRC VIEs owe additional taxes, which could negatively affect our financial condition and the value of your investment.

Under applicable PRC laws and regulations, arrangements and transactions among related parties may be subject to audit or challenge by the PRC tax authorities. We could face material and adverse tax consequences if the PRC tax authorities determine that the VIE contractual arrangements were not entered into on an arm’s length basis in such a way as to result in an impermissible reduction in taxes under applicable PRC laws, rules and regulations, and adjust the income of our VIEs in the form of a transfer pricing adjustment. A transfer pricing adjustment could, among other things, result in a reduction of expense deductions recorded by our VIEs for PRC tax purposes, which could in turn increase its tax liabilities without reducing our WFOE’s tax expenses. In addition, the PRC tax authorities may impose late payment fees and other penalties on our VIEs for the adjusted but unpaid taxes according to the applicable regulations. Our financial position could be materially and adversely affected if our VIEs’ tax liabilities increase or if it is required to pay late payment fees and other penalties.

 

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We may lose the ability to use and enjoy assets held by our VIEs that are material to the operation of certain portion of our business if our VIEs go bankrupt or become subject to a dissolution or liquidation proceeding.

As part of our contractual arrangements with our VIEs, our VIEs and their subsidiaries hold certain assets that are material to the operation of certain portion of our business, including intellectual property and premise. If our VIEs go bankrupt and all or part of its assets become subject to liens or rights of third-party creditors, we may be unable to continue some or all of our business activities, which could materially and adversely affect our business, financial condition and results of operations. Under the contractual arrangements, our VIEs may not, in any manner, sell, transfer, mortgage or dispose of their assets or legal or beneficial interests in the business without our prior consent. If our VIEs undergo a voluntary or involuntary liquidation proceeding, independent third-party creditors may claim rights to some or all of these assets, thereby hindering our ability to operate our business, which could materially and adversely affect our business, financial condition and results of operations.

Risks Related to Doing Business in China

Changes in China’s economic, political or social conditions or government policies could have a material adverse effect on our business and operations.

Substantially all of our assets and operations are located in China. Accordingly, our business, financial condition, results of operations and prospects may be influenced to a significant degree by political, economic and social conditions in China generally. The Chinese economy differs from the economies of most developed countries in many respects, including the level of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. Although the Chinese government has implemented measures emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets, and the establishment of improved corporate governance in business enterprises, a substantial portion of productive assets in China is still owned by the government. In addition, the Chinese government continues to play a significant role in regulating industry development by imposing industrial policies. The Chinese government also exercises significant control over China’s economic growth through allocating resources, controlling payment of foreign currency-denominated obligations, setting monetary policy, and providing preferential treatment to particular industries or companies.

While the Chinese economy has experienced significant growth over the past decades, growth has been uneven, both geographically and among various sectors of the economy, and the rate of growth has been slowing since 2012. Any adverse changes in economic conditions in China, in the policies of the Chinese government or in the laws and regulations in China could have a material adverse effect on the overall economic growth of China. Such developments could adversely affect our business and operating results, lead to reduction in demand for our services and adversely affect our competitive position. The Chinese government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures may benefit the overall Chinese economy, but may have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations. In addition, in the past the Chinese government has implemented certain measures, including interest rate adjustment, to control the pace of economic growth. These measures may cause decreased economic activity in China, which may adversely affect our business and operating results.

Uncertainties with respect to the PRC legal system and changes in laws and regulations in China could adversely affect us.

We conduct our business primarily through our PRC subsidiaries and consolidated VIEs in China. Our operations in China are governed by PRC laws and regulations. Our PRC subsidiaries are subject to laws and regulations applicable to foreign investment in China. The PRC legal system is a civil law system based on written statutes. Unlike the common law system, prior court decisions under the civil law system may be cited for reference but have limited precedential value. In addition, any new or changes in PRC laws and regulations

 

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related to foreign investment in China could affect the business environment and our ability to operate our business in China. For example, the MOFCOM published a discussion draft of the proposed Foreign Investment Law on January 19, 2015, aiming to, upon its enactment, replace the trio of existing laws regulating foreign investment in China, together with their implementation rules and ancillary regulations. The draft Foreign Investment Law embodies an expected PRC regulatory trend to rationalize its foreign investment regulatory regime in line with prevailing international practice and the legislative efforts to unify the corporate legal requirements for both foreign and domestic investments. Substantial uncertainties exist with respect to its enactment timetable, interpretation and implementation. The draft Foreign Investment Law, if enacted as proposed, may materially impact the viability of our current corporate structure, corporate governance and business operations in many aspects.

From time to time, we may have to resort to administrative and court proceedings to enforce our legal rights. Any administrative and court proceedings in China may be protracted, resulting in substantial costs and diversion of resources and management attention. Since PRC administrative and court authorities have significant discretion in interpreting and implementing statutory provisions and contractual terms, it may be more difficult to evaluate the outcome of administrative and court proceedings and the level of legal protection we enjoy than in more developed legal systems. These uncertainties may impede our ability to enforce the contracts we have entered into and could materially and adversely affect our business and results of operations.

Furthermore, the PRC legal system is based in part on government policies and internal rules, some of which are not published on a timely basis or at all and may have retroactive effect. As a result, we may not be aware of our violation of any of these policies and rules until sometime after the violation. Such unpredictability towards our contractual, property and procedural rights could adversely affect our business and impede our ability to continue our operations.

You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing actions in China against us or our management named in the prospectus based on foreign laws.

We are a company incorporated under the laws of the Cayman Islands, we conduct substantially all of our operations in China and substantially all of our assets are located in China. In addition, most of our senior executive officers reside within China for a significant portion of the time and most are PRC nationals. As a result, it may be difficult for you to effect service of process upon us or those persons inside mainland China. It may also be difficult for you to enforce in U.S. courts judgments obtained in U.S. courts based on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors who reside and whose assets are located outside the United States. In addition, there is uncertainty as to whether the courts of the Cayman Islands or the PRC would recognize or enforce judgments of U.S. courts against us or such persons predicated upon the civil liability provisions of the securities laws of the United States or any state.

The recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedures Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based either on treaties between China and the country where the judgment is made or on principles of reciprocity between jurisdictions. China does not have any treaties or other forms of reciprocity with the United States that provide for the reciprocal recognition and enforcement of foreign judgments. In addition, according to the PRC Civil Procedures Law, the PRC courts will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates the basic principles of PRC laws or national sovereignty, security or public interest. As a result, it is uncertain whether and on what basis a PRC court would enforce a judgment rendered by a court in the United States.

 

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We may rely on dividends and other distributions on equity paid by our PRC subsidiaries to fund any cash and financing requirements we may have, and any limitation on the ability of our PRC subsidiaries to make payments to us could have a material and adverse effect on our ability to conduct our business.

We are a Cayman Islands holding company and we rely principally on dividends and other distributions on equity from our PRC subsidiaries for our cash requirements, including the funds necessary to pay dividends and other cash distributions to our shareholders for services of any debt we may incur. If any of our PRC subsidiaries incur debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other distributions to us. Under PRC laws and regulations, our PRC subsidiaries, each of which is a wholly foreign-owned enterprise may pay dividends only out of its respective accumulated profits as determined in accordance with PRC accounting standards and regulations. In addition, a wholly foreign-owned enterprise is required to set aside at least 10% of its accumulated after-tax profits each year, if any, to fund a certain statutory reserve fund, until the aggregate amount of such fund reaches 50% of its registered capital. Such reserve funds cannot be distributed to us as dividends. At its discretion, a wholly foreign-owned enterprise may allocate a portion of its after-tax profits based on PRC accounting standards to an enterprise expansion fund, or a staff welfare and bonus fund.

Our PRC subsidiaries generate primarily all of their revenue in Renminbi, which is not freely convertible into other currencies. As result, any restriction on currency exchange may limit the ability of our PRC subsidiaries to use their Renminbi revenues to pay dividends to us.

The PRC government may continue to strengthen its capital controls, and more restrictions and substantial vetting process may be put forward by SAFE for cross-border transactions falling under both the current account and the capital account. Any limitation on the ability of our PRC subsidiaries to pay dividends or make other kinds of payments to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends, or otherwise fund and conduct our business.

In addition, the Enterprise Income Tax Law and its implementation rules provide that a withholding tax rate of up to 10% will be applicable to dividends payable by Chinese companies to non-PRC-resident enterprises unless otherwise exempted or reduced according to treaties or arrangements between the PRC central government and governments of other countries or regions where the non-PRC-resident enterprises are incorporated.

PRC regulation of loans to and direct investment in PRC entities by offshore holding companies and governmental control of currency conversion may delay or prevent us from using the proceeds of this offering to make loans or additional capital contributions to our PRC subsidiaries, which could materially and adversely affect our liquidity and our ability to fund and expand our business.

We are an offshore holding company conducting our operations in China through our PRC subsidiaries and VIEs. We may make loans to our PRC subsidiaries and VIEs subject to the approval or registration from governmental authorities and limitation of amount, or we may make additional capital contributions to our wholly foreign-owned subsidiaries in China. Any loans to our wholly foreign-owned subsidiaries in China, which are treated as foreign-invested enterprises under PRC law, are subject to foreign exchange loan registrations. In addition, an FIE shall use its capital pursuant to the principle of authenticity and self-use within its business scope. The capital of an FIE shall not be used for the following purposes: (i) directly or indirectly used for payment beyond the business scope of the enterprises or the payment prohibited by relevant laws and regulations; (ii) directly or indirectly used for investment in securities or investments other than banks’ principal-secured products unless otherwise provided by relevant laws and regulations; (iii) the granting of loans to non-affiliated enterprises, except where it is expressly permitted in the business license; and (iv) paying the expenses related to the purchase of real estate that is not for self-use (except for the foreign-invested real estate enterprises).

In light of the various requirements imposed by PRC regulations on loans to and direct investment in PRC entities by offshore holding companies, we cannot assure you that we will be able to complete the necessary

 

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government registrations or obtain the necessary government approvals on a timely basis, if at all, with respect to future loans by us to our PRC subsidiaries or VIEs or with respect to future capital contributions by us to our PRC subsidiaries. If we fail to complete such registrations or obtain such approvals, our ability to use the proceeds from this offering and to capitalize or otherwise fund our PRC operations may be negatively affected, which could materially and adversely affect our liquidity and our ability to fund and expand our business.

Fluctuations in exchange rates could have a material and adverse effect on our results of operations and the value of your investment.

The value of the Renminbi against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and economic conditions in China and by China’s foreign exchange policies. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the Renminbi to the U.S. dollar, and the Renminbi appreciated more than 20% against the U.S. dollar over the following three years. Between July 2008 and June 2010, this appreciation halted and the exchange rate between the Renminbi and the U.S. dollar remained within a narrow band. Since June 2010, the Renminbi has fluctuated against the U.S. dollar, at times significantly and unpredictably. On November 30, 2015, the Executive Board of the International Monetary Fund (IMF) completed the regular five-year review of the basket of currencies that make up the Special Drawing Right, or the SDR, and decided that with effect from October 1, 2016, Renminbi is determined to be a freely usable currency and will be included in the SDR basket as a fifth currency, along with the U.S. dollar, the Euro, the Japanese yen and the British pound. In the fourth quarter of 2016, the Renminbi has depreciated significantly in the backdrop of a surging U.S. dollar and persistent capital outflows of China. With the development of the foreign exchange market and progress towards interest rate liberalization and Renminbi internationalization, the PRC government may in the future announce further changes to the exchange rate system, and we cannot assure you that the Renminbi will not appreciate or depreciate significantly in value against the U.S. dollar in the future. It is difficult to predict how market forces or PRC or U.S. government policy may impact the exchange rate between the Renminbi and the U.S. dollar in the future.

Significant revaluation of the Renminbi may have a material and adverse effect on your investment. For example, to the extent that we need to convert U.S. dollars we receive from this offering into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount we would receive from the conversion. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or ADSs or for other business purposes, appreciation of the U.S. dollar against the Renminbi would have a negative effect on the U.S. dollar amount available to us.

Very limited hedging options are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may decide to enter into hedging transactions in the future, the availability and effectiveness of these hedges may be limited and we may not be able to adequately hedge our exposure or at all. In addition, our currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert Renminbi into foreign currency.

Governmental control of currency conversion may limit our ability to utilize our net revenues effectively and affect the value of your investment.

The PRC government imposes controls on the convertibility of the Renminbi into foreign currencies and, in certain cases, the remittance of currency out of China. We receive substantially all of our revenues in Renminbi. Under our current corporate structure, our Cayman Islands holding company primarily relies on dividend payments from our PRC subsidiaries to fund any cash and financing requirements we may have. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and trade and service-related foreign exchange transactions, can be made in foreign currencies without prior approval of SAFE by complying with certain procedural requirements. Specifically, under the existing

 

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exchange restrictions, without prior approval of SAFE, cash generated from the operations of our PRC subsidiaries in China may be used to pay dividends to our company. However, approval from or registration with appropriate government authorities is required where Renminbi is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of loans denominated in foreign currencies. As a result, we need to obtain SAFE approval to use cash generated from the operations of our PRC subsidiaries and VIEs to pay off their respective debt in a currency other than Renminbi owed to entities outside China, or to make other capital expenditure payments outside China in a currency other than Renminbi. The PRC government may at its discretion restrict access to foreign currencies for current account transactions in the future. If the foreign exchange control system prevents us from obtaining sufficient foreign currencies to satisfy our foreign currency demands, we may not be able to pay dividends in foreign currencies to our shareholders, including holders of our ADSs.

Certain PRC regulations may make it more difficult for us to pursue growth through acquisitions.

Among other things, the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rules, adopted by six PRC regulatory agencies in 2006 and amended in 2009, established additional procedures and requirements that could make merger and acquisition activities by foreign investors more time-consuming and complex. Such regulation requires, among other things, that the MOFCOM be notified in advance of any change-of-control transaction in which a foreign investor acquires control of a PRC domestic enterprise or a foreign company with substantial PRC operations, if certain thresholds under the Provisions on Thresholds for Prior Notification of Concentrations of Undertakings, issued by the State Council in 2008, were triggered. Moreover, the Anti-Monopoly Law promulgated by the Standing Committee of the NPC which became effective in 2008 requires that transactions which are deemed concentrations and involve parties with specified turnover thresholds must be cleared by the MOFCOM before they can be completed. In addition, PRC national security review rules which became effective in September 2011 require acquisitions by foreign investors of PRC companies engaged in military related or certain other industries that are crucial to national security be subject to security review before consummation of any such acquisition. We may pursue potential strategic acquisitions that are complementary to our business and operations. Complying with the requirements of these regulations to complete such transactions could be time-consuming, and any required approval processes, including obtaining approval or clearance from the MOFCOM, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.

PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident beneficial owners or our PRC subsidiaries to liability or penalties, limit our ability to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to increase their registered capital or distribute profits to us, or may otherwise adversely affect us.

In July 2014, SAFE promulgated the Circular on Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Offshore Investment and Financing and Roundtrip Investment Through Special Purpose Vehicles, or SAFE Circular 37, to replace the Notice on Relevant Issues Concerning Foreign Exchange Administration for Domestic Residents’ Financing and Roundtrip Investment Through Offshore Special Purpose Vehicles, or SAFE Circular 75, which ceased to be effective upon the promulgation of SAFE Circular 37. SAFE Circular 37 requires PRC residents (including PRC individuals and PRC corporate entities) to register with SAFE or its local branches in connection with their direct or indirect offshore investment activities. SAFE Circular 37 is applicable to our shareholders who are PRC residents and may be applicable to any offshore acquisitions that we make in the future.

Under SAFE Circular 37, PRC residents who make, or have prior to the implementation of SAFE Circular 37 made, direct or indirect investments in offshore special purpose vehicles, or SPVs, will be required to register such investments with SAFE or its local branches. In addition, any PRC resident who is a direct or indirect shareholder of an SPV, is required to update its filed registration with the local branch of SAFE with respect to that SPV, to reflect any material change. Moreover, any subsidiary of such SPV in China is required to

 

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urge the PRC resident shareholders to update their registration with the local branch of SAFE. If any PRC shareholder of such SPV fails to make the required registration or to update the previously filed registration, the subsidiary of such SPV in China may be prohibited from distributing its profits or the proceeds from any capital reduction, share transfer or liquidation to the SPV, and the SPV may also be prohibited from making additional capital contributions into its subsidiary in China. On February 13, 2015, SAFE promulgated a Notice on Further Simplifying and Improving Foreign Exchange Administration Policy on Direct Investment, or SAFE Notice 13, which became effective on June 1, 2015. Under SAFE Notice 13, applications for foreign exchange registration of inbound foreign direct investments and outbound overseas direct investments, including those required under SAFE Circular 37, will be filed with qualified banks instead of SAFE. The qualified banks will directly examine the applications and accept registrations under the supervision of SAFE.

We have requested PRC residents who we know hold direct or indirect interest in our company to make the necessary applications, filings and registrations as required under SAFE Circular 37 and our PRC resident shareholders, namely Wang Huang, Yunfen Lu, Meihui Fan, Bin Fan, Yi Zhang and Xiaojun Zhang, have completed all necessary registrations with the local SAFE branch or qualified banks as required by SAFE Circular 37. However, we may not be informed of the identities of all the PRC residents holding direct or indirect interest in our company, and we cannot provide any assurance that these PRC residents will comply with our request to make or obtain any applicable registrations or comply with other requirements under SAFE Circular 37. The failure or inability of our PRC resident shareholders to comply with the registration procedures set forth in these regulations may subject us to fines and legal sanctions, restrict our cross-border investment activities, limit the ability of our wholly foreign-owned subsidiaries in China to distribute dividends and the proceeds from any reduction in capital, share transfer or liquidation to us, and we may also be prohibited from injecting additional capital into these subsidiaries. Moreover, failure to comply with the various foreign exchange registration requirements described above could result in liability under PRC law for circumventing applicable foreign exchange restrictions. As a result, our business operations and our ability to distribute profits to you could be materially and adversely affected.

Any failure to comply with PRC regulations regarding the registration requirements for employee stock incentive plans may subject the PRC plan participants or us to fines and other legal or administrative sanctions.

In February 2012, SAFE promulgated the Notices on Issues Concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Publicly-Listed Company, replacing earlier rules promulgated in 2007. Pursuant to these rules, PRC citizens and non-PRC citizens who reside in China for a continuous period of not less than one year who participate in any stock incentive plan of an overseas publicly listed company, subject to a few exceptions, are required to register with SAFE through a domestic qualified agent, which could be the PRC subsidiaries of such overseas-listed company, and complete certain other procedures. In addition, an overseas-entrusted institution must be retained to handle matters in connection with the exercise or sale of stock options and the purchase or sale of shares and interests. We and our executive officers and other employees who are PRC citizens or who reside in the PRC for a continuous period of not less than one year and who have been granted options will be subject to these regulations when our company becomes an overseas-listed company upon the completion of this offering. Failure to complete SAFE registrations may subject them to fines of up to RMB300,000 for entities and up to RMB50,000 for individuals, and legal sanctions and may also limit our ability to contribute additional capital into our PRC subsidiaries and limit our PRC subsidiaries’ ability to distribute dividends to us. We also face regulatory uncertainties that could restrict our ability to adopt additional incentive plans for our directors, executive officers and employees under PRC law. See “Regulation—Regulation on Employee Share Options.”

If we are classified as a PRC resident enterprise for PRC income tax purposes, such classification could result in unfavourable tax consequences to us and our non-PRC shareholders or ADS holders.

Under the PRC Enterprise Income Tax Law and its implementation rules, an enterprise established outside of the PRC with “de facto management body” within the PRC is considered a “resident enterprise” and will be

 

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subject to the enterprise income tax on its global income at the rate of 25%. The implementation rules define the term “de facto management body” as the body that exercises full and substantial control and overall management over the business, productions, personnel, accounts and properties of an enterprise. In 2009, the State Administration of Taxation, or SAT, issued a circular, known as SAT Circular 82, which provides certain specific criteria for determining whether the “de facto management body” of a PRC-controlled enterprise that is incorporated offshore is located in China. Although this circular only applies to offshore enterprises controlled by PRC enterprises or PRC enterprise groups, not those controlled by PRC individuals or foreigners, the criteria set forth in the circular may reflect the SAT’s general position on how the “de facto management body” text should be applied in determining the tax resident status of all offshore enterprises. According to SAT Circular 82, an offshore incorporated enterprise controlled by a PRC enterprise or a PRC enterprise group will be regarded as a PRC tax resident by virtue of having its “de facto management body” in China and will be subject to PRC enterprise income tax on its global income only if all of the following conditions are met: (i) the primary location of the day-to-day operational management is in the PRC; (ii) decisions relating to the enterprise’s financial and human resource matters are made or are subject to approval by organizations or personnel in the PRC; (iii) the enterprise’s primary assets, accounting books and records, company seals, and board and shareholder resolutions, are located or maintained in the PRC; and (iv) at least 50% of voting board members or senior executives habitually reside in the PRC.

We believe that Huami Corporation is not a PRC resident enterprise for PRC tax purposes. See “Regulation—Regulations On Tax—PRC Enterprise Income Tax.” However, the tax resident status of an enterprise is subject to determination by the PRC tax authorities and uncertainties remain with respect to the interpretation of the term “de facto management body.” If the PRC tax authorities determine that Huami Corporation is a PRC resident enterprise for enterprise income tax purposes, we may be required to withhold a 10% withholding tax from dividends we pay to our shareholders that are non-resident enterprises, including the holders of our ADSs. In addition, non-resident enterprise shareholders (including our ADS holders) may be subject to PRC tax on gains realized on the sale or other disposition of ADSs or ordinary shares, if such income is treated as sourced from within the PRC. Furthermore, if we are deemed a PRC resident enterprise, dividends payable to our non-PRC individual shareholders (including our ADS holders) and any gain realized on the transfer of ADSs or ordinary shares by such shareholders may be subject to PRC tax at a rate of 20% unless a reduced rate is available under an applicable tax treaty. It is unclear whether non-PRC shareholders of our company would be able to claim the benefits of any tax treaties between their country of tax residence and the PRC in the event that we are treated as a PRC resident enterprise. Any such tax may reduce the returns on your investment in the ADSs or ordinary shares.

We face uncertainty with respect to indirect transfers of equity interests in PRC resident enterprises by their non-PRC holding companies.

On December 10, 2009, SAT issued the Notice on Strengthening Administration of Enterprise Income Tax for Share Transfers by Non-PRC Resident Enterprises, or SAT Circular 698, with retroactive effect from January 1, 2008, to December 1, 2017. Pursuant to the SAT Circular 698, where a non-resident enterprise transfers the equity interests of a PRC resident enterprise indirectly by disposition of the equity interests of an overseas holding company, or an Indirect Transfer, and such overseas holding company is located in a tax jurisdiction that: (i) has an effective tax rate less than 12.5% or (ii) does not tax foreign income of its residents, the non-resident enterprise, being the transferor, shall report to the competent tax authority of the PRC resident enterprise this Indirect Transfer.

On February 3, 2015, the SAT issued the Public Notice Regarding Certain Corporate Income Tax Matters on Indirect Transfer of Properties by Non-Tax Resident Enterprises, or SAT Public Notice 7. SAT Public Notice 7 extends its tax jurisdiction to not only Indirect Transfers set forth under SAT Circular 698 but also transactions involving transfer of other taxable assets through offshore transfer of a foreign intermediate holding company. In addition, SAT Public Notice 7 provides clearer criteria than SAT Circular 698 for assessment of reasonable commercial purposes and has introduced safe harbors for internal group restructurings and the purchase and sale

 

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of equity through a public securities market. SAT Public Notice 7 also brings challenges to both foreign transferor and transferee (or other person who is obligated to pay for the transfer) of taxable assets. Where a non-resident enterprise transfers taxable assets indirectly by disposing of the equity interests of an overseas holding company, which is an Indirect Transfer, the non-resident enterprise as either transferor or transferee, or the PRC entity that directly owns the taxable assets, may report such Indirect Transfer to the relevant tax authority. Using a “substance over form” principle, the PRC tax authority may disregard the existence of the overseas holding company if it lacks a reasonable commercial purpose and was established for the purpose of reducing, avoiding or deferring PRC tax. As a result, gains derived from such Indirect Transfer may be subject to PRC enterprise income tax, and the transferee or other person who is obligated to pay for the transfer is obligated to withhold the applicable taxes, currently at a rate of 10% for the transfer of equity interests in a PRC resident enterprise. Both the transferor and the transferee may be subject to penalties under PRC tax laws if the transferee fails to withhold the taxes and the transferor fails to pay the taxes.

On October 17, 2017, the SAT released Public Notice Regarding Issues Concerning the Withholding of Non-resident Enterprise Income Tax at Source, or SAT Public Notice 37, effect from December 1, 2017. SAT Public Notice 37 replaced a series of important circulars, including but not limited to SAT Circular 698, and revised the rules governing the administration of withholding tax on China-source income derived by the non-resident enterprise. SAT Public Notice 37 provided certain key changes to the current withholding regime including, such as (i) the withholding obligation for non-resident enterprise deriving dividend arises on the day the payment is actually made rather than on the day of the resolution to declare the dividends; (ii) the provision that non-resident enterprise shall self-report tax within seven days if their withholding agents fail to withhold is removed, etc.

We face uncertainties as to the reporting and other implications of certain past and future transactions where PRC taxable assets are involved, such as offshore restructuring, sale of the shares in our offshore subsidiaries and investments. Our company may be subject to withholding obligations if our company is transferee in such transactions, under SAT Public Notice 37 and SAT Public Notice 7. For transfer of shares in our company by investors who are non-PRC resident enterprises, our PRC subsidiaries may be required to expend valuable resources to comply with SAT Public Notice 37 and SAT Public Notice 7 or to request the relevant transferors from whom we purchase taxable assets to comply with these circulars, or to establish that our company should not be taxed under these circulars, which may have an adverse effect on our financial condition and results of operations.

The approval of the China Securities Regulatory Commission may be required in connection with this offering, and, if required, we cannot predict whether we will be able to obtain such approval.

The Regulations on Mergers and Acquisitions of Domestic Companies by Foreign Investors, or the M&A Rules, adopted by six PRC regulatory agencies requires an overseas special purpose vehicle formed for listing purposes through acquisitions of PRC domestic companies and controlled by PRC companies or individuals to obtain the approval of the CSRC prior to the listing and trading of such special purpose vehicle’s securities on an overseas stock exchange. However, the application of the M&A Rules remains unclear. Currently, there is no consensus among leading PRC law firms regarding the scope and applicability of the CSRC approval requirement.

Our PRC counsel, Zhong Lun Law Firm, has advised us based on their understanding of the current PRC laws, rules and regulations that the CSRC’s approval is not required for the listing and trading of our ADSs on the Nasdaq Global Market in the context of this offering, given that: (i) our PRC subsidiaries were incorporated as wholly foreign-owned enterprises by means of direct investment rather than by merger or acquisition of equity interest or assets of a PRC domestic company owned by PRC companies or individuals as defined under the M&A Rules that are our beneficial owners; and (ii) no provision in the M&A Rules clearly classifies contractual arrangements as a type of transaction subject to the M&A Rules.

 

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However, our PRC counsel has further advised us that there remains some uncertainty as to how the M&A Rules will be interpreted or implemented in the context of an overseas offering and its opinions summarized above are subject to any new laws, rules and regulations or detailed implementations and interpretations in any form relating to the M&A Rules. We cannot assure you that relevant PRC government agencies, including the CSRC, would reach the same conclusion as we do. If it is determined that CSRC approval is required for this offering, we may face sanctions by the CSRC or other PRC regulatory agencies for failure to seek CSRC approval for this offering. These sanctions may include fines and penalties on our operations in the PRC, limitations on our operating privileges in the PRC, delays in or restrictions on the repatriation of the proceeds from this offering into the PRC, restrictions on or prohibition of the payments or remittance of dividends by our China subsidiary, or other actions that could have a material and adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as the trading price of our ADSs. The CSRC or other PRC regulatory agencies may also take actions requiring us, or making it advisable for us, to halt this offering before the settlement and delivery of the ADSs that we are offering. Consequently, if you engage in market trading or other activities in anticipation of and prior to the settlement and delivery of the ADSs we are offering, you would be doing so at the risk that the settlement and delivery may not occur.

The audit report included in this prospectus is prepared by an auditor who is not inspected by the Public Company Accounting Oversight Board and, as such, you are deprived of the benefits of such inspection

Our independent registered public accounting firm that issues the audit reports included in this annual report, as an auditor of companies that are traded publicly in the United States and a firm registered with the Public Company Accounting Oversight Board, or the PCAOB, is required by the laws of the United States to undergo regular inspections by the PCAOB to assess its compliance with the laws of the United States and professional standards. Because our auditors are located in China, a jurisdiction where the PCAOB is currently unable to conduct inspections without the approval of the Chinese authorities, our auditors are not currently inspected by the PCAOB.

Inspections of other firms that the PCAOB has conducted outside of China have identified deficiencies in those firms’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality. The lack of PCAOB inspections in China prevents the PCAOB from regularly evaluating our auditors’ audits and its quality control procedures. As a result, investors may be deprived of the benefits of PCAOB inspections.

The inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of our auditors’ audit procedures or quality control procedures as compared to auditors outside of China that are subject to PCAOB inspections. Investors may lose confidence in our reported financial information and procedures and the quality of our financial statements.

Proceedings instituted by the SEC against Chinese affiliates of the “big four” accounting firms, including our independent registered public accounting firm, could result in financial statements being determined to not be in compliance with the requirements of the Exchange Act.

Starting in 2011 the Chinese affiliates of the “big four” accounting firms, including our independent registered public accounting firm, were affected by a conflict between U.S. and Chinese law. Specifically, for certain U.S.-listed companies operating and audited in mainland China, the SEC and the PCAOB sought to obtain from the Chinese firms access to their audit work papers and related documents. The firms were, however, advised and directed that under Chinese law, they could not respond directly to the U.S. regulators on those requests, and that requests by foreign regulators for access to such papers in China had to be channeled through the CSRC.

In late 2012, this impasse led the SEC to commence administrative proceedings under Rule 102(e) of its Rules of Practice and also under the Sarbanes-Oxley Act of 2002 against the Chinese accounting firms, including

 

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our independent registered public accounting firm. A first instance trial of the proceedings in July 2013 in the SEC’s internal administrative court resulted in an adverse judgment against the firms. The administrative law judge proposed penalties on the firms including a temporary suspension of their right to practice before the SEC, although that proposed penalty did not take effect pending review by the Commissioners of the SEC. On February 6, 2015, before a review by the Commissioner had taken place, the firms reached a settlement with the SEC. Under the settlement, the SEC accepts that future requests by the SEC for the production of documents will normally be made to the CSRC. The firms will receive matching Section 106 requests, and are required to abide by a detailed set of procedures with respect to such requests, which in substance require them to facilitate production via the CSRC. If they fail to meet specified criteria, the SEC retains authority to impose a variety of additional remedial measures on the firms depending on the nature of the failure. Remedies for any future noncompliance could include, as appropriate, an automatic six-month bar on a single firm’s performance of certain audit work, commencement of a new proceeding against a firm, or in extreme cases the resumption of the current proceeding against all four firms. If additional remedial measures are imposed on the Chinese affiliates of the “big four” accounting firms, including our independent registered public accounting firm, in administrative proceedings brought by the SEC alleging the firms’ failure to meet specific criteria set by the SEC with respect to requests for the production of documents, we could be unable to timely file future financial statements in compliance with the requirements of the Exchange Act.

In the event that the SEC restarts the administrative proceedings, depending upon the final outcome, listed companies in the United States with major PRC operations may find it difficult or impossible to retain auditors in respect of their operations in the PRC, which could result in financial statements being determined to not be in compliance with the requirements of the Exchange Act, including possible delisting. Moreover, any negative news about any such future proceedings against these audit firms may cause investor uncertainty regarding China-based, U.S.-listed companies and the market price of our common stock may be adversely affected.

If our independent registered public accounting firm was denied, even temporarily, the ability to practice before the SEC and we were unable to timely find another registered public accounting firm to audit and issue an opinion on our financial statements, our financial statements could be determined not to be in compliance with the requirements of the Exchange Act. Such a determination could ultimately lead to the delisting of our ADSs from the Nasdaq Global Market or deregistration from the SEC, or both, which would substantially reduce or effectively terminate the trading of our ADSs in the United States.

Risks Related to Our ADSs and This Offering

An active trading market for our ordinary shares or our ADSs may not develop and the trading price for our ADSs may fluctuate significantly.

We intend to apply to list our ADSs on the Nasdaq Global Market. We have no current intention to seek a listing for our ordinary shares on any stock exchange. Prior to the completion of this offering, there has been no public market for our ADSs or our ordinary shares, and we cannot assure you that a liquid public market for our ADSs will develop. If an active public market for our ADSs does not develop following the completion of this offering, the market price and liquidity of our ADSs may be materially and adversely affected. The initial public offering price for our ADSs will be determined by negotiation between us and the underwriters based upon several factors, and we can provide no assurance that the trading price of our ADSs after this offering will not decline below the initial public offering price. As a result, investors in our securities may experience a significant decrease in the value of their ADSs.

The trading price of our ADSs is likely to be volatile, which could result in substantial losses to investors.

The trading price of our ADSs is likely to be volatile and could fluctuate widely due to factors beyond our control. This may happen because of broad market and industry factors, including the performance and fluctuation of the market prices of other companies with business operations located mainly in China that have

 

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listed their securities in the United States. In addition to market and industry factors, the price and trading volume for our ADSs may be highly volatile for factors specific to our own operations, including the following:

 

    variations in our revenues, earnings and cash flow;

 

    announcements of new investments, acquisitions, strategic partnerships or joint ventures by us or our competitors;

 

    announcements of new offerings, solutions and expansions by us or our competitors;

 

    changes in financial estimates by securities analysts;

 

    detrimental adverse publicity about us, our services or our industry;

 

    additions or departures of key personnel;

 

    release of lock-up or other transfer restrictions on our outstanding equity securities or sales of additional equity securities; and

 

    potential litigation or regulatory investigations.

Any of these factors may result in large and sudden changes in the volume and price at which our ADSs will trade.

In the past, shareholders of public companies have often brought securities class action suits against those companies following periods of instability in the market price of their securities. If we were involved in a class action suit, it could divert a significant amount of our management’s attention and other resources from our business and operations and require us to incur significant expenses to defend the suit, which could harm our results of operations. Any such class action suit, whether or not successful, could harm our reputation and restrict our ability to raise capital in the future. In addition, if a claim is successfully made against us, we may be required to pay significant damages, which could have a material adverse effect on our financial condition and results of operations.

If securities or industry analysts do not publish research or reports about our business, or if they adversely change their recommendations regarding our ADSs, the market price for our ADSs and trading volume could decline.

The trading market for our ADSs will be influenced by research or reports that industry or securities analysts publish about our business. If one or more analysts who cover us downgrade our ADSs, the market price for our ADSs would likely decline. If one or more of these analysts cease to cover us or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause the market price or trading volume for our ADSs to decline.

The sale or availability for sale of substantial amounts of our ADSs could adversely affect their market price.

Sales of substantial amounts of our ADSs in the public market after the completion of this offering, or the perception that these sales could occur, could adversely affect the market price of our ADSs and could materially impair our ability to raise capital through equity offerings in the future. The ADSs sold in this offering will be freely tradable without restriction or further registration under the Securities Act, and shares held by our existing shareholders may also be sold in the public market in the future subject to the restrictions in Rule 144 and Rule 701 under the Securities Act and the applicable lock-up agreements. There will be              ADSs (representing              class A ordinary shares) outstanding immediately after this offering, or              ADSs (representing              class A ordinary shares) if the underwriters exercise their over-allotment option in full. In connection with this offering, we, our directors and officers, all our existing shareholders and [all] holders of our share-based awards have agreed not to sell any ordinary shares or ADSs for 180 days after the date of this

 

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prospectus without the prior written consent of the underwriters, subject to certain exceptions. However, the underwriters may release these securities from these restrictions at any time, subject to applicable regulations of the Financial Industry Regulatory Authority, Inc. We cannot predict what effect, if any, market sales of securities held by our significant shareholders or any other shareholder or the availability of these securities for future sale will have on the market price of our ADSs. See “Underwriting” and “Shares Eligible for Future Sale” for a more detailed description of the restrictions on selling our securities after this offering.

Because we do not expect to pay dividends in the foreseeable future after this offering, you must rely on a price appreciation of our ADSs for return on your investment.

We currently intend to retain most, if not all, of our available funds and any future earnings after this offering to fund the development and growth of our business. As a result, we do not expect to pay any cash dividends in the foreseeable future. Therefore, you should not rely on an investment in our ADSs as a source for any future dividend income.

Our board of directors has complete discretion as to whether to distribute dividends, subject to certain requirements of Cayman Islands law. In addition, our shareholders may by ordinary resolution declare a dividend, but no dividend may exceed the amount recommended by our directors. Under Cayman Islands law, a Cayman Islands company may pay a dividend out of either profit or share premium account, provided that in no circumstances may a dividend be paid if this would result in the company being unable to pay its debts as they fall due in the ordinary course of business. Even if our board of directors decides to declare and pay dividends, the timing, amount and form of future dividends, if any, will depend on our future results of operations and cash flow, our capital requirements and surplus, the amount of distributions, if any, received by us from our subsidiaries, our financial condition, contractual restrictions and other factors deemed relevant by our board of directors. Accordingly, the return on your investment in our ADSs will likely depend entirely upon any future price appreciation of our ADSs. There is no guarantee that our ADSs will appreciate in value after this offering or even maintain the price at which you purchased the ADSs. You may not realize a return on your investment in our ADSs and you may even lose your entire investment in our ADSs.

Our proposed dual-class voting structure will limit your ability to influence corporate matters and could discourage others from pursuing any change of control transactions that holders of our class A ordinary shares and ADSs may view as beneficial.

Upon completion of this offering, we will have a dual class ordinary share structure. Our ordinary shares will be divided into class A ordinary shares and class B ordinary shares. Holders of class A ordinary shares will be entitled to one vote per share, while holders of class B ordinary shares will be entitled to ten votes per share. Each class B ordinary share is convertible into one class A ordinary share at any time by the holder thereof, while class A ordinary shares are not convertible into class B ordinary shares under any circumstances. Upon any transfer of class B ordinary shares by a holder thereof to any person or entity, such class B ordinary shares shall be automatically and immediately converted into the equal number of class A ordinary shares.

All shares held by our existing shareholders will be converted to class B ordinary shares immediately before the completion of this offering. Upon the completion of this offering, they will own an aggregate of 197,736,467 class B ordinary shares, which will represent         % of the then total outstanding shares and         % of total voting power of our outstanding shares. Therefore, our existing shareholders will continue to have decisive influence over matters requiring shareholders’ approval, including election of directors and significant corporate transactions, such as a merger or sale of our company or our assets. This concentrated control will limit your ability to influence corporate matters and could discourage others from pursuing any potential merger, takeover or other change of control transactions that holders of class A ordinary shares and ADSs may view as beneficial.

 

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We have not determined a specific use for a portion of the net proceeds from this offering and we may use these proceeds in ways with which you may not agree.

We have not determined a specific use for a portion of the net proceeds of this offering, and our management will have considerable discretion in deciding how to apply these proceeds. You will not have the opportunity to assess whether the proceeds are being used appropriately before you make your investment decision. You must rely on the judgment of our management regarding the application of the net proceeds of this offering. We cannot assure you that the net proceeds will be used in a manner that would improve our results of operations or increase our ADS price, nor that these net proceeds will be placed only in investments that generate income or appreciate in value.

Our memorandum and articles of association contain anti-takeover provisions that could have a material adverse effect on the rights of holders of our ordinary shares and ADSs.

We will adopt the second amended and restated memorandum and articles of association that will become effective immediately prior to the completion of this offering. Our new memorandum and articles of association contain provisions to limit the ability of others to acquire control of our company or cause us to engage in change-of-control transactions. These provisions could have the effect of depriving our shareholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transaction. Our board of directors has the authority, without further action by our shareholders, to issue preferred shares in one or more series and to fix their designations, powers, preferences, privileges, and relative participating, optional or special rights and the qualifications, limitations or restrictions, including dividend rights, conversion rights, voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights associated with our ordinary shares, in the form of ADS or otherwise. Preferred shares could be issued quickly with terms calculated to delay or prevent a change in control of our company or make removal of management more difficult. If our board of directors decides to issue preferred shares, the price of our ADSs may fall and the voting and other rights of the holders of our ordinary shares and ADSs may be materially and adversely affected.

Our directors, officers and principal shareholders collectively control a significant amount of our shares, and their interests may not align with the interests of our other shareholders.

Currently, our officers, directors and principal shareholders collectively hold 89.1% of total voting power in our Company. They will continue to have a substantial control of us and collectively hold             % of total voting power immediately after this offering. This significant concentration of share ownership and voting power may adversely affect or reduce the trading price of our ADSs because investors often perceive a disadvantage in owning shares in a company with one or several controlling shareholders. Furthermore, our directors and officers, as a group, have the ability to significantly influence or control the outcome of all matters requiring shareholders’ approvals, including electing directors and approving mergers or other business combination transactions. These actions may be taken even if they are opposed by our other shareholders. This concentration of share ownership and voting power may also discourage, delay or prevent a change in control of our company, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company. For more information regarding our principal shareholders, see “Principal and Selling Shareholders.”

You may face difficulties in protecting your interests, and your ability to protect your rights through U.S. courts may be limited, because we are incorporated under Cayman Islands law.

We are an exempted company incorporated under the laws of the Cayman Islands. Our corporate affairs are governed by our memorandum and articles of association, the Companies Law (2016 Revision) of the Cayman Islands and the common law of the Cayman Islands. The rights of shareholders to take action against our directors, actions by our minority shareholders and the fiduciary duties of our directors to us under Cayman

 

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Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from the common law of England, the decisions of whose courts are of persuasive authority, but are not binding, on a court in the Cayman Islands. The rights of our shareholders and the fiduciary duties of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedent in some jurisdictions in the United States. In particular, the Cayman Islands has a less developed body of securities laws than the United States. Some U.S. states, such as Delaware, have more fully developed and judicially interpreted bodies of corporate law than the Cayman Islands. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action in a federal court of the United States.

Shareholders of Cayman Islands exempted companies like us have no general rights under Cayman Islands law to inspect corporate records or to obtain copies of lists of shareholders of these companies. Our directors have discretion under our articles of association that will become effective immediately prior to completion of this offering to determine whether or not, and under what conditions, our corporate records may be inspected by our shareholders, but are not obliged to make them available to our shareholders. This may make it more difficult for you to obtain the information needed to establish any facts necessary for a shareholder motion or to solicit proxies from other shareholders in connection with a proxy contest.

As a result of all of the above, our public shareholders may have more difficulty in protecting their interests in the face of actions taken by management, members of the board of directors or controlling shareholders than they would as public shareholders of a company incorporated in the United States. For a discussion of significant differences between the provisions of the Companies Law of the Cayman Islands and the laws applicable to companies incorporated in the United States and their shareholders, see “Description of Share Capital—Differences in Corporate Law.”

Certain judgments obtained against us by our shareholders may not be enforceable.

We are a Cayman Islands company and substantially all of our assets are located outside of the United States. Substantially all of our current operations are conducted in China. In addition, most of our current directors and officers are nationals and residents of countries other than the United States. Substantially all of the assets of these persons are located outside the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in the United States in the event that you believe that your rights have been infringed under the U.S. federal securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands and of China may render you unable to enforce a judgment against our assets or the assets of our directors and officers. For more information regarding the relevant laws of the Cayman Islands and China, see “Enforceability of Civil Liabilities.”

The voting rights of holders of ADSs are limited by the terms of the deposit agreement, and you may not be able to exercise your right to vote your class A ordinary shares.

Holders of ADSs do not have the same rights as our registered shareholders. As a holder of our ADSs, you will not have any direct right to attend general meetings of our shareholders or to cast any votes at such meetings. You will only be able to exercise the voting rights which are carried by the underlying class A ordinary shares represented by your ADSs indirectly by giving voting instructions to the depositary in accordance with the provisions of the deposit agreement. Under the deposit agreement, you may vote only by giving voting instructions to the depositary. Upon receipt of your voting instructions, the depositary will try, as far as is practicable, to vote the class A ordinary shares underlying your ADSs in accordance with your instructions. If we ask for your instructions, then upon receipt of your voting instructions, the depositary will try to vote the underlying class A ordinary shares in accordance with these instructions. If we do not instruct the depositary to ask for your instructions, the depositary may still vote in accordance with instructions you give, but it is not required to do so. You will not be able to directly exercise your right to vote with respect to the underlying class A ordinary shares unless you withdraw the shares, and become the registered holder of such shares prior to the

 

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record date for the general meeting. When a general meeting is convened, you may not receive sufficient advance notice of the meeting to withdraw the shares underlying your ADSs and become the registered holder of such shares to allow you to attend the general meeting and to vote directly with respect to any specific matter or resolution to be considered and voted upon at the general meeting. In addition, under our post-offering amended and restated articles of association that will become effective immediately prior to completion of this offering, for the purposes of determining those shareholders who are entitled to attend and vote at any general meeting, our directors may close our register of members and/or fix in advance a record date for such meeting, and such closure of our register of members or the setting of such a record date may prevent you from withdrawing the class A ordinary shares underlying your ADSs and becoming the registered holder of such shares prior to the record date, so that you would not be able to attend the general meeting or to vote directly. If we ask for your instructions, the depositary will notify you of the upcoming vote and will arrange to deliver our voting materials to you. We have agreed to give the depositary at least        days’ prior notice of shareholder meetings. Nevertheless, we cannot assure you that you will receive the voting materials in time to ensure that you can instruct the depositary to vote the underlying class A ordinary shares represented by your ADSs. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions or for their manner of carrying out your voting instructions. This means that you may not be able to exercise your right to direct how the shares underlying your ADSs are voted and you may have no legal remedy if the shares underlying your ADSs are not voted as you requested.

You may not receive dividends or other distributions on our ordinary shares and you may not receive any value for them, if it is illegal or impractical to make them available to you.

The depositary of our ADSs has agreed to pay you the cash dividends or other distributions it or the custodian receives on ordinary shares or other deposited securities underlying our ADSs, after deducting its fees and expenses. You will receive these distributions in proportion to the number of class A ordinary shares your ADSs represent. However, the depositary is not responsible if it decides that it is unlawful or impractical to make a distribution available to any holders of ADSs. For example, it would be unlawful to make a distribution to a holder of ADSs if it consists of securities that require registration under the Securities Act but that are not properly registered or distributed under an applicable exemption from registration. The depositary may also determine that it is not feasible to distribute certain property through the mail. Additionally, the value of certain distributions may be less than the cost of mailing them. In these cases, the depositary may determine not to distribute such property. We have no obligation to register under U.S. securities laws any ADSs, ordinary shares, rights or other securities received through such distributions. We also have no obligation to take any other action to permit the distribution of ADSs, ordinary shares, rights or anything else to holders of ADSs. This means that you may not receive distributions we make on our ordinary shares or any value for them if it is illegal or impractical for us to make them available to you. These restrictions may cause a material decline in the value of our ADSs.

You may experience dilution of your holdings due to the inability to participate in rights offerings.

We may, from time to time, distribute rights to our shareholders, including rights to acquire securities. Under the deposit agreement, the depositary will not distribute rights to holders of ADSs unless the distribution and sale of rights and the securities to which these rights relate are either exempt from registration under the Securities Act with respect to all holders of ADSs, or are registered under the provisions of the Securities Act. The depositary may, but is not required to, attempt to sell these undistributed rights to third parties, and may allow the rights to lapse. We may be unable to establish an exemption from registration under the Securities Act, and we are under no obligation to file a registration statement with respect to these rights or underlying securities or to endeavor to have a registration statement declared effective. Accordingly, holders of ADSs may be unable to participate in our rights offerings and may experience dilution of their holdings as a result.

 

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You may be subject to limitations on the transfer of your ADSs.

Your ADSs are transferable on the books of the depositary. However, the depositary may close its books at any time or from time to time when it deems it expedient in connection with the performance of its duties. The depositary may close its books from time to time for a number of reasons, including in connection with corporate events such as a rights offering, during which time the depositary needs to maintain an exact number of ADS holders on its books for a specified period. The depositary may also close its books in emergencies, and on weekends and public holidays. The depositary may refuse to deliver, transfer or register transfers of our ADSs generally when our share register or the books of the depositary are closed, or at any time if we or the depositary thinks it is advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason.

We are an emerging growth company within the meaning of the Securities Act and may take advantage of certain reduced reporting requirements.

We are an “emerging growth company,” as defined in the JOBS Act, and we may take advantage of certain exemptions from requirements applicable to other public companies that are not emerging growth companies including, most significantly, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002 for so long as we remain an emerging growth company. As a result, if we elect not to comply with such auditor attestation requirements, our investors may not have access to certain information they may deem important.

We will incur increased costs as a result of being a public company, particularly after we cease to qualify as an “emerging growth company.”

Upon completion of this offering, we will become a public company and expect to incur significant legal, accounting and other expenses that we did not incur as a private company. The Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the SEC and the Nasdaq Stock Market, impose various requirements on the corporate governance practices of public companies. As a company with less than US$1.07 billion in revenues for our last fiscal year, we qualify as an “emerging growth company” pursuant to the JOBS Act. An emerging growth company may take advantage of specified reduced reporting and other requirements that are otherwise applicable generally to public companies. These provisions include exemption from the auditor attestation requirement under Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, in the assessment of the emerging growth company’s internal control over financial reporting. The JOBS Act also permits an emerging growth company to delay adopting new or revised accounting standards until such time as those standards apply to private companies. However, we have elected to “opt out” of this provision and, as a result, we will comply with new or revised accounting standards as required when they are adopted for public companies. This decision to opt out of the extended transition period under the JOBS Act is irrevocable.

We expect these rules and regulations to increase our legal and financial compliance costs and to make some corporate activities more time-consuming and costly. After we are no longer an “emerging growth company,” we expect to incur significant expenses and devote substantial management effort toward ensuring compliance with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 and the other rules and regulations of the SEC. For example, as a result of becoming a public company, we will need to increase the number of independent directors and adopt policies regarding internal controls and disclosure controls and procedures. We also expect that operating as a public company will make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. In addition, we will incur additional costs associated with our public company reporting requirements. It may also be more difficult for us to find qualified persons to serve on our board of directors or as executive officers. We are currently evaluating and monitoring developments with respect to these rules and regulations, and we cannot predict or estimate with any degree of certainty the amount of additional costs we may incur or the timing of such costs.

 

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As a company incorporated in the Cayman Islands, we are permitted to adopt certain home country practices in relation to corporate governance matters that differ significantly from the Nasdaq corporate governance listing standards; these practices may afford less protection to shareholders than they would enjoy if we complied fully with the Nasdaq corporate governance listing standards.

As a Cayman Islands company listed on the Nasdaq Stock Market, we are subject to the Nasdaq corporate governance listing standards. However, the Nasdaq corporate governance listing standards permit a foreign private issuer like us to follow the corporate governance practices of its home country. Certain corporate governance practices in the Cayman Islands, which is our home country, may differ significantly from the Nasdaq corporate governance listing standards. Currently, we do not plan to rely on home country practice with respect to our corporate governance after we complete this offering. However, if we choose to follow home country practice in the future, our shareholders may be afforded less protection than they would otherwise enjoy under the Nasdaq corporate governance listing standards applicable to U.S. domestic issuers.

There can be no assurance that we will not be a passive foreign investment company, or PFIC, for U.S. federal income tax purposes for any taxable year, which could result in adverse U.S. federal income tax consequences to U.S. holders of our ADSs or ordinary shares.

A non-U.S. corporation will be a passive foreign investment company, or PFIC, for any taxable year if either (i) at least 75% of its gross income for such year consists of certain types of “passive” income; or (ii) at least 50% of the value of its assets (based on an average of the quarterly values of the assets) during such year is attributable to assets that produce passive income or are held for the production of passive income (the “asset test”). Based on our current and expected income and assets (taking into account the expected cash proceeds and our anticipated market capitalization following this offering), we do not believe that we were a PFIC for the taxable year ended December 31, 2017 and do not anticipate becoming a PFIC in the foreseeable future. However, no assurance can be given in this regard because the determination of whether we are or will become a PFIC is a fact-intensive inquiry made on an annual basis that depends, in part, upon the composition of our income and assets. Fluctuations in the market price of our ADSs may cause us to become a PFIC for the current or subsequent taxable years because the value of our assets for the purpose of the asset test may be determined by reference to the market price of our ADSs. The composition of our income and assets may also be affected by how, and how quickly, we use our liquid assets and the cash raised in this offering.

If we were to be or become a PFIC for any taxable year during which a U.S. Holder (as defined in “Taxation—United States Federal Income Tax Considerations”) holds our ADSs or ordinary shares, certain adverse U.S. federal income tax consequences could apply to such U.S. Holder. See “Taxation—United States Federal Income Tax Considerations—Passive Foreign Investment Company Rules.”

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements that reflect our current expectations and views of future events. The forward looking statements are contained principally in the sections entitled “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.” Known and unknown risks, uncertainties and other factors, including those listed under “Risk Factors,” may cause our actual results, performance or achievements to be materially different from those expressed or implied by the forward-looking statements.

You can identify some of these forward-looking statements by words or phrases such as “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “is/are likely to,” “potential,” “continue” or other similar expressions. We have based these forward-looking statements largely on our current expectations and projections about future events that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements include statements relating to:

 

    our goals and strategies;

 

    our future business development, financial conditions and results of operations;

 

    the expected growth of the smart wearable devices industry;

 

    our expectations regarding demand for and market acceptance of our products and services;

 

    our expectations regarding our relationships with Xiaomi, our other distributors, customers, contract manufacturers, component suppliers, strategic partners and other stakeholders;

 

    competition in our industry; and

 

    relevant government policies and regulations relating to our industry.

These forward-looking statements involve various risks and uncertainties. Although we believe that our expectations expressed in these forward-looking statements are reasonable, our expectations may later be found to be incorrect. Our actual results could be materially different from our expectations. Important risks and factors that could cause our actual results to be materially different from our expectations are generally set forth in “Prospectus Summary—Our Challenges,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Business,” “Regulation” and other sections in this prospectus. You should read thoroughly this prospectus and the documents that we refer to with the understanding that our actual future results may be materially different from and worse than what we expect. We qualify all of our forward-looking statements by these cautionary statements.

This prospectus contains certain data and information that we obtained from various government and private publications. Statistical data in these publications also include projections based on a number of assumptions. The smart wearable devices industry may not grow at the rate projected by market data, or at all. Failure of this market to grow at the projected rate may have a material and adverse effect on our business and the market price of our ADSs. In addition, the rapidly evolving nature of this industry results in significant uncertainties for any projections or estimates relating to the growth prospects or future condition of our market. Furthermore, if any one or more of the assumptions underlying the market data are later found to be incorrect, actual results may differ from the projections based on these assumptions. You should not place undue reliance on these forward-looking statements.

The forward-looking statements made in this prospectus relate only to events or information as of the date on which the statements are made in this prospectus. Except as required by law, we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, after the date on which the statements are made or to reflect the occurrence of unanticipated events. You should read this prospectus and the documents that we refer to in this prospectus and have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect.

 

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USE OF PROCEEDS

We estimate that we will receive net proceeds from this offering of approximately US$            , or approximately US$            if the underwriters exercise their over-allotment option in full, after deducting underwriting discounts and commissions and the estimated offering expenses payable by us. These estimates are based upon an assumed initial public offering price of US$            per ADS, which is the midpoint of the price range shown on the front page of this prospectus. A US$1.00 increase (decrease) in the assumed initial public offering price of US$            per ADS would increase (decrease) the net proceeds to us from this offering by US$            , assuming the number of ADSs offered by us, as set forth on the front cover of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated expenses payable by us.

The primary purposes of this offering are to create a public market for our shares for the benefit of all shareholders, retain talented employees by providing them with equity incentives, and obtain additional capital. We plan to use the net proceeds of this offering as follows:

 

    approximately US$            for research and development of products, services and technologies;

 

    approximately US$            for selling and marketing; and

 

    approximately US$            for general corporate purposes and working capital and potential strategic investments and acquisitions, although we have not identified any specific investments or acquisition opportunities at this time.

The foregoing represents our current intentions based upon our present plans and business conditions to use and allocate the net proceeds of this offering. Our management, however, will have significant flexibility and discretion to apply the net proceeds of this offering. If an unforeseen event occurs or business conditions change, we may use the proceeds of this offering differently than as described in this prospectus. See “Risk Factors—Risks Related to Our ADSs and This Offering—We have not determined a specific use for a portion of the net proceeds from this offering and we may use these proceeds in ways with which you may not agree.”

Pending any use described above, we plan to invest the net proceeds in short-term, interest-bearing, debt instruments or demand deposits.

In using the proceeds of this offering, we are permitted under PRC laws and regulations as an offshore holding company to provide funding to our PRC subsidiaries only through loans or capital contributions and to our VIEs only through loans, subject to satisfaction of applicable government registration and approval requirements. We cannot assure you that we will be able to obtain these government registrations or approvals on a timely basis, if at all. See “Risk Factors—Risks Related to Doing Business in China—PRC regulation of loans to and direct investment in PRC entities by offshore holding companies and governmental control of currency conversion may delay or prevent us from using the proceeds of this offering to make loans or additional capital contributions to our PRC subsidiaries, which could materially and adversely affect our liquidity and our ability to fund and expand our business.”

We will not receive any of the proceeds from the sale of ADSs by the selling shareholders.

 

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DIVIDEND POLICY

Our board of directors has discretion on whether to distribute dividends, subject to certain requirements of Cayman Islands law. In addition, our shareholders may by ordinary resolution declare a dividend, but no dividend may exceed the amount recommended by our board of directors. In either case, all dividends are subject to certain restrictions under Cayman Islands law, namely that our company may only pay dividends out of profits or share premium, and provided always that in no circumstances may a dividend be paid if this would result in our company being unable to pay its debts as they fall due in the ordinary course of business. Even if we decide to pay dividends, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant.

We do not have any present plan to pay any cash dividends on our ordinary shares in the foreseeable future after this offering. We currently intend to retain most, if not all, of our available funds and any future earnings to operate and expand our business.

We are a holding company incorporated in the Cayman Islands. We may rely on dividends from our subsidiaries in China for our cash requirements, including any payment of dividends to our shareholders. PRC regulations may restrict the ability of our PRC subsidiaries to pay dividends to us. See “Regulation—Regulation on Dividend Distributions.”

If we pay any dividends on our class A ordinary shares, we will pay those dividends which are payable in respect of the class A ordinary shares underlying our ADSs to the depositary, as the registered holder of such class A ordinary shares, and the depositary then will pay such amounts to our ADS holders in proportion to class A ordinary shares underlying the ADSs held by such ADS holders, subject to the terms of the deposit agreement, including the fees and expenses payable thereunder. See “Description of American Depositary Shares.” Cash dividends on our ordinary shares, if any, will be paid in U.S. dollars.

 

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CAPITALIZATION

The following table sets forth our capitalization as of September 30, 2017:

 

    on an actual basis;

 

    on a pro forma basis to reflect (i) the automatic conversion of all of our issued and outstanding preferred shares into class B ordinary shares on a one-for-one basis immediately prior to the completion of this offering and (ii) the issuance of 12,064,825 class B ordinary shares to preferred shareholders immediately prior to the completion of this offering in consideration of their waiver of the conditions of qualified initial public offering; and

 

    on a pro forma as adjusted basis to reflect (i) the automatic conversion of all of our issued and outstanding preferred shares into class B ordinary shares on a one-for-one basis upon immediately prior to the completion of this offering, (ii) the issuance of 12,064,825 class B ordinary shares to preferred shareholders immediately prior to the completion of this offering in consideration of their waiver of the conditions of qualified initial public offering, and (iii) the sale of                class A ordinary shares in the form of ADSs by us in this offering at an assumed initial public offering price of US$            per ADS, which is the midpoint of the estimated range of the initial public offering price shown on the front cover of this prospectus, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us, assuming the underwriters do not exercise over-allotment option.

You should read this table together with our consolidated financial statements and the related notes included elsewhere in this prospectus and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

     As of September 30, 2017  
     Actual      Pro Forma      Pro Forma As
Adjusted(1)
 
     (in thousands)         
     RMB      US$      RMB      US$      RMB      US$  

Long-term debt:

                 

Amount due to related party

     3,000        451        3,000        451        
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total long-term debt

     3,000        451        3,000        451        
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Mezzanine equity:

                 

Series A convertible redeemable participating preferred shares, US$0.0001 par value; 71,641,792 shares authorized, issued and outstanding on an actual basis, and none authorized or outstanding on a pro forma and pro forma as adjusted basis

     25,794        3,877                      

Series B-1 convertible redeemable participating preferred shares, US$0.0001 par value; 2,000,000 shares authorized, issued and outstanding on an actual basis, and none authorized or outstanding on a pro forma and pro forma as adjusted basis

     26,103        3,923                      

Series B-2 convertible redeemable participating preferred shares, US$0.0001 par value; 20,895,523 shares authorized, issued and outstanding on an actual basis, and none authorized or outstanding on a pro forma and pro forma as adjusted basis

     287,111        43,153                      
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total mezzanine equity

     339,008        50,953                      
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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     As of September 30, 2017  
     Actual      Pro Forma      Pro Forma As
Adjusted(1)
 
     (in thousands)         
     RMB      US$      RMB      US$      RMB      US$  

Equity:

              

Ordinary shares, US$0.0001 par value; 405,462,685 shares authorized, 91,304,327 shares issued and outstanding on an actual basis; nil class A ordinary shares and 197,736,467 class B ordinary shares issued and outstanding on a pro forma basis;             class A ordinary shares and 197,736,467 class B ordinary shares issued and outstanding on a pro forma as adjusted basis(2)

     56        8        114        17        

Additional paid-in capital(3)

     68,825        10,345              

Retained earnings

     58,888        8,851              

Accumulated other comprehensive income

     13,210        1,986        13,210        1,986        
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Huami Corporation shareholders’ equity

     140,979        21,190              

Non-controlling interests

     2,713        408        2,713        408        
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total equity

     143,692        21,598              
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total capitalization(4)

     485,700        73,002              
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

Notes:

(1)   The pro forma as adjusted information discussed above is illustrative only. Our additional paid-in capital, total shareholders’ equity and total capitalization following the completion of this offering are subject to adjustment based on the actual initial public offering price and other terms of this offering determined at pricing.
(2)   The 91,304,327 shares on an actual basis include 91,134,327 shares outstanding and 170,000 shares that we are in the process to log into our register of members upon the exercise of vested options by certain employees.
(3)   A US$1.00 increase (decrease) in the assumed initial public offering price of US$            per share, which is the midpoint of the estimated range of the initial public offering price shown on the front cover of this prospectus, would increase (decrease) each of additional paid-in capital, total shareholders’ equity, total equity and total capitalization by US$            million.
(4)   Total capitalization includes the company’s long-term debt, mezzanine equity and total equity.

 

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DILUTION

If you invest in our ADSs, your interest will be diluted to the extent of the difference between the initial public offering price per ADS and our net tangible book value per ADS after this offering. Dilution results from the fact that the initial public offering price per ordinary share is substantially in excess of the book value per ordinary share attributable to the existing shareholders for our presently outstanding ordinary shares.

Our net tangible book value as of September 30, 2017 was approximately RMB132.4 million (US$19.9 million), or RMB1.45 (US$0.22) per ordinary share as of that date and US$            per ADS. Net tangible book value represents the amount of our total consolidated tangible assets, less the amount of our total consolidated liabilities and convertible redeemable preferred shares. Dilution is determined by subtracting net tangible book value per ordinary share, after giving effect to the additional proceeds we will receive from this offering, from the assumed initial public offering price of US$            per ordinary share, which is the midpoint of the estimated initial public offering price range set forth on the front cover of this prospectus adjusted to reflect the ADS-to-ordinary share ratio, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

Without taking into account any other changes in net tangible book value after September 30, 2017, other than to give effect to our sale of the ADSs offered in this offering at the assumed initial public offering price of US$            per ADS, which is the midpoint of the estimated initial public offering price range, after deduction of the underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of September 30, 2017 would have been US$            , or US$            per ordinary share and US$            per ADS. This represents an immediate increase in net tangible book value of US$            per ordinary share and US$            per ADS to the existing shareholders and an immediate dilution in net tangible book value of US$            per ordinary share and US$            per ADS to investors purchasing ADSs in this offering. The following table illustrates such dilution:

 

     Per Ordinary Share      Per ADS  

Assumed initial public offering price

   US$                   US$               

Net tangible book value as of September 30, 2017

   US$      US$  

Pro forma net tangible book value after giving effect to the conversion of our preferred shares

   US$      US$  

Pro forma as adjusted net tangible book value after giving effect to the conversion of our preferred shares and this offering

   US$      US$  

Amount of dilution in net tangible book value to new investors in this offering

   US$      US$  

A US$1.00 increase (decrease) in the assumed initial public offering price of US$            per ADS would increase (decrease) our pro forma as adjusted net tangible book value after giving effect to this offering by US$            , the pro forma as adjusted net tangible book value per ordinary share and per ADS after giving effect to this offering by US$            per ordinary share and US$            per ADS and the dilution in pro forma as adjusted net tangible book value per ordinary share and per ADS to new investors in this offering by US$            per ordinary share and US$            per ADS, assuming no change to the number of ADSs offered by us as set forth on the front cover of this prospectus, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

 

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The following table summarizes, on a pro forma as adjusted basis as of September 30, 2017, the differences between existing shareholders and the new investors with respect to the number of ordinary shares (in the form of ADSs or shares) purchased from us, the total consideration paid and the average price per ordinary share and per ADS paid before deducting the underwriting discounts and commissions and estimated offering expenses payable by us. The total number of ordinary shares does not include class A ordinary shares underlying the ADSs issuable upon the exercise of the over-allotment option granted to the underwriters.

 

    
Ordinary Shares Purchased
     Total Consideration      Average
Price Per
Ordinary
Share
     Average
Price Per
ADS
 
     Number      Percent      Amount      Percent        

Existing shareholders

         US$                     %      US$                   US$               

New investors

         US$        %      US$      US$  
  

 

 

    

 

 

    

 

 

    

 

 

       

Total

         US$        100.0%        
  

 

 

    

 

 

    

 

 

    

 

 

       

The pro forma as adjusted information discussed above is illustrative only. Our net tangible book value following the completion of this offering is subject to adjustment based on the actual initial public offering price of our ADSs and other terms of this offering determined at pricing.

The discussion and tables above assume no exercise of any share options outstanding nor any request by holders of restricted shares to register their vested restricted shares as of the date of this prospectus. As of the date of this prospectus, there are 7,354,007 class A ordinary shares issuable upon exercise of outstanding share options at a weighted average exercise price of US$0.16 per share, 4,458,247 restricted shares, and 2,298,775 restricted share units outstanding. To the extent that any of these options are exercised, there will be further dilution to new investors.

 

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EXCHANGE RATE INFORMATION

Our reporting currency is the Renminbi because our business is mainly conducted in China and substantially all of our revenues are denominated in Renminbi. This prospectus contains translations of Renminbi amounts into U.S. dollars at specific rates solely for the convenience of the reader. The conversion of Renminbi into U.S. dollars in this prospectus is based on the exchange rate set forth in the H.10 statistical release of the Board of Governors of the Federal Reserve System. Unless otherwise noted, all translations from Renminbi to U.S. dollars and from U.S. dollars to Renminbi in this prospectus were made at a rate of RMB6.6533 to US$1.00, the exchange rate in effect as of September 30, 2017. We make no representation that any Renminbi or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or Renminbi, as the case may be, at any particular rate, the rates stated below, or at all. The PRC government imposes control over its foreign currency reserves in part through direct regulation of the conversion of Renminbi into foreign currency and through restrictions on foreign trade. On January 5, 2018, the exchange rate was RMB6.4875 to US$1.00.

The following table sets forth information concerning exchange rates between the Renminbi and the U.S. dollar for the periods indicated. These rates are provided solely for your convenience and are not necessarily the exchange rates that we used in this prospectus or will use in the preparation of our periodic reports or any other information to be provided to you.

 

     Exchange Rate  

Period

   Period
End
     Average(1)      Low      High  
     (RMB per US$1.00)  

2012

     6.2301        6.2990        6.3879        6.2221  

2013

     6.0537        6.1412        6.2438        6.0537  

2014

     6.2046        6.1704        6.2591        6.0402  

2015

     6.4778        6.2869        6.4896        6.1870  

2016

     6.9430        6.6549        6.9580        6.4480  

2017

           

August

     6.5888        6.6670        6.7272        6.5888  

September

     6.6533        6.5690        6.6591        6.4773  

October

     6.6328        6.6254        6.6533        6.5712  

November

     6.6090        6.6200        6.6385        6.5967  

December

     6.5063        6.5392        6.6210        6.5063  

2018

           

January (through January 5)

     6.4875        6.4928        6.5010        6.4875  

 

Source: Federal Reserve Statistical Release

Note:

(1)   Annual averages are calculated by using the average of the exchange rates on the last day of each month during the relevant year. Monthly averages are calculated by using the average of the daily rates during the relevant month.

 

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ENFORCEABILITY OF CIVIL LIABILITIES

We are incorporated in the Cayman Islands to take advantage of certain benefits associated with being a Cayman Islands exempted company, such as:

 

    political and economic stability;

 

    an effective judicial system;

 

    a favorable tax system;

 

    the absence of exchange control or currency restrictions; and

 

    the availability of professional and support services.

However, certain disadvantages accompany incorporation in the Cayman Islands. These disadvantages include but are not limited to:

 

    the Cayman Islands has a less developed body of securities laws as compared to the United States and these securities laws provide provides significantly less protection to investors as compared to the United States; and

 

    Cayman Islands companies may not have standing to sue before the federal courts of the United States.

Our constituent documents do not contain provisions requiring that disputes, including those arising under the securities laws of the United States, between us, our officers, directors and shareholders, be arbitrated.

Substantially all of our operations are conducted in China, and substantially all of our assets are located in China. A majority of our directors and executive officers are nationals or residents of jurisdictions other than the United States and most of their assets are located outside the United States. As a result, it may be difficult for a shareholder to effect service of process within the United States upon these individuals, or to bring an action against us or these individuals in the United States, or to enforce against us or them judgments obtained in United States courts, including judgments predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States.

We have appointed Law Debenture Corporate Services Inc., located at 801 2nd Avenue, Suite 403, New York, New York 10017, as our agent upon whom process may be served in any action brought against us under the securities laws of the United States.

We have been informed by Maples and Calder (Hong Kong) LLP that the United States and the Cayman Islands do not have a treaty providing for reciprocal recognition and enforcement of judgments of U.S. courts in civil and commercial matters and that a final judgment for the payment of money rendered by any federal or state court in the United States based on civil liability, whether or not predicated solely upon the U.S. federal securities laws, would not be automatically enforceable in the Cayman Islands. We have also been advised by Maples and Calder (Hong Kong) LLP that a judgment obtained in any federal or state court in the United States will be recognized and enforced in the courts of the Cayman Islands at common law, without any re-examination of the merits of the underlying dispute, by an action commenced on the foreign judgment debt in the Grand Court of the Cayman Islands, provided such judgment (i) is given by a foreign court of competent jurisdiction, (ii) imposes on the judgment debtor a liability to pay a liquidated sum for which the judgment has been given, (iii) is final, (iv) is not in respect of taxes, a fine or a penalty, and (v) was not obtained in a manner and is not of a kind the enforcement of which is contrary to natural justice or the public policy of the Cayman Islands.

There is uncertainty as to whether the courts of the Cayman Islands would recognize or enforce judgments of United States courts obtained against us or our directors or officers predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States. Such uncertainty relates to

 

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whether a judgment obtained from the United States courts under the civil liability provisions of the securities laws will be determined by the courts of the Cayman Islands as penal or punitive in nature. If such a determination is made, the courts of the Cayman Islands will not recognize or enforce the judgment against a Cayman Islands company or its directors and officers. Because the courts of the Cayman Islands have yet to rule on whether such judgments are penal or punitive in nature, it is uncertain whether they would be enforceable in the Cayman Islands.

Zhong Lun Law Firm, our counsel as to PRC law, has advised us that there is uncertainty as to whether the courts of China would:

 

    recognize or enforce judgments of United States courts obtained against us or our directors or officers predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States; or

 

    entertain original actions brought in each respective jurisdiction against us or our directors or officers predicated upon the securities laws of the United States or any state in the United States.

Zhong Lun Law Firm has further advised us that the recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedures Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based either on treaties between China and the country where the judgment is made or on principles of reciprocity between jurisdictions. China does not have any treaties or other form of reciprocity with the United States or the Cayman Islands that provide for the reciprocal recognition and enforcement of foreign judgments. In addition, according to the PRC Civil Procedures Law, courts in the PRC will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates the basic principles of PRC law or national sovereignty, security or public interest. As a result, it is uncertain whether and on what basis a PRC court would enforce a judgment rendered by a court in the United States or in the Cayman Islands. Under the PRC Civil Procedures Law, foreign shareholders may originate actions based on PRC law against a company in China for disputes if they can establish sufficient nexus to the PRC for a PRC court to have jurisdiction, and meet other procedural requirements, including, among others, the plaintiff must have a direct interest in the case, and there must be a concrete claim, a factual basis and a cause for the suit.

It will be, however, difficult for U.S. shareholders to originate actions against us in the PRC in accordance with PRC laws because we are incorporated under the laws of the Cayman Islands and it will be difficult for U.S. shareholders, by virtue only of holding our ADSs or ordinary shares, to establish a connection to the PRC for a PRC court to have jurisdiction as required under the PRC Civil Procedures Law.

 

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CORPORATE HISTORY AND STRUCTURE

We commenced operations in December 2013 through Anhui Huami Information Technology Co., Ltd., or Anhui Huami, to develop, manufacture and sell smart wearable devices. In July 2014, we incorporated Huami (Beijing) Information Technology Co., Ltd., or Beijing Huami, to expand our operation.

In December 2014, we incorporated Huami Corporation in Cayman Islands as our offshore holding company to facilitate financing and offshore listing. Shortly following its incorporation, Huami Corporation established a wholly-owned Hong Kong subsidiary, Huami HK Limited. From December 2014 to April 2015, our Cayman holding company Huami Corporation issued ordinary shares and preferred shares to the holding vehicles of the then shareholders of Anhui Huami, in proportion to these shareholders’ then respective equity interest percentages in Anhui Huami.

In February 2015, Huami HK Limited established a wholly-owned subsidiary in China, Beijing Shunyuan Kaihua Technology Co., Ltd., which we refer to as Shunyuan Kaihua or our WFOE in this prospectus. Our WFOE later entered into a series of contractual arrangements with Anhui Huami, Beijing Huami, which two entities we collectively refer to as our VIEs in this prospectus, and their respective shareholders. These contractual arrangements enable us to exercise effective control over our VIEs; receive substantially all of the economic benefits of our VIEs; and have an exclusive option to purchase all or part of the equity interests in and assets of them when and to the extent permitted by PRC law. For more details, please see “—Contractual Arrangements with the VIEs and Their Respective Shareholders.”

As a result of our direct ownership in our WFOE and the VIE contractual arrangements, we are regarded as the primary beneficiary of our VIEs, and we treat them and their subsidiaries as our consolidated affiliated entities under U.S. GAAP. We have consolidated the financial results of our VIEs and their respective subsidiaries in our consolidated financial statements in accordance with U.S. GAAP.

Currently, our officers, directors and principal shareholders collectively hold 89.1% of the total voting power in our Company. They will continue to have a substantial control of us and hold             % of total voting power immediately after this offering.

 

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The chart below summarizes our corporate structure and identifies our subsidiaries, our VIEs and their subsidiaries, as of the date of this prospectus:

 

LOGO

 

 

 

Notes:

(1)   Messrs. Wang Huang, Yunfen Lu, Meihui Fan, Bin Fan, Yi Zhang and Xiaojun Zhang are beneficial owners of the shares of our company and hold 45.8%, 2.1%, 2.1%, 2.1% 2.1% and 1.4% equity interests in Beijing Huami, respectively. They are either directors or employees of our company. De Liu and Bin Yue, who are also our directors, hold 17.7% and 5.9% equity interests in Beijing Huami, respectively. The remaining 20.7% equity interests in Beijing Huami are held by Liping Cao and Lhassa Multi-Industry Investment Management Co. Ltd., who are employee or affiliate of our shareholders, respectively.
(2)   Messrs. Wang Huang and Yunfen Lu are beneficial owners of the shares of our company and hold 54.9% and 0.3% equity interests in Anhui Huami, respectively. They are also directors of our company. De Liu and Bin Yue, who are also our directors, hold 17.9% and 6.0% equity interests in Anhui Huami, respectively. The remaining 20.9% equity interests in Anhui Huami are held by Liping Cao and Lhassa Multi-Industry Investment Management Co. Ltd., who are employee or affiliate of our shareholders, respectively.

The following is a summary of the currently effective contractual arrangements by and among our wholly-owned subsidiary, Shunyuan Kaihua (our WFOE), our VIEs and their respective shareholders.

Contractual Agreements with the VIEs and Their Respective Shareholders

Agreements that provide us with effective control over the VIEs

Shareholder Voting Proxy Agreements and Powers of Attorney. Pursuant to the amended and restated Shareholder Voting Proxy Agreement, dated November 3, 2017, among our WFOE, Anhui Huami and each of

 

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the shareholders of Anhui Huami, each of the shareholders of Anhui Huami has executed a power of attorney to irrevocably authorize our WFOE or any person designated by our WFOE to act as his, her or its attorney-in-fact to exercise all of his, her or its rights as a shareholder of Anhui Huami, including, but not limited to, the right to convene and attend shareholders’ meetings, vote on any resolution that requires a shareholder vote, such as the appointment and removal of directors, supervisors and officers, as well as the sale, transfer and disposal of all or part of the equity interests owned by such shareholder. The power of attorney will remain effective until the termination of the Shareholder Voting Proxy Agreement unless otherwise instructed by our WFOE.

On November 3, 2017, our WFOE, Beijing Huami and each of the shareholders of Beijing Huami entered into an amended and restated Shareholder Voting Proxy Agreement and power of attorney, which contain terms substantially similar to the Shareholder Voting Proxy Agreement and power of attorney executed by the shareholders of Anhui Huami described above.

Equity Pledge Agreements. Pursuant to the amended and restated Equity Pledge Agreement, dated November 3, 2017, among our WFOE, Anhui Huami and each of the shareholders of Anhui Huami, the shareholders of Anhui Huami have pledged 100% equity interests in Anhui Huami to our WFOE to guarantee the performance by the shareholders of their obligations under the Exclusive Option Agreement, the Shareholder Voting Proxy Agreement and the Equity Pledge Agreement, as well as the performance by Anhui Huami of its obligations under the Exclusive Option Agreement, the Shareholder Voting Proxy Agreement, the Exclusive Service Agreement and the Equity Pledge Agreement. In the event of a breach by Anhui Huami or any shareholder of contractual obligations under the Equity Pledge Agreement, our WFOE, as pledgee, will have the right to dispose of the pledged equity interests in Anhui Huami and will have priority in receiving the proceeds from such disposal. The shareholders of Anhui Huami also undertake that, without the prior written consent of our WFOE, they will not dispose of, create or allow any encumbrance on the pledged equity interests. Anhui Huami undertakes that, without the prior written consent of our WFOE, they will not assist or allow any encumbrance to be created on the pledged equity interests. Each shareholder has also executed a power of attorney to irrevocably authorize Wang Huang as his, her or its attorney-in-fact to sign any legal documents that are required or useful in exercising our WFOE’s rights under the Equity Pledge Agreement.

On November 3, 2017, our WFOE, Beijing Huami and each of the shareholders of Beijing Huami entered into an amended and restated Equity Pledge Agreement, which contains terms substantially similar to the Equity Pledge Agreement described above.

We have completed the registration of the equity pledge with the competent office of the State Administration for Industry and Commerce in accordance with the PRC Property Rights Law.

Loan Agreement. Pursuant to the loan agreement between our WFOE and Mr. Wang Huang, one of shareholders of Anhui Huami, dated November 3, 2017, our WFOE made interest-free loans in an aggregate amount of RMB15 million to Mr. Wang Huang for the exclusive purpose of acquiring equity interests in Anhui Huami. The loans can only be repaid with the proceeds derived from the sale of all of the equity interests in Anhui Huami to our WFOE or its designated representatives pursuant to the Exclusive Option Agreements. The term of the Loan Agreement is ten years from the date of the loan agreement and will be extended on a yearly basis unless otherwise instructed by our WFOE until the loan is repaid.

Agreements that allow us to receive economic benefits from the VIEs

Exclusive Consultation and Service Agreements. Pursuant to the amended and restated Exclusive Consultation Service Agreement, dated November 3, 2017, between our WFOE and Anhui Huami, our WFOE has the exclusive right to provide Anhui Huami with the consulting and technical services required by Anhui Huami’ business. Without our WFOE’s prior written consent, Anhui Huami may not accept any services subject to this agreement from any third party. Anhui Huami agrees to pay our WFOE an annual service fee at an amount that is equal to 100% of its net income or the amount which is adjusted in accordance with our WFOE’s sole

 

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discretion for the relevant year as well as the mutually-agreed amount for certain other technical services, both of which should be paid within three months after the end of the relevant calendar year. Our WFOE has the exclusive ownership of all the intellectual property rights created as a result of the performance of the Exclusive Consultation and Service Agreement, to the extent permitted by applicable PRC laws. To guarantee Anhui Huami’s performance of its obligations thereunder, the shareholders have pledged their equity interests in Anhui Huami to our WFOE pursuant to the Equity Pledge Agreement. The Exclusive Consultation and Service Agreement will remain effective for an indefinite term, unless otherwise terminated pursuant to mutual agreement in writing or applicable PRC laws.

On November 3, 2017, our WFOE, Beijing Huami and each of the shareholders of Beijing Huami entered into an amended and restated Exclusive Consultation and Service Agreement, which contains terms substantially similar to the Exclusive Consultation and Service Agreement described above.

Agreements that provide us with the option to purchase the equity interests in and assets of the VIEs

Exclusive Option Agreements. Pursuant to the amended and restated Exclusive Option Agreement, dated November 3, 2017, among our WFOE, Anhui Huami and each of the shareholders of Anhui Huami, the shareholders of Anhui Huami have irrevocably granted our WFOE an exclusive option to purchase all or part of their equity interests in Anhui Huami, and Anhui Huami has irrevocably granted our WFOE an exclusive option to purchase all or part of its assets. Our WFOE or its designated person may exercise such options at the lowest price permitted under applicable PRC laws. The shareholders of Anhui Huami undertake that, without our WFOE’s prior written consent, they will not, among other things, (i) create any pledge or encumbrance on their equity interests in Anhui Huami, (ii) transfer or otherwise dispose of their equity interests in Anhui Huami, (iii) change Anhui Huami’s registered capital, (iv) amend Anhui Huami’s articles of association, (v) dispose of Anhui Huami’s material assets (except in the ordinary course of business), or (vi) merge Anhui Huami with any other entity. In addition, Anhui Huami undertakes that, without our WFOE’s prior written consent, it will not, among other things, create any pledge or encumbrance on any of its assets, or transfer or otherwise dispose of its material assets (except in the ordinary course of business). The Exclusive Option Agreement will remain effective until the entire equity interests in and all the assets of Anhui Huami have been transferred to our WFOE or its designated person.

On November 3, 2017, our WFOE, Beijing Huami and each of the shareholders of Beijing Huami entered into an amended and restated Exclusive Option Agreement, which contains terms substantially similar to the Exclusive Option Agreement described above.

In the opinion of Zhong Lun Law Firm, our PRC legal counsel:

 

    the ownership structures of our VIEs in China and our WFOE, both currently and immediately after giving effect to this offering, comply with all existing PRC laws and regulations; and

 

    the contractual arrangements between our WFOE, our VIEs and their respective shareholders governed by PRC law are valid, binding and enforceable, and will not result in any violation of PRC laws or regulations currently in effect.

However, our PRC legal counsel has also advised us that there are substantial uncertainties regarding the interpretation and application of current and future PRC laws, regulations and rules. Accordingly, the PRC regulatory authorities may take a view that is contrary to the opinion of our PRC legal counsel. It is uncertain whether any new PRC laws or regulations relating to variable interest entity structures will be adopted or if adopted, what they would provide. If we or any of our VIEs are found to be in violation of any existing or future PRC laws or regulations, or fail to obtain or maintain any of the required permits or approvals, the relevant PRC regulatory authorities would have broad discretion to take action in dealing with such violations or failures. See “Risk Factors—Risks Related to Our Corporate Structure—If the PRC government finds that the agreements that establish the structure for operating some of our operations in China do not comply with PRC regulations relating

 

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to the relevant industries, or if these regulations or the interpretation of existing regulations change in the future, we could be subject to severe penalties or be forced to relinquish our interests in those operations” and “Risk Factors—Risks Related to Doing Business in China—Uncertainties with respect to the PRC legal system and changes in laws and regulations in China could adversely affect us.”

 

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SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA

The following selected consolidated statements of operations data for the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2017, selected consolidated balance sheet data as of December 31, 2015 and 2016 and September 30, 2017 and selected consolidated cash flow data for the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2017 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The following selected consolidated statements of operating data for the nine months ended September 30, 2016 and selected consolidated cash flow data for the nine months ended September 30, 2016 are derived from our unaudited consolidated financial statements included elsewhere in this prospectus. Our consolidated financial statements are prepared and presented in accordance with U.S. GAAP. Our historical results do not necessarily indicate results expected for any future periods. You should read this Selected Consolidated Financial and Operating Data section together with our consolidated financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

 

     For the Year Ended December 31,     For the Nine Months
Ended September 30,
 
     2015     2016     2016     2017  
     RMB     RMB     US$     RMB     RMB     US$  
     (in thousands, except for per share data)  

Selected Consolidated Statements of Operating Data:

            

Revenues(1)

     896,458       1,556,476       233,940       943,511       1,296,248       194,828  

Cost of revenues(2)

     785,867       1,280,324       192,434       791,212       968,369       145,547  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     110,591       276,152       41,506       152,299       327,879       49,281  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

            

Research and development expenses(3)

     61,553       132,304       19,885       98,008       108,590       16,321  

General and administrative expenses(3)

     69,984       102,644       15,428       69,043       82,474       12,396  

Selling and marketing expenses

     19,168       27,821       4,181       14,801       29,680       4,461  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     150,705       262,769       39,494       181,852       220,744       33,178  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating (loss)/income

     (40,114     13,383       2,012       (29,553     107,135       16,103  

Other income and expenses:

            

Realized gain from investments

                             2,335       351  

Interest income

     255       754       113       646       1,463       220  

Other income

     1,109       14,726       2,213       7,287       1,066       160  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss)/income before income tax

     (38,750     28,863       4,338       (21,620     111,999       16,834  

Income tax benefit/(expense)

     897       (3,088     (464     3,731       (15,462     (2,324
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss)/income before loss from equity method investments

     (37,853     25,775       3,874       (17,889     96,537       14,510  

Loss from equity method investments

     —         (1,829     (275     (1,156     (1,422     (214
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss)/income

     (37,853     23,946       3,599       (19,045     95,115       14,296  

Less: net loss attributable to non-controlling interest

     —         —         —         —         (263     (39
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss)/income attributable to Huami Corporation

     (37,853     23,946       3,599       (19,045     95,378       14,335  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss)/income per share attributable to Huami Corporation:

            

Basic (loss)/income per ordinary share

     (1.22     (0.22     (0.03     (0.84     0.35       0.05  

Diluted (loss)/income per ordinary share

     (1.22     (0.22     (0.03     (0.84     0.33       0.05  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Notes:

(1)   Includes RMB876.7 million, RMB1,449.9 million (US$217.9 million), RMB879.6 million and RMB1,124.8 million (US$169.1 million) with related parties for the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2016 and 2017, respectively.
(2)   Includes RMB762.9 million and RMB1,198.3 million (US$180.1 million), RMB742.1 million and RMB853.3 million (US$128.3 million) with related parties for the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2016 and 2017, respectively.
(3)   Share-based compensation expenses were allocated in operating expenses as follows. Our share-based compensation expenses were the result of (i) our grants of options, restricted shares and restricted share units under our share incentive plans to our employees, and (ii) the share restriction agreements entered into among our founders and our preferred shareholders in relation to our private financing transactions in January 2014 and April 2015. For the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2017, we recorded share-based compensation expenses of RMB37.2 million, RMB50.8 million and RMB38.9 million, respectively, in relation to the vesting of the restricted shares of our founders under the share restriction agreements.

 

     For the Year Ended December 31,      For the Nine Months
Ended September 30,
 
     2015      2016      2016      2017  
     RMB      RMB      US$      RMB      RMB      US$  
     (in thousands)  

Research and development expenses

     2,588        2,626        395        1,970        6,428        966  

General and administrative expenses

     53,403        55,109        8,283        41,393        42,147        6,335  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     55,991        57,735        8,678        43,363        48,575        7,301  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     As of December 31,      As of September 30,  
     2015      2016      2017  
     RMB      RMB      US$      RMB      US$  
     (in thousands)  

Selected Consolidated Balance Sheet Data:

              

Current assets:

              

Cash and cash equivalents

     219,987        153,152        23,019        504,388        75,810  

Accounts receivable (net of allowance of nil, nil and nil as of December 31, 2015 and 2016 and September 30, 2017, respectively)

     21,924        19,707        2,962        28,655        4,307  

Amount due from related parties

     172,966        476,698        71,648        171,575        25,788  

Inventories

     89,946        192,372        28,914        191,101        28,723  

Non-current assets:

              

Property and equipment, net

     2,926        10,801        1,623        10,665        1,603  

Total assets

     529,079        972,896        146,227        1,090,430        163,892  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Current liabilities:

              

Accounts payable

     252,073        524,072        78,769        435,270        65,422  

Bank borrowings

     —          10,000        1,503        40,000        6,012  

Total liabilities

     277,823        634,370        95,347        607,730        91,341  

Total liabilities, mezzanine equity and equity

     529,079        972,896        146,227        1,090,430        163,892  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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     For the Year Ended
December 31,
    For the Nine Months Ended
September 30,
 
     2015     2016     2016     2017  
     RMB     RMB     US$     RMB     RMB     US$  
     (in thousands)  

Selected Consolidated Cash Flow Data:

            

Net cash (used in)/provided by operating activities

     (6,767     17,266       2,595       59,769       336,216       50,533  

Net cash used in investing activities

     (4,911     (99,387     (14,938     (45,256     (5,507     (827

Net cash provided by financing activities

     214,063       10,024       1,507       —         30,089       4,522  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase/(decrease) in cash and cash equivalents

     202,385       (72,097     (10,836     14,513       360,798       54,228  

Exchange rate effect on cash and cash equivalents

     10,226       5,262       791       2,568       (2,635     (396

Cash, cash equivalents and restricted cash at beginning of the period

     7,376       219,987       33,064       219,987       153,152       23,019  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash, cash equivalents and restricted cash at end of the period

     219,987       153,152       23,019       237,068       511,315       76,851  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The following table presents certain of our operating data for the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2017.

 

     For the Year Ended
December 31,
     For the Nine
Months Ended
September 30,
 
     2015      2016      2017  
     (in millions)  

Units shipped

     14.4        17.8        11.6  
  

 

 

    

 

 

    

 

 

 

Non-GAAP Measures

We use adjusted net income, a non-GAAP financial measure, in evaluating our operating results and for financial and operational decision-making purposes. Adjusted net income represents net income excluding share-based compensation expenses, and such adjustment has no impacts on income tax.

We believe that adjusted net income helps identify underlying trends in our business that could otherwise be distorted by the effect of certain expenses that we include in net income. We believe that adjusted net income provides useful information about our operating results, enhance the overall understanding of our past performance and future prospects and allow for greater visibility with respect to key metrics used by our management in its financial and operational decision-making.

Adjusted net income should not be considered in isolation or construed as an alternative to net income or any other measure of performance or as an indicator of our operating performance. Investors are encouraged to review the historical non-GAAP financial measures to the most directly comparable GAAP measures. Adjusted net income presented here may not be comparable to similarly titled measures presented by other companies. Other companies may calculate similarly titled measures differently, limiting their usefulness as comparative measures to our data. We encourage investors and others to review our financial information in its entirety and not rely on a single financial measure.

 

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The table below sets forth a reconciliation of our adjusted net income to net (loss)/income for the periods indicated.

 

     For the Year Ended December 31,      For the Nine Months Ended September 30,  
     2015     2016      2016     2017  
     RMB     RMB      US$      RMB     RMB     US$  
     (in thousands)  

Net (loss)/income

     (37,853     23,946        3,599        (19,045     95,115       14,296  

Add:

              

Share-based compensation expenses

     55,991       57,735        8,678        43,363       48,575       7,301  
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Adjusted net income

     18,138       81,681        12,277        24,318       143,690       21,597  
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis together with our consolidated financial statements and the related notes included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties about our business and operations. Our actual results may differ materially from those we currently anticipate as a result of various factors, including those we describe under “Risk Factors” and elsewhere in this prospectus. See “Special Note Regarding Forward-Looking Statements.”

Overview

We are a biometric and activity data-driven company with significant expertise in smart wearable technology. We shipped 11.6 million units of smart wearable devices in the first nine months of 2017, more than any other company in the world, according to the Frost & Sullivan Report. Leveraging our proprietary technologies, strong supply chain management capabilities and strategic relationship with Xiaomi, as of September 30, 2017, we had shipped a total of 45.3 million smart wearable devices through Xiaomi and other distribution partners since our inception in 2013, quickly establishing our global market position and recognition.

We generate substantially all of our revenues from the sale of smart wearable devices, including Xiaomi Wearable Products, and our self-branded products. The global smart wearables market has been growing rapidly and the momentum is expected to continue in the near future. By 2021, the global smart wearables market size is expected to reach US$46.2 billion, representing a five-year CAGR of 23.6% from 2016 to 2021, with shipment volume of 281.9 million devices, representing a CAGR of 22.3% for the same period, according to the Frost & Sullivan Report. Our global market leadership positions us well to capture the tremendous growth potential. However, the current industry landscape in wearable technology is becoming increasingly complex as technology and consumer preferences evolve constantly and rapidly. To sustain the growth and the margin level of our company, we must continually develop and introduce new generations of our existing product lines and new forms of smart wearable technology with enhanced functionalities and value-added services. Our capability to roll out new or enhanced products and services in turn depend on a number of factors, including timely and successful research and development efforts by us as well as our suppliers’ capabilities to bring cutting-edge technologies to the market and quality control of service provision and product manufacturing and our distribution channels.

We have been the sole partner of Xiaomi to design and manufacture Xiaomi Wearable Products. Our strategic cooperation agreement with Xiaomi grants us the most-preferred-partner status globally to develop future Xiaomi Wearable Products, including the Mi Band series, our best-selling products to date. We rely on Xiaomi as our sole distribution channel for all Xiaomi Wearable Products, and derived a substantial majority of our revenues from the sales of Xiaomi Wearable Products historically. For the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2017, revenues from our Xiaomi Wearable Products segment represented 97.1%, 92.1% and 82.4% of our total revenues, respectively. We also offer smart bands, smart watches and other smart wearable devices under our own Amazfit brand.

We have achieved significant growth since our inception in 2013. Our revenues increased by 73.6% from RMB896.5 million in the year ended December 31, 2015 to RMB1,556.5 million (US$233.9 million) in the year ended December 31, 2016, and increased by 37.4% from RMB943.5 million for the nine months ended September 30, 2016 to RMB1,296.2 million (US$194.8 million) for the same period of 2017. We recorded a net loss of RMB37.9 million in the year ended December 31, 2015 and a net income of RMB23.9 million (US$3.6 million) in the year ended December 31, 2016. For the nine months ended September 30, 2017, we had a net income of RMB95.1 million (US$14.3 million), compared to a net loss of RMB19.0 million for the nine months ended September 30, 2016. Our adjusted net income, which excludes share-based compensation expenses, increased from RMB18.1 million in the year ended December 31, 2015 to RMB81.7 million (US$12.3 million) in the year ended December 31, 2016, and increased from RMB24.3 million for the nine months ended

 

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September 30, 2016 to RMB143.7 million (US$21.6 million) for the same period of 2017. See “Prospectus Summary—Summary Consolidated Financial and Operating Data—Non-GAAP Measures” for a reconciliation of adjusted net income to net income.

Key Factors Affecting Our Results of Operations

Key factors affecting our results of operations include the following:

Our research and development of innovative products and services

We have dedicated and will continue to dedicate significant research and development efforts in developing innovative products and services. For the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2017, research and development expenses accounted for 40.8%, 50.3% and 49.2% of our total operating expenses and 6.9%, 8.5% and 8.4% of our revenues, respectively. Our future success is significantly dependent on our ability to continually launch products and services that are popular among consumers, particularly relative to those offered by our competitors. The popularity of our products and services in turn affect users’ engagement on our platform, the data of which form a critical foundation of our research and development efforts.

Relationship with Xiaomi

We have been the sole partner of Xiaomi to design and manufacture Xiaomi Wearable Products. Our strategic cooperation agreement with Xiaomi grants us the most-preferred-partner status globally to develop future Xiaomi Wearable Products and provides us with significant business demand, allowing us to commercially launch our products and ramp up our business quickly. Xiaomi is our exclusive distribution channel for all Xiaomi Wearable Products. Historically, we derived a substantial majority of our revenues from the sales of Xiaomi Wearable Products. For the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2017, revenues from our Xiaomi Wearable Products segment represented 97.1%, 92.1% and 82.4% of our total revenues, respectively. In addition, we leverage Xiaomi’s established distribution network and global presence for the sales and promotion of our self-branded products and international expansion. Therefore, maintaining a close and mutually beneficial relationship with Xiaomi is critical to our operations and future growth.

Effective control over material and manufacturing costs

Material and manufacturing costs of our products have historically accounted for the largest portion of our cost of revenues. Our ability to effectively control material and manufacturing costs, especially by enhancing our bargaining power with suppliers and manufacturers, has affected and will continue to affect our profitability significantly. We expect our material and manufacturing costs to increase in absolute amounts as we increase our smart wearable device shipment volume. However, given our efficient supply chain management and industry leading market share, we believe we have the ability to control the overall level of material and manufacturing costs as percentage of revenues.

Brand promotion and international expansion

One of our important growth strategies is to attract new users through enhancing our brand recognition, particularly for our self-branded products. To execute this strategy, we plan to engage in a variety of marketing and brand promotion campaigns in China, which may cause our selling and marketing expenses to increase in the near future. Selling and marketing expenses as a percentage of our revenues were low historically, but it is possible that they may increase.

International expansion also represents a significant opportunity to further grow our business. With our close collaboration with Xiaomi, we have leveraged and plan to continue to leverage Xiaomi’s global distribution

 

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network and fan base to expand into Xiaomi’s key target markets. At the same time, we are also building our own distribution network and promoting our own brand with a focus on North America, Japan, Korea, India and Southeast Asia, which requires us to dedicate additional time and resources.

Seasonality

We have historically experienced higher sales in the fourth quarter, primarily due to “Singles’ Day” online shopping festival organized by TMall. Given the significant seasonality of our sales, timely and effective forecasting and product introductions for the peak seasons are critical to our operations.

Key Components of Results of Operations

Revenues

We derive our revenues from two operating segments, (i) Xiaomi Wearable Products, and (ii) our self-branded products and others. The following table sets forth our revenues by segment and as a percentage of total revenues for the periods indicated:

 

    Year Ended December 31,     For the Nine Months Ended September 30,  
    2015     2016     2016     2017  
    RMB     %     RMB     US$     %     RMB     %     RMB     US$     %  
    (in thousands, except for percentages)  

Xiaomi Wearable Products

    870,766       97.1       1,434,136       215,552       92.1       873,171       92.5       1,068,490       160,595       82.4  

Self-branded products and others

    25,692       2.9       122,340       18,388       7.9       70,340       7.5       227,758       34,233       17.6  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    896,458       100.0       1,556,476       233,940       100.0       943,511       100.0       1,296,248       194,828       100.0  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

We generate revenues primarily from sales of Xiaomi Wearable Products and our self-branded products. Our Xiaomi Wearable Products include Xiaomi-branded smart bands, watches, scales and associated accessories. Our self-branded products are our Amazfit-branded smart wearable products, which currently include smart bands, watches, modules and associated accessories.

Cost of revenues

Our cost of revenues is comprised of the following:

 

    material costs;

 

    manufacturing and fulfillment costs of our products;

 

    an estimate of warranty costs; and

 

    related expenses that are directly attributable to the production of products.

We procure a variety of raw materials and components from third-party suppliers, and outsource our manufacturing and order fulfillment activities to third parties. Our product costs fluctuate with the costs of raw materials and underlying product components as well as the prices we are able to negotiate with our contract manufacturers and raw material and component suppliers. Shipping costs for raw materials and components from domestic locations are borne by our suppliers and contract manufacturers. For raw materials and components procured overseas, our suppliers cover the shipping costs from place of origin to China, and we are responsible for the additional logistics costs if we consign these raw materials and components to our contract manufacturers.

 

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For Xiaomi Wearable Products, we offer a standard product warranty for a period of up to six months to Xiaomi and following the sale of products to consumers, 12 months to the end users from the date of purchase. For our self-branded products, we offer a standard product warranty for a period of up to 12 months to end users from the date of purchase from us or our distribution partners. We generally elect to replace the defective products covered under the warranty. At the time revenue is recognized, an estimate of warranty costs in relation to the products sold is recorded as a component of cost of revenues.

The following table sets forth our cost of revenues by segment and as a percentage of total cost of revenues for the periods indicated:

 

    Year Ended December 31,     For the Nine Months Ended September 30,  
    2015     2016     2016     2017  
    RMB     %     RMB     US$     %     RMB     %     RMB     US$     %  
    (in thousands, except for percentages)  

Xiaomi Wearable Products

    762,211       97.0       1,182,646       177,753       92.4       734,369       92.8       803,764       120,807       83.0  

Self-branded products and others

    23,656       3.0       97,678       14,681       7.6       56,843       7.2       164,605       24,740       17.0  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenues

    785,867       100.0       1,280,324       192,434       100.0       791,212       100.0       968,369       145,547       100.0  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The following table sets forth the gross profit and gross margin by segment:

 

     Year ended December 31,      For the Nine Months
Ended September 30,
 
     2015      2016      2016      2017  
     RMB      RMB      US$      RMB      RMB      US$  
     (in thousands, expect for percentages)  

Xiaomi Wearable Products

     108,555        251,490        37,799        138,802        264,726        39,789  

Self-branded products and others

     2,036        24,662        3,707        13,497        63,153        9,492  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total gross profit

     110,591        276,152        41,506        152,299        327,879        49,281  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Xiaomi Wearable Products

     12.5%        17.5%           15.9%        24.8%     

Self-branded products and others

     7.9%        20.2%           19.2%        27.7%     

Overall gross margin

     12.3%        17.7%           16.1%        25.3%     

Operating expenses

We classify our operating expenses into three categories: research and development, general and administrative, and selling and marketing.

Research and Development Expenses. Research and development expenses primarily consist of salaries and benefits (including employee benefit expenses and share-based compensation expenses) for research and development personnel and other expenses associated with our research and development activities.

General and Administrative Expenses. General and administrative expenses primarily consist of salaries and benefits (including employee benefit expenses and share-based compensation expenses) for administrative personnel, as well as other expenses primarily relating to professional services and our facilities and other administrative expenses. We expect our general and administrative expenses to increase in absolute amounts in the foreseeable future due to the anticipated growth of our business as well as accounting, insurance, investor relations and other public company costs.

Selling and Marketing Expenses. Selling and marketing expenses primarily consist of advertising and promotion expenses (including expenses for new product launch events), salaries and benefits for selling and

 

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marketing personnel, expenses related to business development through e-commerce platforms and other expenses associated with our selling and marketing activities. We bear the advertising and marketing expenses for our self-branded products. We do not bear such expenses for Xiaomi Wearable Products. We expect our selling and marketing expenses to increase in absolute amounts as we seek to increase our brand awareness and expand the marketing efforts for our self-branded products in both China and the international markets.

Other income

Other income primarily consists of subsidies received from local government authorities to encourage technology innovation and investment.

Taxation

Cayman Islands

We are not subject to income or capital gains tax under the current laws of the Cayman Islands. There are no other taxes likely to be material to us levied by the government of the Cayman Islands. In addition, the Cayman Islands does not impose withholding tax on dividend payments.

Hong Kong

Our subsidiary incorporated in Hong Kong, Huami HK Limited, is subject to 16.5% Hong Kong profit tax on its taxable income generated from operations in Hong Kong. Under the Hong Kong tax laws, we are exempted from the Hong Kong income tax on our foreign-derived income. In addition, payments of dividends from our Hong Kong subsidiary to us are not subject to any Hong Kong withholding tax.

PRC

Generally, our PRC subsidiaries, variable interest entities and their subsidiaries are subject to enterprise income tax on their taxable income in China at a statutory rate of 25%. A “high and new technology enterprise” is entitled to a favorable statutory tax rate of 15% and such qualification is reassessed by relevant governmental authorities every three years. Anhui Huami began to qualify as a high and new technology enterprise since 2015, and was subject to a tax rate of 15% for the years ended December 31, 2015 and 2016. The enterprise income tax is calculated based on the entity’s global income as determined under PRC tax laws and accounting standards.

We are subject to value added tax, or VAT, at a rate of 17% on sales and/or import goods and 6% on the services (research and development services, technology services, information technology services and/or culture and creativity services), in each case less any deductible VAT we have already paid or borne. We are also subject to surcharges on VAT payments in accordance with PRC law.

Dividends paid by our wholly foreign-owned subsidiaries in China to our intermediary holding company in Hong Kong will be subject to a withholding tax rate of 10%, unless the relevant Hong Kong entity satisfies all the requirements under the Arrangement between the PRC and the Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion with respect to Taxes on Income and Capital and receives approval from the relevant tax authority. If our Hong Kong subsidiary satisfies all the requirements under the tax arrangement and receives approval from the relevant tax authority, then the dividends paid to the Hong Kong subsidiary would be subject to withholding tax at the standard rate of 5%. Effective from November 1, 2015, the above mentioned approval requirement has been abolished, but a Hong Kong entity is still required to file application package with the relevant tax authority, and settle the overdue taxes if the preferential 5% tax rate is denied based on the subsequent review of the application package by the relevant tax authority. See “Risk Factors—Risks Related to Doing Business in China—We may rely on dividends and other distributions on equity paid by our PRC subsidiaries to fund any cash and financing requirements we may have, and any limitation on the ability of our PRC subsidiaries to make payments to us could have a material and adverse effect on our ability to conduct our business.”

 

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If our holding company in the Cayman Islands or any of our subsidiaries outside of China were deemed to be a “resident enterprise” under the PRC Enterprise Income Tax Law, it would be subject to enterprise income tax on its worldwide income at a rate of 25%. See “Risk Factors—Risks Related to Doing Business in China—If we are classified as a PRC resident enterprise for PRC income tax purposes, such classification could result in unfavourable tax consequences to us and our non-PRC shareholders or ADS holders.”

Results of Operations

The following table sets forth a summary of our consolidated results of operations for the periods presented, both in absolute amount and as a percentage of our revenues for the periods presented.

 

    For the Year Ended December 31,     For the Nine Months Ended September 30,  
    2015     2016     2016     2017  
    RMB     %     RMB     US$     %     RMB     %     RMB     US$     %  
    (in thousands)  

Summary Consolidated Statements of Operating Data:

                   

Revenues(1)

    896,458       100.0       1,556,476       233,940       100.0       943,511       100.0       1,296,248       194,828       100.0  

Cost of revenues(2)

    785,867       87.7       1,280,324       192,434       82.3       791,212       83.9       968,369       145,547       74.7  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    110,591       12.3       276,152       41,506       17.7       152,299       16.1       327,879       49,281       25.3  

Operating expenses:

                   

Research and development expenses(3)

    61,553       6.9       132,304       19,885       8.5       98,008       10.4       108,590       16,321       8.4  

General and administrative expenses(3)

    69,984       7.8       102,644       15,428       6.6       69,043       7.3       82,474       12,396       6.4  

Selling and marketing expenses

    19,168       2.1       27,821       4,181       1.8       14,801       1.6       29,680       4,461       2.3  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    150,705       16.8       262,769       39,494       16.9       181,852       19.3       220,744       33,178       17.0  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating (loss)/income

    (40,114     (4.5     13,383       2,012       0.9       (29,553     (3.1     107,135       16,103       8.3  

Realized gain from investments

                                              2,335       351       0.2  

Interest income

    255       0.0       754       113       0.0       646       0.1       1,463       220       0.1  

Other income

    1,109       0.1       14,726       2,213       0.9       7,287       0.8       1,066       160       0.1  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss)/income before income tax

    (38,750     (4.3     28,863       4,338       1.9       (21,620     (2.3     111,999       16,834       8.6  

Income tax benefit/(expense)

    897       0.1       (3,088     (464     (0.2     3,731       0.4       (15,462     (2,324     (1.2

(Loss)/income before loss from equity method investments

    (37,853     (4.2     25,775       3,874       1.7       (17,889     (1.9     96,537       14,510       7.4  

Loss from equity method investments

    —         —         (1,829     (275     (0.1     (1,156     (0.1     (1,422     (214     (0.1
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss)/income

    (37,853     (4.2     23,946       3,599       1.5       (19,045     (2.0     95,115       14,296       7.3  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Notes:

(1)   Includes RMB876.7 million, RMB1,449.9 million (US$217.9 million), RMB879.6 million and RMB1,124.8 million (US$169.1 million) with related parties for the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2016 and 2017, respectively.
(2)   Includes RMB762.9 million, RMB1,198.3 million (US$180.1 million), RMB742.1 million and RMB853.3 million (US$128.3 million) with related parties for the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2016 and 2017, respectively.

 

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(3)   Share-based compensation expenses were allocated in operating expenses as follows. Our share-based compensation expenses were the result of (i) our grants of options, restricted shares and restricted share units under our share incentive plans to our employees, and (ii) the share restriction agreements entered into among our founders and our preferred shareholders in relation to our private financing transactions in January 2014 and April 2015. For the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2017, we recorded share-based compensation expenses of RMB37.2 million, RMB50.8 million and RMB38.9 million, respectively, in relation to the vesting of the restricted shares of our founders under the share restriction agreements.

 

     For the Year Ended December 31,      For the Nine Months Ended September 30,  
     2015      2016      2016      2017  
     RMB      RMB      US$      RMB      RMB      US$  
     (in thousands)  

Research and development expenses

     2,588        2,626        395        1,970        6,428        966  

General and administrative expenses

     53,403        55,109        8,283        41,393        42,147        6,335  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     55,991        57,735        8,678        43,363        48,575        7,301  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Non-GAAP Measures

We use adjusted net income, a non-GAAP financial measure, in evaluating our operating results and for financial and operational decision-making purposes. Adjusted net income represents net income excluding share-based compensation expenses, and such adjustment has no impacts on income tax.

We believe that adjusted net income helps identify underlying trends in our business that could otherwise be distorted by the effect of certain expenses that we include in net income. We believe that adjusted net income provides useful information about our operating results, enhance the overall understanding of our past performance and future prospects and allow for greater visibility with respect to key metrics used by our management in its financial and operational decision-making.

Adjusted net income should not be considered in isolation or construed as an alternative to net income or any other measure of performance or as an indicator of our operating performance. Investors are encouraged to review the historical non-GAAP financial measures to the most directly comparable GAAP measures. Adjusted net income presented here may not be comparable to similarly titled measures presented by other companies. Other companies may calculate similarly titled measures differently, limiting their usefulness as comparative measures to our data. We encourage investors and others to review our financial information in its entirety and not rely on a single financial measure.

The table below sets forth a reconciliation of our adjusted net income to net (loss)/income for the periods indicated.

 

     For the Year Ended December 31,      For the Nine Months Ended September 30,  
     2015     2016      2016     2017  
     RMB     RMB      US$      RMB     RMB      US$  
     (in thousands)  

Net (loss)/income

     (37,853     23,946        3,599        (19,045     95,115        14,296  

Add:

               

Share-based compensation expenses

     55,991       57,735        8,678        43,363       48,575        7,301  
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Adjusted net income

     18,138       81,681        12,277        24,318       143,690        21,597  
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

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Nine Months Ended September 30, 2017 Compared to Nine Months Ended September 30, 2016

Revenues

Our revenues increased by 37.4% from RMB943.5 million for the nine months ended September 30, 2016 to RMB1,296.2 million (US$194.8 million) for the same period of 2017.

Xiaomi Wearable Products. Our Xiaomi Wearable Products segment revenues increased by 22.4% from RMB873.2 million for the nine months ended September 30, 2016 to RMB1,068.5 million (US$160.6 million) for the same period of 2017. The increase was primarily attributable to an increase in average revenue per unit of Xiaomi Wearable Products by 28.8% from RMB74.6 in the nine months ended September 30, 2016 to RMB96.0 in the nine months ended September 30, 2017.

Self-branded products and others. Our self-branded products and others segment revenues increased significantly from RMB70.3 million in the nine months ended September 30, 2016 to RMB227.8 million (US$34.2 million) in the nine months ended September 30, 2017. The increase was primarily attributable to an increase in shipment volume of our self-branded products from approximately 129,000 in the nine months ended September 30, 2016 to approximately 464,000 in the nine months ended September 30, 2017.

Cost of revenues

Our cost of revenues increased by 22.4% from RMB791.2 million for the nine months ended September 30, 2016 to RMB968.4 million (US$145.5 million) for the same period of 2017.

Xiaomi Wearable Products. Cost of revenues for our Xiaomi Wearable Products segment increased by 9.4% from RMB734.4 million for the nine months ended September 30, 2016 to RMB803.8 million (US$120.8 million) for the same period of 2017. The increase was primarily attributable to the shift in production focus from Mi Band 1 to Mi Band 2 during the nine months ended September 30, 2017 and the higher per unit cost of Mi Band 2 compared to Mi Band 1.

Self-branded products and others. Cost of revenues for our self-branded products and others segment increased significantly from RMB56.8 million in the nine months ended September 30, 2016 to RMB164.6 million (US$24.7 million) in the nine months ended September 30, 2017. The increase was in line with the growth of the sales of our self-branded products.

Gross profit

Our gross profit increased by 115.3% from RMB152.3 million for the nine months ended September 30, 2016 to RMB327.9 million (US$49.3 million) for the same period of 2017.

Our gross margin improved from 16.1% to 25.3% for the same periods, which was primarily attributable to the increase of the gross margin of Xiaomi Wearable Products, particularly Mi Band products. Gross margin for our Xiaomi Wearable Products segment increased from 15.9% in the nine months ended September 30, 2016 to 24.8% in the nine months ended September 30, 2017 primarily due to the increase in sales volume of Mi Band 2, which had a higher suggested retail price than Mi Band 1, as well as greater economies of scale and stronger negotiating power with our suppliers and manufacturers. Gross margin for our self-branded products and others segment increased to 27.7% in the nine months ended September 30, 2017 from 19.2% in the same period of 2016. The increase of gross margin of our self-branded products and others segment was primarily attributable to the launch of new products resulting in greater economies of scale as the shipment volume of our self-branded products increased significantly in the nine months ended September 30, 2017. We are currently in the early stage of developing our self-branded products, and we expect the gross margin of the self-branded products and

 

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others segment to continue to increase as we further realize economies of scale and improve operating efficiency with the increase in sales volume of our self-branded products. However, such factors may have limited effect on gross margin once our self-branded products become more mature and the shipment volume reaches a certain level.

Research and development expenses

Research and development expenses increased by 10.8% from RMB98.0 million for the nine months ended September 30, 2016 to RMB108.6 million (US$16.3 million) for the same period of 2017, primarily due to a RMB4.5 million increase in share-based compensation expenses and a RMB1.6 million increase in personnel-related costs associated with an increase of average compensation level. For the nine months ended September 30, 2017, research and development expenses, as a percentage of revenues, decreased to 8.4% from 10.4% for same period of 2016.

General and administrative expenses

General and administrative expenses increased by 19.5% from RMB69.0 million for the nine months ended September 30, 2016 to RMB82.5 million (US$12.4 million) for the nine months ended September 30, 2017. Share-based compensation is a large component of our general and administrative expenses. For the nine months ended September 30, 2016 and 2017, general and administrative expenses included RMB41.4 million and RMB42.1 million (US$6.3 million) of share-based compensation expenses, respectively. The increase in general and administrative expenses was primarily due to (i) a RMB6.0 million increase in personnel-related costs associated with an increase in headcount of our general and administrative personnel from 56 as of September 30, 2016 to 72 as of September 30, 2017, and (ii) a RMB4.6 million increase in government fees and charges. For the nine months ended September 30, 2017, general and administrative expenses, as a percentage of revenues, decreased to 6.4% from 7.3% for the nine months ended September 30, 2016.

Selling and marketing expenses

Selling and marketing expenses increased by 100.5% from RMB14.8 million for the nine months ended September 30, 2016 to RMB29.7 million (US$4.5 million) for the nine months ended September 30, 2017, primarily due to a RMB11.0 million increase in expenses to promote our self-branded products through e-commerce platforms, such as JD.com and TMall, and a RMB3.7 million increase in personnel-related costs associated with the increase in average compensation level and an increase in headcount of our selling and marketing personnel from 28 as of September 30, 2016 to 42 as of September 30, 2017. For the nine months ended September 30, 2017, selling and marketing expenses, as a percentage of revenues, increased to 2.3% from 1.6% for the nine months ended September 30, 2016.

Operating (loss)/income

As a result of the factors set out above, we recorded an operating income of RMB107.1 million (US$16.1 million) for the nine months ended September 30, 2017, as compared to an operating loss of RMB29.6 million for the nine months ended September 30, 2016.

Realized gain from investments

We had RMB2.3 million (US$0.4 million) of realized gain from investments for the nine months ended September 30, 2017, primarily as a result of the remeasurement of the fair value of the equity interests we had in an investee company, immediately before it was acquired by us.

 

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Interest income

Interest income represents interest earned on bank deposits. We had RMB0.6 million and RMB1.5 million (US$0.2 million) of interest income for the nine months ended September 30, 2016 and 2017, respectively.

Other income

We had RMB7.3 million and RMB1.1 million (US$0.2 million) of other income for the nine months ended September 30, 2016 and 2017, respectively, primarily as a result of subsidies income we recorded for the periods.

Income tax benefits/(expenses)

We recorded income tax benefits in the amount of RMB3.7 million and income tax expenses in the amount of RMB15.5 million (US$2.3 million) for the nine months ended September 30, 2016 and 2017, respectively. The income tax benefits for the nine months ended September 30, 2016 were the result of RMB12.7 million in deferred tax benefits offset by RMB9.0 million in current tax expenses. The income tax expenses for the nine months ended September 30, 2017 were the result of RMB39.4 million in current tax expenses offset by RMB23.9 million in deferred tax benefits.

 

Net income

As a result of the foregoing, our operating result improved from a net loss of RMB19.0 million for the nine months ended September 30, 2016 to a net income of RMB95.1 million (US$14.3 million) for the nine months ended September 30, 2017. Excluding share-based compensation expenses, our adjusted net income increased by 490.9% from RMB24.3 million in the nine months ended September 30, 2016 to RMB143.7 million (US$21.6 million) in the nine months ended September 30, 2017. See “—Results of Operations—Non-GAAP Measures” for a reconciliation of adjusted net income to net income.

Year Ended December 31, 2016 Compared to Year Ended December 31, 2015

Revenues

 

Our revenues increased by 73.6% from RMB896.5 million for the year ended December 31, 2015 to RMB1,556.5 million (US$233.9 million) for the year ended December 31, 2016.

Xiaomi Wearable Products. Our Xiaomi Wearable Products segment revenues increased by 64.7% from RMB870.8 million in 2015 to RMB1,434.1 million (US$215.6 million) in 2016. The increase was primarily attributable to an increase in units of Xiaomi Wearable Products shipped by 22.2% from 14.4 million in 2015 to 17.6 million in 2016 as well as an increase in average revenue per unit of Xiaomi Wearable Products by 34.8% from RMB60.5 in 2015 to RMB81.6 in 2016.

Self-branded products and others. Our self-branded products and others segment revenues increased significantly from RMB25.7 million in 2015 to RMB122.3 million (US$18.4 million) in 2016. The increase was primarily attributable to an increase in shipment volume of our self-branded products from approximately 28,000 in 2015 to approximately 253,000 in 2016.

Cost of revenues

 

Our cost of revenues increased by 62.9% from RMB785.9 million for the year ended December 31, 2015 to RMB1,280.3 million (US$192.4 million) for the year ended December 31, 2016.

 

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Xiaomi Wearable Products. Costs of revenues for our Xiaomi Wearable Products segment increased by 55.2% from RMB762.2 million in 2015 to RMB1,182.6 million (US$177.8 million) in 2016. This increase was primarily attributable to the increase in units of Xiaomi Wearable Products shipped in this period as well as the higher average unit cost as a result of the launch of Mi Band 2.

Self-branded products and others. Cost of revenues for our self-branded products and others segment increased significantly from RMB23.7 million in 2015 to RMB97.7 (US$14.7 million) in 2016 which was in line with the rapid growth of sales of our self-branded products.

Gross profit

Our gross profit increased by 149.7% from RMB110.6 million for the year ended December 31, 2015 to RMB276.2 million (US$41.5 million) for the year ended December 31, 2016.

Our gross margin improved from 12.3% to 17.7% for the same period, which was primarily attributable to the increase of the gross margin of Xiaomi Wearable Products, particularly Mi Band products. Gross margin for our Xiaomi Wearable Products segment increased from 12.5% in 2015 to 17.5% in 2016 primarily due to the launch of our higher-priced Mi Band 2 product in June 2016 as well as greater economies of scale and larger negotiating power with our suppliers and contract manufacturers. Mi Band 2 was our best-selling product in 2016 and had a suggested retail price of RMB149 in China. In comparison, Mi Band 1, our best-selling product in 2015, had a suggested retail price of RMB79 in China. Gross margin for our self-branded products and others segment increased to 20.2% in 2016 from 7.9% in 2015. The increase of gross margin for our self-branded products and others segment was primarily attributable to greater economies of scale and lower costs per unit as we launched more products under own brand and the volume for these products ramped up in 2016.

Research and development expenses

Research and development expenses increased by 114.9% from RMB61.6 million for the year ended December 31, 2015 to RMB132.3 million (US$19.9 million) for the year ended December 31, 2016, primarily due to a RMB67.1 million increase in personnel-related costs associated with an increase in headcount of our research and development personnel from 213 as of December 31, 2015 to 274 as of December 31, 2016 and an increase of average compensation level. For the year ended December 31, 2016, research and development expenses, as a percentage of revenues, increased to 8.5% from 6.9% for the year ended December 31, 2015.

General and administrative expenses

General and administrative expenses increased by 46.7% from RMB70.0 million for the year ended December 31, 2015 to RMB102.6 million (US$15.4 million) for the year ended December 31, 2016. Share-based compensation is a large component of our general and administrative expenses. For the years ended December 31, 2015 and 2016, general and administrative expenses included RMB53.4 million and RMB55.1 million (US$8.3 million) of share-based compensation expenses, respectively. The increase in general and administrative expenses was primarily due to (i) a RMB7.1 million increase in consulting service fee in relation to consultant service for our U.S. operations, (ii) a RMB6.4 million increase in personnel-related costs associated with an increase in headcount of our general and administrative personnel from 29 as of December 31, 2015 to 63 as of December 31, 2016, and (iii) a RMB5.5 million increase in foreign exchange loss. For the year ended December 31, 2016, general and administrative expenses, as a percentage of revenues, decreased to 6.6% from 7.8% for the year ended December 31, 2015.

Selling and marketing expenses

 

Selling and marketing expenses increased by 45.1% from RMB19.2 million for the year ended December 31, 2015 to RMB27.8 million (US$4.2 million) for the year ended December 31, 2016, primarily due

 

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to a RMB4.8 million increase in personnel-related costs associated with the increase in average compensation level, and a RMB4.3 million increase in expenses to promote our self-branded products through e-commerce platforms, such as JD.com and TMall. For the year ended December 31, 2016, selling and marketing expenses, as a percentage of revenues, decreased to 1.8% from 2.1% for the year ended December 31, 2015.

Operating (loss)/income

As a result of the factors set out above, we recorded an operating income of RMB13.4 million (US$2.0 million) for the year ended December 31, 2016, as compared to an operating loss of RMB40.1 million for the year ended December 31, 2015.

Interest income

Interest income represents interest earned on bank deposits. We had RMB0.3 million and RMB0.8 million (US$0.1 million) of interest income for the years ended December 31, 2015 and 2016, respectively.

Other income

We had RMB1.1 million and RMB14.7 million (US$2.2 million) of other income for the year ended December 31, 2015 and 2016, respectively, primarily as a result of subsidies income we recorded for the periods.

Income tax benefits/(expenses)

We recorded income tax benefits in the amount of RMB0.9 million and income tax expenses in the amount of RMB3.1 million (US$0.5 million) for the years ended December 31, 2015 and 2016, respectively. The income tax benefits for the year ended December 31, 2015 were the result of RMB3.2 million in deferred tax benefits offset by RMB2.3 million in current tax expenses. The income tax expenses for the year ended December 31, 2016 were the result of RMB21.6 million in current tax expenses offset by RMB18.5 million in deferred tax benefits.

Net income

As a result of the foregoing, our operating result improved from a net loss of RMB37.9 million for the year ended December 31, 2015 to a net income of RMB23.9 million (US$3.6 million) for the year ended December 31, 2016. Excluding share-based compensation expenses, our adjusted net income increased by 350.3% from RMB18.1 million in the year ended December 31, 2015 to RMB81.7 million (US$12.3 million) in the year ended December 31, 2016. See “—Results of Operations—Non-GAAP Measures” for a reconciliation of adjusted net income to net income.

Selected Quarterly Results of Operations

The following table sets forth our unaudited consolidated quarterly results of operations for each of the seven quarters from January 1, 2016 to September 30, 2017. You should read the following table in conjunction with our consolidated financial statements and the related notes included elsewhere in this prospectus. We have prepared this unaudited condensed consolidated quarterly financial data on the same basis as we have prepared our audited consolidated financial statements. The unaudited condensed consolidated financial data include all adjustments, consisting only of normal and recurring adjustments, that our management considered necessary for a fair statement of our financial position and results of operation for the quarters presented.

 

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    For the Three Months Ended,  
    March 31,
2016
    June 30,
2016
    September 30,
2016
    December 31,
2016
    March 31,
2017
    June 30,
2017
    September 30,
2017
 
    (Unaudited)  
    (in RMB thousands)  

Revenues

    295,741       274,953       372,817       612,965       331,104       491,065       474,079  

Cost of revenues

    255,348       233,073       302,791       489,112       257,136       364,059       347,174  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    40,393       41,880       70,026       123,853       73,968       127,006       126,905  

Operating expenses:

             

Research and development expenses(1)

    29,864       31,274       36,870       34,296       40,502       32,843       35,245  

General and administrative expenses(1)

    20,292       22,668       26,083       33,601       28,498       26,600       27,376  

Selling and marketing expenses

    2,363       3,622       8,816       13,020       10,393       9,391       9,896  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    52,519       57,564       71,769       80,917       79,393       68,834       72,517  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating (loss)/income

    (12,126)       (15,684)       (1,743)       42,936       (5,425)       58,172       54,388  

Other income/(expenses):

             

Realized gain from investments

    —         —         —         —         —         —         2,335  

Interest income

    232       239       175       108       433       339       691  

Other income

    850       4,401       2,036       7,439       420       318       328  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss)/income before income tax

    (11,044)       (11,044)       468       50,483       (4,572)       58,829       57,742  

Income tax benefit/(expense)

    1,877       1,877       (23)       (6,819)       603       (8,530)       (7,535)  

(Loss)/income before loss from equity method investments

    (9,167)       (9,167)       445       43,664       (3,969)       50,299       50,207  

(Loss)/income from equity method investments

    (67)       (511)       (578)       (673)       (568)       (574)       (280)  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss)/income

    (9,234)       (9,678)       (133)       42,991       (4,537)       49,725       49,927  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Note:  
(1)   Share-based compensation expenses were allocated in operating expenses as follows:

 

    For the Three Months Ended  
    March 31,
2016
    June 30,
2016
    September 30,
2016
    December 31,
2016
    March 31,
2017
    June 30,
2017
    September 30,
2017
 
    (Unaudited)  
    (in RMB thousands)  

Research and development expenses

    657       656       657       656       572       572       5,284  

General and administrative expenses

    13,960       13,716       13,717       13,716       14,049       14,049       14,049  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    14,617       14,372       14,374       14,372       14,621       14,621       19,333  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Quarterly trends

Our overall results of operations fluctuate from quarter to quarter as a result of a variety of factors, including seasonal factors and the launch of new products or new generations of existing products.

 

We generally experience higher sales volume and revenues in the fourth quarter of each year primarily due to the “Singles’ Day” online shopping festival. Our revenues are also affected by our product strategy, particularly our product launch timeline. Our revenues tend to increase as we introduce new products or new generations of existing products, but can be negatively affected during the transition period where an existing product is being replaced by its next generation counterpart. For example, our revenues decreased in the second quarter of 2016 as the sales of Mi Band 1, our best-selling product in 2015, declined in anticipation of the launch

 

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of its new generation, Mi Band 2. Our revenues increased in the third quarter of 2016 as we successfully launched Mi Band 2 in June 2016. Our quarterly cost of revenues exhibits similar trends as our quarterly revenues.

On a year-over-year basis, our quarterly research and development expenses, general and administrative expenses and selling and marketing expenses have generally been increasing in absolute amounts during the period from January 1, 2016 to September 30, 2017 as we expanded our product offerings, continued to invest in research and development capabilities, increased the number of our personnel and enhanced our marketing efforts.

We expect our quarterly performance continues to be affected by seasonal trends, behavior of consumers, economic conditions, market competition and our operational decisions, which include the launch of new products as well as newer generations of existing products. Consequently, the results of any prior quarterly or annual period should not be relied upon as indications of our future operating performance.

Liquidity and Capital Resources

Cash flows and working capital

To date, we have financed our operations primarily through cash generated by operating activities and historical equity financing activities.

As of December 31, 2015 and 2016 and September 30, 2017, our cash, cash equivalents and restricted cash were RMB220.0 million, RMB153.2 million (US$23.0 million) and RMB511.3 million (US$76.9 million), respectively, out of which RMB164.2 million, RMB98.6 million (US$14.8 million) and RMB78.1 million (US$11.7 million) was held in U.S. dollars, and RMB55.8 million, RMB54.6 million (US$8.2 million) and RMB433.2 million (US$65.1 million) was held in Renminbi, as of December 31, 2015 and 2016 and September 30, 2017, respectively. Our cash, cash equivalents and restricted cash primarily consist of cash at banks and on hand. 88.6% of our cash, cash equivalents and restricted cash as of September 30, 2017 were held in China, and 88.0% of our cash, cash equivalents and restricted cash were held by our VIEs.

We believe the net proceeds we receive from this offering, together with our cash on hand, will be sufficient to meet our current and anticipated needs for general corporate purposes for at least the next 12 months. After this offering, we may decide to enhance our liquidity position or increase our cash reserve for future investments through additional capital and finance funding. The issuance and sale of additional equity would result in further dilution to our shareholders. The incurrence of indebtedness would result in increased fixed obligations and could result in operating covenants that would restrict our operations.

Although we consolidate the results of our VIEs and their subsidiaries, we only have access to the assets or earnings of our VIEs and their subsidiaries through our contractual arrangements with our consolidated variable interest entities and their shareholders. See “Corporate History and Structure—Contractual Arrangements with the VIEs and Their Respective Shareholders.” For restrictions and limitations on liquidity and capital resources as a result of our corporate structure, see “—Holding Company Structure.”

In utilizing the proceeds we expect to receive from this offering, we may make additional capital contributions to our PRC subsidiaries, establish new PRC subsidiaries and make capital contributions to these new PRC subsidiaries, make loans to our PRC subsidiaries, or acquire offshore entities with business operations in China in offshore transactions. However, most of these uses are subject to PRC regulations and approvals. For example:

 

    capital contributions to our PRC subsidiaries must be approved by the Ministry of Commerce or its local counterparts; and

 

    loans by us to our PRC subsidiaries to finance their activities cannot exceed statutory limits and must be registered with SAFE or its local branches.

See “Regulation—Regulation on Foreign Exchange.”

 

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A majority of our future revenues are likely to continue to be in the form of Renminbi. Under existing PRC foreign exchange regulations, Renminbi may be converted into foreign exchange for current account items, including profit distributions, interest payments and trade-and service-related foreign exchange transactions.

Our PRC subsidiaries may convert Renminbi amounts that they generate in their own business activities, including technical consulting and related service fees pursuant to their contracts with the consolidated variable interest entities, as well as dividends they receive from their own subsidiaries, into foreign exchange and pay them to their non-PRC parent companies in the form of dividends. However, current PRC regulations permit our PRC subsidiaries to pay dividends to us only out of their accumulated profits, if any, determined in accordance with Chinese accounting standards and regulations. Each of our PRC subsidiaries is required to set aside at least 10% of its after-tax profits after making up previous years’ accumulated losses each year, if any, to fund certain reserve funds until the total amount set aside reaches 50% of its registered capital. These reserves are not distributable as cash dividends. Furthermore, capital account transactions, which include foreign direct investment and loans, must be approved by and/or registered with SAFE and its local branches. The total amount of loans we can make to our PRC subsidiaries cannot exceed statutory limits and must be registered with the local counterpart of SAFE. The statutory limit for the total amount of foreign debts of a foreign-invested company is the difference between the amount of total investment as approved by the Ministry of Commerce or its local counterpart and the amount of registered capital of such foreign-invested company. As of December 31, 2015, profit appropriation made by our PRC subsidiaries to the reserve fund reached the maximum required amount of 50% of their registered capital. As a result, during the year ended December 31, 2016, no additional profit appropriation was required to be made to the reserve fund.

We expect to invest substantially all of the proceeds from this offering in our PRC operations for general corporate purposes within the business scopes of our WFOE and our VIEs. See “Risk Factors—Risks Relating to Doing Business in China—Governmental control of currency conversion may limit our ability to utilize our net revenues effectively and affect the value of your investment.”

The following table sets forth the movements of our cash flows for the periods presented:

 

     For the Year Ended December 31,     For the Nine Months Ended September 30,  
     2015     2016     2016     2017  
     RMB     RMB     US$     RMB     RMB     US$  
     (in thousands)  

Summary Consolidated Cash Flow Data:

            

Net cash (used in)/provided by operating activities

     (6,767     17,266       2,595       59,769       336,216       50,533  

Net cash used in investing activities

     (4,911     (99,387     (14,938     (45,256     (5,507     (827

Net cash provided by financing activities

     214,063       10,024       1,507       —         30,089       4,522  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase/(decrease) in cash and cash equivalents

     202,385       (72,097     (10,836     14,513       360,798       54,228  

Exchange rate effect on cash and cash equivalents

     10,226       5,262       791       2,568       (2,635     (396

Cash, cash equivalents and restricted cash at beginning of the period

     7,376       219,987       33,064       219,987       153,152       23,019  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash, cash equivalents and restricted cash at end of the period

     219,987       153,152       23,019       237,068       511,315       76,851  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Operating activities

Net cash provided by operating activities for the nine months ended September 30, 2017 was RMB336.2 million (US$50.5 million). The difference between our net income of RMB95.1 million (US$14.3 million) and the net cash provided by operating activities was primarily due to (i) an adjustment of RMB26.3 million (US$4.0 million) in non-cash items, which primarily consisted of depreciation and amortization, share-based compensation and deferred income taxes, and (ii) a decrease of RMB214.8 million (US$32.3 million) in working capital. Changes in working capital for the nine months ended September 30, 2017 primarily consisted of a decrease of RMB296.8 million (US$44.6 million) in amount due from related parties, an increase of RMB8.9 million (US$1.3 million) in notes payable and an increase of RMB7.8 million (US$1.2 million) in accrued expense and other current liabilities partially offset by a decrease of accounts payable of RMB90.9 million (US$13.7 million) and an increase of prepaid expenses and other current assets of RMB12.4 million (US$1.9 million).

Net cash provided by operating activities for the year ended December 31, 2016 was RMB17.3 million (US$2.6 million). The difference between our net income of RMB23.9 million (US$3.6 million) and the net cash provided by operating activities was primarily due to (i) an adjustment of RMB63.0 million (US$9.5 million) in non-cash items, which primarily consisted of depreciation and amortization and share-based compensation, and (ii) an increase of RMB69.7 million (US$10.5 million) in working capital. Changes in working capital for the year ended December 31, 2016 primarily consisted of an increase of RMB103.5 million (US$15.6 million) in inventories, and an increase of RMB287.7 million (US$43.2 million) in amount due from related parties partially offset by an increase of accounts payable of RMB272.0 million (US$40.9 million).

Net cash used in operating activities for the year ended December 31, 2015 was RMB6.8 million. The difference between our net loss of RMB37.9 million and the net cash used in operating activities was primarily due to (i) an adjustment of RMB56.3 million in non-cash items, which primarily consisted of depreciation and amortization and share-based compensation, and (ii) an increase of RMB25.2 million in working capital. Changes in working capital for the year ended December 31, 2015 primarily consisted of an increase of RMB52.8 million in inventories, an increase of RMB128.5 million in amount due from related parties partially offset by an increase of accounts payable of RMB164.0 million.

As of December 31, 2015 and 2016 and September 30, 2017, we had amount due from related parties of RMB173.0 million, RMB476.7 million (US$71.6 million) and RMB171.6 million (US$25.8 million), respectively, among which RMB170.0 million, RMB460.6 million (US$69.2 million) and RMB163.5 million (US$24.6 million) were from Xiaomi and its affiliates, respectively. Xiaomi usually places significant product orders in the fourth quarter of each year relating to major promotional events, and this results in high inventories and account receivables from Xiaomi at the end of each year. All of the amount due from Xiaomi as of December 31, 2015 and 2016 was collected in the first quarter of 2016 and 2017, respectively.

Investing activities

Net cash used in investing activities was RMB5.5 million (US$0.8 million) for the nine months ended September 30, 2017, primarily due to prepayment for other non-current assets of RMB12.9 million (US$1.9 million), purchase of property, plant and equipment of RMB2.3 million (US$0.4 million) and loans provided to others of RMB8.7 million (US$1.3 million) partially offset by the proceeds of RMB17.5 million (US$2.6 million) received from the disposal of long-term and short-term investments.

Net cash used in investing activities was RMB99.4 million (US$14.9 million) for the year ended December 31, 2016, primarily due to purchase of property, plant and equipment of RMB10.3 million (US$1.5 million) and purchase of long-term investments of RMB62.9 million (US$9.5 million).

Net cash used in investing activities was RMB4.9 million for the year ended December 31, 2015, primarily due to purchase of property, plant and equipment of RMB2.9 million and purchase of long-term investments of RMB2.0 million.

 

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Financing activities

Net cash provided by financing activities for the nine months ended September 30, 2017 was primarily due to a one-year bank borrowing of RMB30.0 million (US$4.5 million).

Net cash provided by financing activities for the year ended December 31, 2016 was primarily due to a one-year bank borrowing of RMB10.0 million (US$1.5 million).

Net cash provided by financing activities in the year ended December 31, 2015 was RMB214.1 million in the form of capital injection from preferred shareholders.

Capital expenditures

Our capital expenditures are primarily incurred for purchases of property, plant and equipment and intangible assets. Our capital expenditures were RMB2.9 million in 2015, RMB11.5 million (US$1.7 million) in 2016 and RMB2.3 million (US$0.4 million) in the nine months ended September 30, 2017. We intend to fund our future capital expenditures with our existing cash balance and proceeds from this offering.

We intend to continue to make capital expenditures to meet the expected growth of our business.

Contractual Obligations

The following table sets forth our contractual obligations as of September 30, 2017:

 

     Payment due by December 31,  
     Total      2017      2018      2019 and after  
     (in RMB thousands)  

Lease commitments(1)

     10,795        2,214        6,571        2,010  
  

 

 

    

 

 

    

 

 

    

 

 

 

Capital commitments(2)

     433,091        9,650        —          423,441  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     443,886        11,864        6,571        425,451  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

Notes:  
(1)   Lease commitments consist of the commitments under the lease agreements for our office premises. We lease our office facilities under non-cancelable operating leases with various expiration dates through 2019.
(2)   Capital commitments consist of the capital commitments for the purchase of property, plant and equipment under a non-cancelable agreement between Anhui Huami and Hefei High-Tech Administrative Office, pursuant to which the two parties agreed to develop a 60,000 square feet industry base that focuses on the development of wearable technology and smart hardware. The two parties also entered into a supplemental agreement with respect to certain subsidy benefits conditional on Anhui Huami’s fulfillment of certain revenue and tax contribution commitments for each fiscal year during the term of the supplemental agreement.

On January 4, 2017, Anhui Huami entered into a one-year loan agreement with the Hefei Branch of China Merchants Bank, pursuant to which Anhui Huami borrowed RMB30.0 million at a fixed interest rate of 5.00%.

Other than as shown above, we did not have any significant capital and other commitments, long-term obligations or guarantees as of September 30, 2017.

Off-Balance Sheet Commitments and Arrangements

We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any unconsolidated third parties. In addition, we have not entered into any derivative contracts that are indexed to our shares and classified as shareholders’ equity or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. Moreover, we do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or product development services with us.

 

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Critical Accounting Policies

We prepare our financial statements in accordance with U.S. GAAP, which requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the balance sheet dates and the reported amounts of revenues and expenses during the reporting periods. We continually evaluate these judgments and estimates based on our own historical experience, knowledge and assessment of current business and other conditions, our expectations regarding the future based on available information and assumptions that we believe to be reasonable, which together form our basis for making judgments about matters that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, our actual results could differ from those estimates. Some of our accounting policies require a higher degree of judgment than others in their application.

The selection of critical accounting policies, the judgments and other uncertainties affecting application of those policies and the sensitivity of reported results to changes in conditions and assumptions are factors that should be considered when reviewing our financial statements. We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements. You should read the following description of critical accounting policies, judgments and estimates in conjunction with our consolidated financial statements and other disclosures included in this prospectus.

Revenue recognition

We generate substantially all of our revenues from sales of smart wearable devices. We also generate a small amount of our revenues from subscription-based services. We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred and the services have been rendered, the sales price is fixed or determinable, and collection is reasonably assured. We recognize revenue, net of estimated sales returns and value-added taxes (VAT).

Our contracts with our customers have multiple element arrangements. The first deliverable is the smart wearable device and embedded firmware that is essential to the functionality of the device. The second deliverable is the software services included with the products, which are provided free of charge and enable users to sync, view, and access real-time data on our mobile apps. The third deliverable is the embedded right included with the purchase of the device to receive, on a when-and-if-available basis, future unspecified firmware upgrades and features relating to the product’s essential firmware.

We allocate revenue to all deliverables based on their relative selling prices. We use a hierarchy to determine the selling price to be used for allocating revenue to the deliverables: (i) vendor-specific objective evidence (“VSOE”) of fair value, (ii) third-party evidence (“TPE”), and (iii) best estimate of the selling price (“BESP”). Because we currently have neither VSOE nor TPE for any of its deliverables, revenue is allocated to the deliverables on BESP as if each deliverable was sold regularly on a stand-alone basis. Our process for determining its BESP considers multiple factors including consumer behaviors and our internal pricing model. The BESP for the smart wearable devices comprises the majority of the arrangement consideration. Our BESP for the software services and software upgrades is currently estimated at RMB 0.31 per unit, RMB0.43 per unit and RMB1.19 per unit for the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2017, respectively. We recognize revenue for the amounts allocated to the smart wearable devices at the time of delivery (except as noted below), provided the other conditions for revenue recognition have been met. Revenue for products sold through distributors is recognized on a sell-in basis. Amounts allocated to the software services and unspecified upgrade rights are deferred and recognized on a straight-line basis over their estimated usage period which approximates 9 months.

During the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2017 we generated 97.4%, 93.2% and 86.8% of revenues from one customer that entered into a cooperation agreement as further described below. The remaining revenues for the years ended December 31, 2015 and 2016 and the nine

 

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months ended September 30, 2017 was mostly generated from sales of our self-branded products to retailers, distributors and end users. Our revenue recognition for self-branded products is consistent with that described in the preceding paragraphs.

Cooperation agreement with one customer (Xiaomi)

During the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2017, we generated most of our revenues from sales of exclusively designed and manufactured smart wearable devices to one customer, who is also the sole distribution channel for such smart wearable devices. This customer is one of our shareholders. Under a cooperation agreement with this customer, we produce and assemble final product for shipments of smart wearable devices to that customer, who is then responsible for commercial distribution and sale of the product. The arrangement includes two payment installments. The first payment installment is priced to recover the costs incurred by us in developing and shipping the devices to the customer and is due from the customer once products have been delivered. We allocate the initial payment installment between the hardware device, the software services, and the software upgrades based on their relative fair value and recognizes revenue based on its recognition policy further described in the preceding paragraph. We are also entitled to receive a potential second installment payment calculated as 50 percent of the future net profits from commercial sales made by the customer. Given the revenue from the profit sharing arrangement is contingent on the commercial sale, we recognize revenue from the second installment in the period following the commercial sale by the customer, which is when the fee is fixed and determinable. The fee related to the second installment is usually earned by us between 30 to 45 days after initial shipment of the product to the customer. The second installment is also allocated between the hardware device, the software services, and the software upgrades based on their relative fair value and is recognized based on our recognition policy further described in the preceding paragraph.

Rights of return

We offer limited sales returns for products sold directly to end-users. We estimate reserves for these sales based on historical experience, and records the reserve as a reduction of revenue and accounts receivable. Throughout the year ended December 31, 2016 and the nine months ended September 30, 2017 , actual returns have been insignificant.

Product Warranty

We offer a standard product warranty that the product will operate under normal use. The warranty period includes an 18-month warranty which includes a six-month warranty to our main customer and an additional 12 months warranty to end-users. We also offer standard product warranty of 12 months to end users from the date of purchase for our self-branded products. We have the obligation, at our option, to either repair or replace the defective product.

At the time revenue is recognized, an estimate of warranty costs is recorded as a component of cost of revenues. The reserves established are regularly monitored based upon historical experience and any actual claims charged against the reserve. Warranty reserves are recorded as a cost of revenue.

Inventories

Our inventories consist of raw materials, finished goods and work in process. Inventories are stated at the lower of cost or market on a weighted average basis. We assess the valuation of inventory and periodically write down the value for estimated excess and obsolete inventory based upon estimates of future demand and market conditions. For the fiscal years ended December 31, 2015 and 2016 and the nine months ended September 30, 2017 , the inventories write-down was nil, RMB1.0 million and nil, respectively.

 

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Acquired intangible asset

Acquired intangible assets other than goodwill consist of the domain name for the Company’s website www.huami.com and the patents from the acquisition of Shenzhen Yunding Information Technology Co., Ltd. The domain name is recognized as an intangible asset with indefinite life and evaluated for impairment at least annually or if events or changes in circumstances indicate that the asset might be impaired. Such impairment test compares the fair value of asset with its carrying amount, and an impairment loss is recognized if and when the carrying amount exceed the fair value. The estimates of values of the intangible asset not subject to amortization are determined using discounted cash flow valuation approach. Significant assumptions are inherent in this process, including estimates of discount rates. The patents are recognized as intangible assets with finite lives and are amortized on a straight-line basis over their expected useful economic lives. Amortization is calculated on a straight-line basis over the estimated useful life of 10 years.

Goodwill

Goodwill represents the excess of the purchase price over the fair value of identifiable net assets acquired in business combinations. Goodwill is not amortized but is tested for impairment annually or more frequently if events or changes in circumstances indicate that it might be impaired.

Goodwill is tested for impairment at the reporting unit level on an annual basis and between annual tests if an event or change in circumstances would more likely than not reduce the fair value of a reporting unit below its carrying amount. These events or circumstances could include a significant change in the stock prices, business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit.

Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. The estimation of fair value of each reporting unit using a discounted cash flow methodology also requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the useful life over which cash flows will occur, and determination of our weighted average cost of capital. The estimates used to calculate the fair value of a reporting unit change from year to year based on results of operations and market conditions. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for the reporting unit.

We perform a two-step goodwill impairment test. The first step compares the fair values of each reporting unit to its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill is not considered impaired and the second step will not be required. If the carrying amount of a reporting unit exceeds its fair value, the second step compares the implied fair value of the affected reporting unit’s goodwill to the carrying amount of that goodwill. The implied fair value of goodwill is determined in a manner similar to accounting for a business combination with the allocation of the assessed fair value determined in the first step to the assets and liabilities of the reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to the assets and liabilities is the implied fair value of goodwill. This allocation process is only performed for purposes of evaluating goodwill impairment and does not result in an entry to adjust the value of any assets or liabilities. An impairment loss is recognized for any excess in the carrying amount of goodwill over the implied fair value of goodwill.

During the nine months ended September 30, 2017, there were no reporting units that were at risk of failing step 1, and we recognized nil impairment loss on goodwill.

 

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Long-term investments

Our long-term investments consist of cost method investments, equity method investments and available-for-sale securities investments.

(a) Cost Method Investment. For investee companies over which we do not have significant influence or a controlling interest, we carry the investment at cost and recognizes as income any dividend received from distribution of the investee’s earnings. We review the cost method investments for impairment whenever an event or circumstance indicates that an other-than-temporary impairment has occurred. We estimated the fair value of these investee companies based on the discounted cash flow approach. Factors we consider in making such a determination include general market conditions, the duration and the extent to which the fair value of an investment is less than its cost, and our intent and ability to hold such investment. An impairment charge is recorded if the carrying amount of an investment exceeds its fair value and such excess is determined to be other-than-temporary. We recorded nil impairment loss on the cost method investments during the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2017.

(b) Equity Method Investment. For an investee company over which we have the ability to exercise significant influence, but does not have a controlling interest, we account for the investment under the equity method. Significant influence is generally considered to exist when we have an ownership interest in the voting stock of the investee between 20% and 50%. Other factors, such as representation on the investee’s board of directors, voting rights and the impact of commercial arrangements, are also considered in determining whether the equity method of accounting is appropriate. Under the equity method of accounting, the investee company’s accounts are not reflected within our consolidated balance sheets and statements of operations; however, our share of the earnings or losses of the investee company is reflected in the caption “Loss from equity method investments” in the consolidated statements of operations.

An impairment charge is recorded if the carrying amount of the investment exceeds its fair value and this condition is determined to be other-than-temporary. We estimated the fair value of the investee company based on comparable quoted price for similar investment in active market, if applicable, or discounted cash flow approach which requires significant judgments, including the estimation of future cash flows, which is dependent on internal forecasts, the estimation of long term growth rate of a company’s business, the estimation of the useful life over which cash flows will occur, and the determination of the weighted average cost of capital. We recorded nil impairment losses on our equity method investments during the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2017.

(c) Available-for-sale Investment. For investment in investees’ convertible notes which is determined to be debt securities, we account for our as long-term available-for-sale securities investments when it is not classified as either trading or held-to-maturity investments. Available-for-sale securities investment is carried at its fair value and the unrealized gains or losses from the changes in fair values are included in accumulated other comprehensive income. We review our investments for other than temporary impairment based on the specific identification method. We consider available quantitative and qualitative evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds the investment’s fair value, we consider, among other factors, general market conditions, government economic plans, the duration and the extent to which the fair value of the investment is less than the cost, our intent and ability to hold the investment, and the financial condition and near term prospects of the investees. We recorded nil losses on our investments during the years ended December 31, 2015 and 2016 and the nine months ended September 30, 2017.

Income taxes

Current income taxes are provided for in accordance with the laws of the relevant tax authorities. Deferred income taxes are recognized when temporary differences exist between the tax bases of assets and liabilities and their reported amounts in the consolidated financial statements. Net operating loss carry forwards and credits are

 

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applied using enacted statutory tax rates applicable to future years. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more-likely-than-not that a portion of or all of the deferred tax assets will not be realized.

We account for uncertain tax positions by reporting a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. Tax benefits are recognized from uncertain tax positions when we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. We recognize interest and penalties, if any, related to unrecognized tax benefits in income tax expense.

Share-based payment

Share-based payment transactions with employees, such as share options, restricted shares and restricted share units are measured based on the grant date fair value of the equity instrument. We have elected to recognize compensation expense using the straight-line method for all employee equity awards granted with graded vesting provided that the amount of compensation cost recognized at any date is at least equal to the portion of the grant-date value of the options that are vested at that date, over the requisite service period of the award, which is generally the vesting period of the award.

We estimated the fair value of share options using the binomial option-pricing model with the assistance from an independent valuation firm. The fair value of each option grant is estimated on the date of grant with the following key assumptions:

 

      October 21,
2015