Zepp Health Corporation (ZEPP) Q4 2020 Earnings Report, Transcript and Summary

Hello, ladies and gentlemen, thank you for standing by for Zepp Health's Fourth Quarter and Full Year 2020 Earnings Conference Call. [Operator Instructions] Today's conference call is being recorded. I will now turn the call over to your host, Ms. Grace Zhang, Director of Investor Relations for the company. Please go ahead, Grace.

Hello, everyone, and welcome to Zepp Health Corporation's Fourth Quarter and Full Year 2020 Earnings Conference Call. The company's financial and operating results were issued in our press release via newswire services earlier today and are posted online. You can also view the earnings press release and the slides through which we will refer on this call by visiting the IR section of the company's website at www.zepp.com/investor. Participating in today's call are Mr. Huang Wang, our Chairman of the Board of Directors and Chief Executive Officer; and Mr. Leon Cheng Deng, our Chief Financial Officer. The company's management will begin with prepared remarks, and the call will conclude with a Q&A session. Mr. Mike Yeung, our Chief Operating Officer, will join us for the Q&A session. Before we continue, please note that today's discussion will contain forward-looking statements made under the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, the company's actual results may be materially different from the views expressed today. Further information regarding this and other risks and uncertainties is included in the company's Annual Report on Form 20-F for the fiscal year ended December 31, 2019, and other filings as filed with the U.S. Securities and Exchange Commission. The company does not assume any obligation to update any forward-looking statements, except as required under applicable law. Please also note that Zepp's earnings press release and this conference call include decisions of our audited GAAP financial information as well as our audited non-GAAP financial information. Zepp's press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited most directly comparable GAAP measures. I will now turn the call over to our CEO, Mr. Huang Wang. Please go ahead.

Hello, everyone. Thank you for joining our call. 2020 was a remarkable year for all of us. Yet with all the severe disruptions brought by the global pandemic, I'm pleased to report we recorded full year revenue growth on a year-over-year basis of 10.7%, and total shipment volume rose 8% for the year, reached 45.7 million units, especially our self-branded products, which rose 20%, reached 4.7 million units. These results are despite a fourth quarter tempered by COVID's impact in several of the international markets we serve. Specifically in Q4, our revenue dipped by 6.6%, and total shipment volume fell 9.5%, both on a year-over-year basis. We should highlight, however, against the challenges, our own brands achieved 31.3% shipment growth in the fourth quarter and continuously strengthened market leadership in countries and regions, such as Indonesia and Spain, which we still ranked #1 in terms of adult smartwatch shipment. As vaccinations worldwide have begun rolling out in [ March ] we are confident that our business will rise again should in both revenue and shipment volume in 2021, especially our own branded watches, which will become the main engine for the business to grow. Our solid full year results bear evidence to the soundness of our strategy of connecting health with technology, the broad appeal of our smart health products and services, and our adaptability to execute in a rapidly changing environment. In 2020, we made significant strides in building out our strategy of connecting health with technology. Notably, we identified 3 pillars that will function and be developed as the framework for our business. These are consumer health technology, data analytics and industrial health. I would like to take a few minutes to explain this now. Consumer health technology is the backbone of our business. Our products and services in this portfolio showcase many of attributes that have made us a global leader in the smart wearable space, namely commitment to innovation, cutting-edge technology and speed to market. In 2020, we introduced a record 20-plus new products and upgrade versions. We also branched into new product categories, including ear buds, scales and home fitness equipment, such as treadmills. Many of these new products will present at the Consumer Electronic Show, CES, in January and several of our Amazfit and Zepp branded products received best in show distinction and accolade from the reviewers in leading publications, including Wearables Techradar, Digital Trends and Gadgets & Wearables. A key element of our strategy in this segment is to continue to rapidly innovate and bring increased functionality and features to our product at all price points. This has been the bedrock of our success in the wearable space, and you can expect more the same from us going forward. Supporting this effort is our ongoing commitment to R&D, which is core to our DNA. Our proprietary designed and built AI smart chips, the Huangshan is shining example of the -- of our prowess in technology that distinguish us from competitors. Now in its second generation, the Huangshan-2, introduced in 2020, is the most powerful and [indiscernible] AI smart chip for wearables of this kind. And we have already begun rolling out in our products. In the meantime, we are also in the process of developing the new Huangshan-3. And we believe we are in the leading position on the AI smart chips industry for wearables. Data analytics is the second pillar in our framework and is an integral part in expanding our smart health ecosystem. [ Primarily ] targeting insurance care providers and employers, this segment works to utilize our data analytics from more than 30 million active users in partnership with industry to empower better wellness decisions. In this regard, in late 2020, U.S.-based lead insurance company generally cited study results using analytics from our PAI Health units as providing units value beyond traditional tools in the underwriting process. Just last week, Gen Re had another announcement of study documenting PAI's effectiveness at improving employee health and longevity. We see these as harbingers of growing recognition for the value -- valuable data analytics can bring to the industry. While the pandemic largely consumed the attention of the insurance industry in 2020, we are hopeful 2021 will afford more opportunities for insurers to integrate wearable device data analysis into their business. Industrial health care is the first area we are developing as part of our framework. This is a long-term development effort. I believe the industrial health technology base represents a tremendous opportunity for us to apply our engineering expertise in precision sensors, biometrics, AI chips and engineering capability, focused on minaturization and health data analytics. I believe this space is also ripe for disruption. Most recently, you have seen the announcement of the partnership agreement and investment with Promaxo, a provider of miniaturized MRI technology target initially at urologic applications. Just 2 weeks ago, they received their FDA 510(k) clearance, which was a very exciting critical step. You also should have noted 2 different announcements about our partnership with Rouumtech, a first mover leader in portable x-ray technology. We are working towards private labeling, all of their miniaturized x-ray systems for sale in China. In the industrial health care segment, in the near term, we will derive incremental revenue from helping sell products in China. In the long term, we plan to engage in select joint research and harness base to integrate in imaging data or imaging devices into our health technologies eco system. To better reflect our strategy, positioning, connecting health with technology, our expanding product portfolio and our growth in the global industrial health care technology market, on February 25, we announced our name change to Zepp Health corporation. This name is easy to remember, [ strengthens ] languages and cultures. Last but not least, in October, we extended our strategic cooperation agreement with Xiaomi Corporation for an additional 3 years. As part of the extended agreement, we will continue to receive the most preferred partner status to develop Xiaomi  wearable products and enjoy most preferred strategies partnership status for research and development of AI chips and algorithms for wearable devices. We are currently working on MI Band 6 and expect to launch in the near future. In closing, while no one could have predicted the enormous impact COVID had on the world in 2020, our results for this year serve as a solid proof points for the reference of our business. The soundness of our strategy and the broad-based appeal of our partners. Even though we can still foresee that the COVID still remains our smart wearables business in the short term, especially in a few European countries, which are our key markets, I am confident that as we continue to execute on our strategy of connecting health with technology, we are well positioned to capture new and exciting opportunities and deliver long-term shareholder value. I will now turn the call over to Leon to go over highlights of our fourth quarter and full year results.

Thank you, Huang. I'm going to drill down from 1 full year view to talk specifically about the fourth quarter. As I did last quarter, I want to provide some specific color, commentary on just a few key metrics. Starting with sales. From my perspective, the company had a great quarter despite renewed impact of the COVID virus, reinstituting lockdowns in some of our key European markets for the important holiday period. Our unit sales were up in most of these markets, but they were up not as much as we believe they would have been otherwise. In addition, a second COVID-related impact on the quarter was product deliveries delays in China with some of our new products in the quarter. As a result, Q4 revenue from our own Amazfit and Zepp branded products was up 25% year-over-year, which we believe could have been even stronger. The third and the largest factor pushing our numbers to the lower end of our guidance range was that sales of Xiaomi products were not as robust as we had hoped for, resulting in a 21% decrease in revenue in the quarter compared to 2019. We believe consumer anticipation of Xiaomi's new model may have factored into this effect. These effects together translated into Q4 revenue of RMB 1.97 billion compared to our guidance range of RMB 1.95 billion to RMB 2.15 billion. One of the important takeaways of the quarter is that we saw strong product sales performance across our pricing spectrum from the higher end to the value priced. For example, of our own branded smartwatch and band products, the more fashion-oriented GT series, in which the new model sell for USD 180 comprised 41% of the smartwatch and band unit shipments in the quarter. Sales of our basic smartwatch series Bip and Pop, in which the U.S. models sell for around USD 60 to USD 70, comprised around 28% of our fourth quarter smartwatch and band unit shipments. We think it is important to highlight that our products appeal across a broad spectrum of price points, feature sets and consumer expectations. Revenue from our self-branded products grew mid-teens to mild 30 percentage points each quarter in 2020, and we expect that trend to continue. Now moving to gross margin. Gross margin can be affected by product mix, product launch timing and product life cycles, including model upgrades. The 480 basis point decrease in gross margin from a year ago fourth quarter was predominantly driven by lower margins on products produced for Xiaomi and to a lesser extent, on our own branded products from discounting to roll out older products and holiday promotional discounting. Next, I want to provide additional color on operating expenses. Total operating expenses ended up through the first 3 quarters of 2020, but in the fourth quarter, decreased sequentially in both absolute amount as well as a percentage of sales. This was the result of the cost control measures we discussed in last quarter's call to prioritize the highest returns activities in all expense areas. When reduced sequentially, total fourth quarter operating expenses were up 8.9% year-over-year, reflecting sales and marketing investments in additional headcount as well as marketing and support for global expansion of our self-branded products. I'm sure you noted in our release, the threefold increase in the number of countries in which we had 100,000 or more device activations in this year's fourth quarter compared to 2019. The increase in sales and marketing expenses year-over-year was offset by reductions in R&D and G&A expenses. We believe R&D is mostly scaled to continue driving our new product developments in 2021, which we know is a key factor to our success. Given the uncertainties of the pandemic for the foreseeable future, we're going to continue to manage operating expenses to a percent of sales, targets at about where we are now in order to drive profitability. Reported net income as a percentage of sales was 5.8% for fourth quarter compared to 9.8% in a year ago fourth quarter. Q4 net income benefit from a net year-over-year increase of RMB 56.5 million in gains from deconsolidation of a subsidiary which is a result of 2017 partnership with the electric toothbrush company in China. The company's cash position continues to be strong, finishing the fourth quarter with the cash and cash equivalents of RMB 2.27 billion, up 26% from December 31, 2019, but down from September 30, 2020. The sequential decline was driven mainly by working capital swings and investments in industrial health companies such as Hyperfine and Promaxo. Looking forward to guidance, there remains much uncertainties globally about the pandemic. While vaccination rates are rising, risks from different strains are being discussed. And there are concerns with losing restrictions and resuming travel. Europe is currently looking like it would stay largely closed for the near term. While in the U.S., a number of states have dropped mask mandates and college spring breaks seems to be back in swing, which risks driving new surges. Our guidance reflects this continuing uncertainty as well as first quarter seasonality. For the first quarter 2021, management currently expects net revenue to be between RMB 1.0 billion and RMB 1.15 billion. That outlook is based on the current market conditions and reflects the company management's current and preliminary estimates of market and operating conditions and customer demand, which are all subject to change. This concludes our prepared remarks. We'll now open the call to questions. Operator, please go ahead.

[Operator Instructions] The first question is from Clive Cheung from Crédit Suisse.

My first question in regards to, I guess, the lower-than-expected sales in fourth quarter. I think Leon mentioned that partly it was due to the, I guess, waiting for the new generation of the products. So the question is, do you see this as an extension of the replacement cycle, the risk to your company? And if there is any structural change in the demand? That's my first question.

Clive, I think I can take this question. The answer to your question is no, right? So as I just explained in the script, Xiaomi's sales drop for this quarter is very much driven by, number one, COVID, especially in the international markets; and number two, there's certain expectation on the new products, which is going to be launched very soon, right? So from that perspective, I think what we experienced in Q4, we think it's very much a seasonality pattern rather than a structural issue. I guess, I mean, our forecast for 2021 and also for Q1 the outlook reflects that point. And also, we believe we should have a solid 2021 based on what we prepared in Q4 and Q3 for the product introductions.

Okay. Just a follow-up to that question, I guess. Could you remind us what is the current split in terms of geography for new band products?

I think the Xiaomi products, I think China remains as a key market for the Xiaomi products and also the international market is playing a bigger and bigger role. I think, overall, if you take our own self-branded and Xiaomi products together, Europe and the international market overtakes the Chinese market as our biggest region of sales.

[Operator Instructions] The next question is from Andre Lin from Citigroup.

And I have a question regarding the recent acquisition of Yitong. Can you please share with us your strategy or your plan on the new acquisition and the timetable if possible?

Yes. Maybe I will answer this question. I will take this one, again, Andre. So there's a few things on, Yitong? So number one, Yitong is actually a minority stake investment, which we had invested in January. So it's not a Q4 event, it's rather than a Q1 event. And then we also don't consolidate Yitong in our financial results. And number two, Yitong has its own core business. And I'm not sure if you have noticed that they recently, I think it's last week, published their annual result and then the net income of Yitong actually in 2020 grew by more than 20% versus 2019. And the third thing, which I want to mention here is also very much in line with what we disclosed before. We want to leveraging -- the rationale behind taking this minority stake in Yitong is that we want to leveraging that health's core capabilities as well as Yitong access to Chinese domestic capital market. And then by join hand, Zepp and Yitong we're going to expand the health care ecosystem for China market in the longer term, right? I think that's everything we can say about it at this moment.

And I have a follow-up question. And given you have provided your sales guidance for the first quarter. Can you please also share with us unit forecast or current status in the first 2 months of this year? And also the -- when do you think the contribution of the new generation of [indiscernible] were picking. And so that will drive the seasonal sales in this year?

Yes. So I think we have guided -- we have given the outlook for 2021 Q1, and you just heard that. Last year, at the same period, I think our turnover was around RMB 1.09 billion. And then this year, we guide around CNY 1 billion to CNY 1.15 billion. So we think there's a high chance that our revenue is going to fall between this range. And the first 2 months trend actually provides some confidence on this outlook, right? And looking at the Xiaomi's new product, I cannot say too much about the exact timing. But the only thing I can tell you is that this MI Band 6 is coming out very, very soon.

The next question is from [ Joe Lee from Investor Securities ].

Congratulations on this quarter performance in spite of the unfavorable environment. I have several questions to follow-up. My first question is about house monitoring. Could the management team give us more color on how we operate with insurance companies, like social insurance or even hospitals? I think this could be a potentially huge market.

I could -- Mike to answer.

Yes. This is Mike Yeung, yes. Yes, let me try to answer the question. Yes. So as Wang mentioned in the script, the data analytics is one of our strengths, pillar, especially the PAI technology and algorithm, which we acquired. When we work with the insurance companies, basically PAI can provide value in at least a couple of ways. First is PAI can help increase customer engagement for the insurance companies. Because monitoring the PAI score, PAI Health is a -- can be a customer engagement tool to increase the customer engagement for the insurance company. Secondly, because PAI is scientifically proven with many years of study and large calculation, insurance companies can use PAI score as a factor in their actuary formula to help in their underwriting, whether it's for health insurance or for life insurance, both can use the a PAI score to help them improve their underwriting. So this is a second way that the -- we're working with insurance companies to integrate the PAI technology. And also, Gen Re, we mentioned earlier, has given a -- make a lot of study and published that the PAI score is a very effective tool for both of these services from insurance companies. Does that answer your question?

Yes. Yes. And my second question is that it's easy to understand the company's advantage in -- to be market things since company's product resembles third-party hardware supplier with leading technology. However, I wonder how to build a stronger brand recognition? And what is the target shipment or revenue mix between Xiaomi and self-branded products?

Yes. That's a good question. Now -- so I think you have seen our 20-F in 2019, the current weight between Xiaomi and self-branded products is around 70%/30% from an absolute revenue value perspective, right? And I think in gradually throughout the year, we're seeing this trend gradually moving for more self-branded products in the weight versus Xiaomi, although the moving is gradual, right? So because Xiaomi was such a big contribution factor to our top line and any move for our self-branded product to gain the weight to actually require the self-branded products sales or revenue growth to be double or triple the Xiaomi growth rate in order to change that mix, right? So to answer your question, I think starting from Q3 and going into Q4 and Q1, we're seeing this self-branded product mix in the overall sales mix taking place. So the self-branded products as an overall company's portfolio has gradually gaining weight. But as I just mentioned, any changes to a significant amount will require a few quarters for you to see such significant or structural change.

Okay. Got it. And my third question is about the paying rate of your health service? Or could you share us the current paying rate and how this rate would go up in the future? And how would that contribute to our revenue mix?

I think it's -- as we mentioned before, most of these services or health services, are -- there are 2 things. One is actually the PAI Health and the prudential and the Gen Re type of insurance tech type of a cooperation. So these type of -- the revenue out of these type of services is going to come up in second half of 2021 based on our latest forecast, right? And then if you're talking about the more industrial health, as what we mentioned today, early on in the script, the investments of the x-ray machines, MRI machines, that's going to be a long-term investments. And it's going to be very much self-sustaining like the business model of white labeling, right? And in order for you to see a significant revenue of that part of the business coming up, probably, it's going to be a year out. So probably you will see something coming up in early 2022 or mid-2022. That's our best estimation at this moment in time.

Okay. Got it. And I have one last question is how is the shipment rolling off second-generation of Huangshan? And would the industrial shortage impact the supply of our chips?

I think we cannot disclose the specific information on a product line. But as we mentioned in the script early on that the Huangshan-2 to is being rolling out to all the self-branded of our products as we go, right? So that progress is being carried out as we speak. And then yes, we also have noticed that there's a shortage of the IC chips across the industry. And for that reason, we're also piling up some of the inventories for the key components of the IC chips also for our smartwatch products. So you will see a little bit of that in the inventory number of our balance sheet probably in Q1.

The next question is from Jacky He from China Renaissance.

And I only have 1 question for the next quarter or the whole year. Could you give us some guidance on the shipments and ASP for Xiaomi and self-branded product?

Yes. No. So I think we have already given the outlook for Q1. And then on the full year basis, normally, we don't give that outlook. But I think based on what we see and also there's a caveat how bad the COVID in the international market and how fast we can resume the back to normal type of working pattern. We believe at this moment that the full year sales growth for the company overall, taking the Xiaomi plus, the self-branded products should be at least at the same pace of the growth rate of 2020, if not more, right? On the ASP part, ASP is actually one of those metrics that is affected by timing of product introductions and seasonality as well as the product mix changes. So we want to be very careful about its use. So for the full year, if you look at the combined ASP, it declined slightly versus last year, versus 2019, the ASP for Xiaomi products for the year flat, and the ASP for our own branded products was up dramatically. So -- and we think the ASP trend for our own branded products will continue to expand in the coming quarters. I hope that, to some extent, answers your question?

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

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

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