Zepp Health Corp Q4 FY2021 Earnings Call

Hello, ladies and gentlemen. Thank you for standing by for ZEPP Health Corporation's Fourth Quarter and Full Year 2021 Earnings Conference Call. At this time, all participants are in listen-only mode. Today's conference call is being recorded. I will now turn the call over to your host, Ms. Grace Zhang, Director of Investor Relations for the Company. Please go ahead, Grace.

Hello, everyone. And welcome to ZEPP Health Corporation's Fourth Quarter and Full Year 2021 Earnings Conference Call. The company's financial and operating results were issued in our press release via News Wire Services earlier today and are posted online. You can also view the earnings press release and the slides which we will refer on this call by visiting the IR section of the company's website: www.ir.zepp.com. Participating in today's call are Mr. Wang Huang, 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. Before we continue, please note that today's discussion will contain forward-looking statements under the Safe Harbor Provision of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, the company's actual results may be materially different from the views expressed today. Further information regarding 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, 2020, and other filings as filed with U.S. Securities and Exchange Commission. The company does not assume any obligation to update any forward-looking statements, except as required under applicable law. Please also note that Zepp's earnings press release and this conference call include discussions of unaudited GAAP financial information, as well as unaudited non-GAAP financial information. Zepp's press release contains reconciliation of the unaudited non-GAAP measures to the unaudited most directly comparable GAAP measures. I'll now turn the call over to our CEO, Mr. Huang. Please go ahead.

Hello, everyone. Thank you for joining our call. In 2021, we made significant progress despite the challenging macro environment. Our full-year revenue reached 612.5 billion RMB as we executed our growth strategies in the market's consumer health and fitness sector. We maintained our profitability and, at the same time, grew our self-branded product shipments by 60% during the past year despite worldwide shipping shortages, as well as the Delta and Omicron COVID variants. As of the first quarter of 2021, we had cumulatively shipped over 200 million health management devices since our inception. These achievements reflect our increasing global appeal and our dedication to improving our users’ lives through technological advancements. Let me expand on our global progress. The momentum of our overseas expansion remains robust, with over 80% of our self-branded products sourced internationally. Notably, our self-branded product shipment volumes for the North American region increased by approximately 200% year-over-year as we entered major retail sales channels including more than 1,000 offline Target stores as well as QEC. As for European markets, our shipments to Italy and France increased by more than 100% in the fourth quarter, thanks to our country-specific strategy. We are now ranked number 5 in the Adults Smartwatch Market according to the fourth quarter 2021 IDC market data. We have been among the top 5 in the global market for several quarters, demonstrating our enhanced product capability and flourishing brand recognition in the growing Smart Watch Industry. As we work to enlarge our global footprint, we remain steadfast in our mission to connect health with technology. To that end, we continue to develop priority technologies, including AI chips, biometric sensors, and data algorithms to improve user experience and create new usage scenarios as we grow our portfolio of Smart health devices for consumers. For example, to further optimize user experience, we will soon launch an AI sleep service to help users with sleeping disorders. Based on our powerful AI algorithms, our Zepp app will compose and command high-quality music designed to enhance sleep quality, improving users' sleep hygiene and overall health and wellness. In addition, these algorithm-based user services are playing an integral role in expanding our smart health ecosystem. As Zepp Health's user base continues to grow, surpassing 40 million active users by the end of 2021, we are also exploring opportunities in the industrial health segment, including investments in Promaxo and Neuro42, which has bolstered our foothold in imaging technology. We entered the portable MRI business to advance the same mission that drives our smart wearable business, which is to empower our users to quantify their health data. This can assist them in managing health conditions and potentially help detect earlier warning signs for certain diseases. In the future, we plan to integrate these investments along with our data analysis and smart wearable business into our extensive healthcare services, addressing a critical need and creating value for our users. Now, turning to our smart wearable business. Our newly launched GT 3 series smartwatches, which are our first products incorporating blood pressure measuring functionality, are currently under review by the NMPA National Medical Products Administration of China, and we have already achieved initial results in this process. They have exceeded our expectations in terms of market response and product performance and have sold exceptionally well, ranking number one in both JD and other smartwatch categories immediately after we commenced sales. Additionally, the GT 3 was named editor's recommended smartwatch by Germany's Brigitte Magazine. Not only is our smartwatch attracting consumer attention, but our other products are also rapidly gaining popularity and industry recognition. For example, our wireless active noise cancellation has that Amazfit PowerBuds Pro received an honorary award in the health and wellness categories at the CES 2022 Innovation Awards. Our progress in 2021 went far beyond our hardware products. In terms of technology achievements, we unveiled our Huangshan 2s chip in July, the first wearable artificial intelligence processor based on RISC architecture. Its super power core computing performance can support high-load calculations such as graphics and UI operations with low power consumption. We also released our Zepp OS in the fourth quarter, one of the industry's most compact and energy-efficient smartwatch operating systems, at 55 megabytes—about 1/128th the size of Apple's watch OS. Furthermore, Zepp OS serves as the foundation for our open mini-program framework, which we envision will comprise thousands of developers and countless mini-smartwatch applications. Our Zepp Live app's success has been notable, achieving many impressive milestones over the years. As you may have seen, we renamed the Amazfit app to Zepp Live to optimize the user experience. The Zepp Live app inherits tens of millions of the Mi Band users and offers them more comprehensive services, such as the sleep service we mentioned earlier. Going forward, the Zepp Live app and the Xiaomi health and sports app will cater to both Mi Band users. Moreover, the Mi Band 7 will be launched this year as expected. We will further expand our cooperation with Xiaomi, from smart bands and smart scales to future chips and sensors. Together with Xiaomi, we look forward to bringing more innovation to all of our users. I would like to conclude by saying that I'm incredibly proud of our team, which has persevered and excelled against the backdrop of a very challenging two-year period. This obstacle, however, has made us stronger. Today, our brand recognition, along with our sales and distribution outreach, has expanded considerably compared with two years ago. In 2022, we will continue to build our own brand and enhance our product experience as we pursue a path of vertical integration, relentlessly working to strengthen our capabilities in chips, cloud services, algorithms, operating systems, and products. In the meantime, we also extend our reach to other health and medical-related hardware and introduce our brand-new health subscription service, which altogether will lead us to a new stage as a company offering comprehensive healthcare solutions and services. I remain confident in Zepp's future as we continue to lead the industry in technology and product innovation, and bring better health through technology to all of our users. Lastly, we are pleased to announce a special cash dividend of US$0.025 per ordinary share or US$0.10 per ADS to thank our shareholders for their ongoing support, as well as the continuation of our share buyback program. We are convinced that as we strive to execute our strategy, we will maximize our shareholders' value in the long term. Thank you all. With that, I will now turn the call over to Leon who will review the highlights of our fourth quarter financial results.

Thank you, Huang. I would like to start by highlighting some of the key metrics driving that development. As Wang mentioned, our full-year 2021 revenue was 6.25 billion RMB, representing 1% in comparable revenue growth. Our self-branded products played an important role in our 2021 results as our full-year shipments increased by 60% despite the challenges posed by surging COVID-19 outbreaks and the chip shortage, which impacted shipments of both our self-branded wearables and Xiaomi wearable products. Although we cannot fully predict how the supply chain issues will evolve, we're hopeful that we'll start seeing improvements in the second half of 2022. While we see a net increase in unit shipments of our brands, this growth was offset by a decrease in unit shipments of Xiaomi wearable products. Xiaomi remains a valued partner, and our Mi Band still ranks number one in market share with 35.6% of the total global smart band market. At the same time, we're also excited to expand and diversify our business and build our own brand with the goal of achieving sustainable, long-term growth. Total revenue in Q4 was RMB 1.7 billion, representing a nominal year-over-year decrease of 15.8%. Again, this decrease was mostly driven by the decrease in band sales. In the meantime, COVID-19 and chip shortages also constrained the growth of our self-branded products. Like many other companies, we have faced ongoing external challenges since the second half of 2021, many of which still persist today. COVID-19 not only impacted us due to widespread offline store closures, especially during the holiday seasons, but also dampened our courier services. For example, with the January 2022 lockdown of China's Jilin and Shenzhen areas, which are critical to our global supply chain and product availability, disrupted deliveries and sales worldwide. Moreover, the global semiconductor shortage constrained our supply chain, particularly because many major semiconductor producers prioritized their auto-industry EV customers. All of these factors negatively influenced our Q4 and full-year 2021 performance, and some continue into 2022. I must say that we're very proud of our self-branded products' growth, especially in light of all these headwinds. Our self-branded products contributed over 47% of total revenue compared to 31% in 2020, as well as over half of our gross profit in fiscal year 2021. We believe our self-branded products will continue to gain momentum as we further develop our product capabilities and enhance our brand's market recognition globally. Now, let's look at gross margin, which can be affected by product mix, product launch timing, and product life cycles, including model upgrades. Our fourth-quarter 2021 gross margin was 19.3%, a slight improvement of 30 basis points compared with the same period of 2020. This improvement was supported by refinements of our product mix, including a net increasing proportion of self-branded products which contributed over 60% of total gross profit in Q4. Turning now to costs. Operating expenses have been a key focus of mine since joining the company in the third quarter of 2020, both in terms of absolute numbers, as well as a percentage of sales. A portion of operating expenses are fixed, so it takes time and creativity to gradually reduce these expenses while we will have to carefully balance cost controls with expenditures to fuel growth. I'm pleased to report that we have already seen a decreasing trend in total operating expenses since Q3 2020. That will continue to be my focus. Going forward, we'll continue to maintain operating expenses at approximately their current cost levels in order to drive profitability. Our first-quarter 2021 operating expenses decreased slightly in absolute terms compared with the same period in 2020. However, at 18.7% of sales, they represented a percentage increase when compared with the fourth quarter of 2020, during which operating expenses were 15.8% of sales. This was mostly driven by the growth in our sales and marketing expenses in the first quarter of 2021, which increased by 30.2% year-over-year, representing 9.2% of sales compared with 5.9% of sales for the same period in 2020. This relative increase reflects our efforts to fuel growth, including brand building initiatives such as our 'Up Your Game' campaign designed to drive the global growth of our self-branded Amazfit and Zepp wearables, as well as the launch of our GT3 series of smartwatches. Furthermore, we carefully managed our research and development costs, as well as G&A expenses in the fourth quarter. We're still investing in R&D, sales and marketing, and G&A to support growth, but we have taken a more balanced approach to these expenses. To that end, R&D expenses were down 27.6% year-over-year, representing 5.6% of sales for the fourth quarter of 2021, compared with 6.6% for the same period last year. This reflects effective expense control in the company's R&D activities, as well as the recognition of certain government subsidies. Our G&A expenses year-on-year have remained flat, attributed to our effective cost control of operating activities. We'll continue to refine this balanced strategy of supporting our brand-building efforts and growth while controlling costs as we progress through 2022. Next, let's look at net profit, which was lower than last year as a result of higher relative expenses as a percentage of sales, as well as lower other business income due to our RMB56.5 million partial selldown of our equity stake in a leading electric toothbrush company in 2020. Consequently, net income attributed to ZEPP Health for the fourth quarter of 2021 was RMB 36 million, compared with RMB 150 million in the fourth quarter of 2020. Thanks to our implementation of more effective working capital management practices, our balance of cash and cash equivalents remains strong, improving to RMB 1.47 billion as of December 31, 2021. Our working capital ratio also continued to strengthen. In 2021, the Board approved the deployment of up to USD 20 million as part of a share repurchase program. So far, we have repurchased $6 million worth of shares. Given our confidence in our growth strategy and financial trajectory, we'll continue with this program. As Wang mentioned earlier, we also announced a one-off dividend program of approximately RMB 40 million, equivalent to 29% of our full-year 2021 net income, which will be funded with our current cash-on-hand. I'd like to finish by addressing some key considerations reflected in our guidance for the first quarter of 2022. The supply chain challenges resulting from chip shortages and delivery uncertainties from the recent COVID lockdowns in China have caused us to continue to provide conservative guidance. In addition, from a seasonality perspective, the first quarter typically generates the lowest revenue for the company after the strong holiday season, and consumer anticipation of Xiaomi's new wearable products in the second quarter may negatively impact our Q1 sales. Given the seasonality and supply chain issues, and the uncertainties surrounding the conflict between Russia and Ukraine, for the first quarter of '22, we currently expect net revenues to be between RMB 0.75 billion and RMB 1 billion, compared with RMB 1.15 billion for the first quarter of 2021. Given this outlook, we will continue to apply our strict cost control measures from 2021 into 2022. That outlook is based on our current market conditions and reflects the company's management's current and preliminary estimates of market and operating conditions and customer demand, which are all subject to change. This concludes our prepared remarks. We will now open the call to questions. Operator, please go ahead.

We will now begin the question-and-answer session. For the benefit of all participants on today's call, if you wish to ask your question to the company's management in Chinese, please immediately repeat your question in English. At this time, we will pause momentarily to assemble our roster. The first question is from Yalin Lou of TNA Securities. Please go ahead.

Hi management. Thank you for taking my question, and congratulations on the fourth quarter. I have two questions. Firstly, about your gross margin. We know since the beginning of the year, we see semiconductor shortages affecting the industry's gross margin. I'm curious how the chip shortage has impacted your gross margin and any progress regarding your functional chip. Thank you.

Yes. Thank you for the question. On the gross margin, I think the answer is twofold. Number one, we actually proactively changed our mix to focus more on self-branded products, which carry on average twice the gross margin as our Xiaomi products. If you look at 2020, our mix skewed more towards 70% Xiaomi products and 30% self-branded products. By the end of 2021, we're actually hovering around half and that self-branded products trend will continue to grow into 2022. Due to this change, we see an improvement in our overall gross margin. Regarding the chip shortage, we had announced in previous quarters that we had made certain risk buys ahead of this situation materializing, which also has had an impact on our inventory level. In the mid to short term, we didn’t see too much of a material impact on the gross margin due to those risk buys. For the functional chip, the progress is proceeding very well according to our schedule.

A follow-up question about your gross margin; it seems that your Xiaomi product sales and self-branded product sales affected gross margin, although the mix was better this quarter?

I think Xiaomi's gross margin has been in a decreasing trend for the company for a few years. As you may have also read in the news, Xiaomi is targeting a cost plus 5%. So, Xiaomi's gross margin is actually in the low teens and has decreased quarter-over-quarter by one percentage point. But our self-branded gross margin has been quite strong and has held up over the year.

My second question is about your marketing strategy. The global environment seems more uncertain this year. What changes could we expect in your marketing strategy this year to adapt to this global environment?

I think the short answer is no, but we do see risks related to the Russia and Ukraine situation. We have a strong market share in Russia and Ukraine and neighboring countries. To be honest, Russia and Ukraine's revenue, if I take 2021 as the basis, represented around 4% of our total revenue. So that is a risk we need to manage; in the short to mid-term, we think we can continue to manage that risk. If the conflict continues for one or two more years, that will definitely impact our revenue. However, we are slightly different from other Chinese tech companies because the majority of our self-branded products are overseas sales, so China actually represents only a small portion of our overall mix. On that note, aside from Russia and Ukraine, our marketing strategy in Western Europe, which is actually a strong foothold for our revenue, and the United States has not changed and will continue to grow.

Thank you.

Okay. For the next question, we have Kevin Chen of China Ren. Please go ahead.

Hello, hi. Thank you, management, for taking my question. I have two questions. Number one will be regarding your newly launched GT 3 series. I was just wondering how the sales and general feedback are tracking so far. Is it matching your expectations, or is it better than expected or slightly lagging behind?

Thank you for your questions. On the GT3, as Wang mentioned earlier, it's actually a very successful product. We have received a lot of good reviews in China and overseas markets. However, if you compare the GT3 against our expectations, we did encounter delays due to chip shortages and logistics challenges in Q4. It's not a demand problem; it's a supply problem for the GT3. Compare with our internal expectations, we believe we could have achieved more. Still, the product is a big success, and through the launch of the GT3, we’ve noticed an opportunity to increase our average selling price further, not only in China but also overseas. This will help us to raise the gross margin of the company in the long run.

Thank you. Just a quick follow-up. The Chairman mentioned that the GT3 series is currently under review for qualification for more medical applications. Do we have an approximate timeline for how this review might turn out? Once we obtain this approval, will we have new business opportunities with the GT Series?

Yes, for sure. We also mentioned that we're not only doing this for the Chinese market, but we're also working for the European market and the U.S. Essentially, we are doing certifications across multiple geographies at the same time. This is related to the blood pressure monitoring that you have using our GT3 watch. We think this is a very unique and elegant solution compared with our competitors. The Chinese review, I believe, will have a much shorter timeline because it involves software and algorithms certification. So we expect approval to be obtained sometime during the course of this year. The CE and FDA reviews may take a bit longer, but should not be too much longer. Once we get these certifications, it will certainly allow us to provide new services and unique selling points versus our peers.

Got it. That's good to hear. My second question is regarding the European market. Are you observing any changes in consumer demand there or are we currently facing mostly logistical issues in these markets?

No, I think apart from Russia and Ukraine, we are seeing very healthy growth for the Western European markets. There is no need to say that we are already the market leader in countries like Italy and Spain. We are expanding very rapidly in Eastern European countries such as Poland and Czech Republic, as well as strengthening our foothold in Western Europe, including Germany, the UK, Nordics, etc. There remains a lot of potential in Europe for us to grow because we have various product offerings. We also have numerous exciting products targeting sports and outdoor activities that we expect to launch very soon. With this new mix of product introductions, we hope to even further grow our European market.

Thank you, very clear.

The next question is from Clive Cheung of Credit Suisse, please go ahead.

Thank you, management for taking my question. My first question is regarding Xiaomi. Clearly, we continue to see the downward trend in terms of Xiaomi product shipments. Can you give us a sense of management's view on the risks there in terms of product and whether you see this as the end of a cycle or just an extension of the replacement cycle that is driving the slowdown in shipments? Secondly, regarding new products discussed with Xiaomi, will they act as a volume driver that could bring us back to previous shipment levels or are they simply variations of current product types extending their lifecycle? Thank you.

First, let me just comment on the Xiaomi relationship. We sign our Xiaomi contract every three years, and last year we renewed it for another three-year period. Our relationship with Xiaomi is very strong, and we also have different co-operations beyond the band and various algorithms we are working with them. Xiaomi remains a significant shareholder of ours, and we have various collaborations with them. Regarding the new Xiaomi products, I think I mentioned before. If you read the recent announcements published by Xiaomi regarding the name change for the brand, we also noted our intention to explore more chip development for the wearable market, alongside using different algorithms and introducing new product forms. While I cannot disclose too much, I can confirm that we intend to drive sales of Xiaomi products and continue to deepen our partnership much further than it is now.

Thank you very much. My second question is on R&D. You've reduced R&D spending a bit as a percentage of revenue. Is this because it was elevated in prior years? Does this impact your ongoing research and development of key healthcare chipsets? Thank you.

Yes, R&D has a lot to do with new product introductions as well. Different years have different rhythms when we release new products. For example, Q3 2020 was a product-intense quarter, so our R&D expenses in that quarter were extremely high. Since we didn't have many new product launches in Q4, the R&D expenses were naturally lower compared with the same period last year. Meanwhile, we have also asked the team to optimize return on investment for R&D developments. So rather than just investing in everything, we are prioritizing our R&D activities to be more effective. This also allows us to maintain our competitive advantage while controlling costs. If you look at R&D expenses as a percentage of sales for the overall company, I believe we remain an R&D-driven company because we spend around 8% to 9% of sales on R&D activity, although it may fluctuate in different quarters.

Thank you very much. Lastly, I would like to ask about the COVID impact. Has there been any recent forward-looking developments related to Q4 or the first quarter that may have affected our manufacturing capacity?

Yes. COVID has certainly posed a lot of uncertainties and negatively impacted all our results. In Q4, the sudden lockdown in many European countries around the holiday season dampened our offline sales, contributing to why our numbers for Q4 were weaker than expected. The pandemic has also created logistical nightmares for our supply chain. The sudden lockdown in Shenzhen and all logistics flows halted have posed numerous challenges to our team, which is one of the reasons we provided conservative guidance for Q1. Additionally, COVID has historically impacted our results more in overseas markets, but the recent zero-COVID policy in China has started disrupting our supply chain and manufacturing. However, our supply chain team is exploring alternative solutions to resolve this situation, which will take time and may have influenced some conservativeness in our guidance. We expect the situation to improve substantially as we reach the second half of this year.

Thank you very much. Very clear.

The next question is from Andre Lin of Citi. Please go ahead.

Thank you for taking my question. Regarding the semiconductor supply challenge, when do you expect the situation to be resolved, this year or next?

I mentioned earlier that we think by the second half of 2022, the situation should be resolved or much improved. While Q4 was serious, we took precautionary actions to secure inventory. In certain product types, we do not have a shortage issue now. However, more semiconductor companies are prioritizing their chips for EV producers, which will impact Q2 as well. Thus, we see our constraints stemming from supply rather than demand. Based on the current information available, it looks likely that we will see significant improvement by the end of Q2, so from May onwards.

Thank you. That's very helpful. I have a follow-up question regarding the first quarter guidance—could you provide more details on shipment or revenue expectations?

No, we are experiencing considerable uncertainty in Q1, making it a difficult quarter, which is why we provided conservative guidance. We see many companies, including ourselves, reducing or avoiding offering guidance due to the situation. We still sought to offer guidance, albeit a wider range. Several factors have influenced this, including the recent lockdown of Shenzhen, which halted manufacturing and logistics. Our export routes are affected because they run through Shenzhen into Hong Kong. We're exploring other methods for product exports. If the Shenzhen lockdown lasts only seven days or even if we can manage to export during that time, I believe we could hit the high end of the guidance range. However, if it's prolonged, we may end up closer to the middle of the guidance range.

Thank you. That was clear. I have no further questions.

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

Thank you. Once again for joining us today. If you have further questions, please feel free to contact the Investor Relations department through the contact information provided on our website. Thank you.

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