Earnings Call Transcript - ZEPP Q1 2021

Operator, Operator

Hello everyone, thank you for joining Zepp Health Corp.'s First Quarter 2021 Earnings Conference Call. I will now pass the call to your host, Ms. Grace Zhang, Director of Investor Relations for the company. Please proceed, Grace.

Grace Zhang, Director of Investor Relations

Hello, everyone, and welcome to Zepp Health's first quarter earnings conference call. The company's financial and operating results were issued in a press release via newswire services earlier today and are posted online. You can also view the earnings press release and the slides to which we will refer on this call by visiting the IR section of the company's website, ir.zepp/investor. Participating in today's call are Mr. Huang Wang, our Chairman of the Board of Directors and Chief Executive Officer; and Mr. Leon 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, 2020, 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 release and this conference call include discussions of our audited GAAP financial information as well as unaudited 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.

Huang Wang, CEO

Hello, everyone. Thank you for joining our call. Our first quarter results demonstrate both the resilience of our strategy and the popularity of our brand while, at the same time, we are challenged by supply chain and market channel dynamics that were at play due to the global pandemic. The highlight of the first quarter was the performance of our self-branded products. Shipments of self-branded products more than doubled in the first quarter compared with the same period a year ago. They also contribute to 64% of our total revenue. As the product acceptance on our key product lines, such as Amazfit, Pop, Bip, and the GT series, as well as our newly launched T-Rex product line continued to strengthen, these results were achieved amidst challenging market conditions. In the first quarter, our overseas multichannels continued to be adversely impacted by COVID-19. Supported by the robust performance of our self-branded products, in Q1, we recorded 5.4% year-over-year growth in total revenues to RMB1.1 billion despite a decrease in shipments for Mi Band 5 ahead of the launch of Mi Band 6. As all of the pandemic-related issues continued to drop their ratio and out of the market, I would like to bring the focus back to our products, especially some new product launches as well as functionality and partnerships which we expect to push both our brands' popularity as well as revenues upward. First, executing on our mission to connect health with technology, in the first quarter, we continued to build out our comprehensive health and fitness ecosystem by enriching our product portfolio. In March, we launched the Amazfit T-Rex Pro, which is the latest addition to our outdoor sports series of smartwatches. It is built to last with 15 military-grade certifications and 100-meter waterproof for extreme temperatures and conditions and has passed 3 additional performance endurance tests in addition to exciting functionalities, such as the blood-oxygen saturation management system, 4 global navigation satellite systems, and more than 100 different sports mode settings. One of my favorite features is its ability to monitor sleep quality. We believe that quality rest and sleep are essential elements of good physical and mental health. Also, in March, as we continuously seek new ways to create value for our users, we started to provide WeChat Pay automatically in Amazfit GTS 2 and GTR 2 smartwatches, rolling this out to the majority of our smartwatch portfolio as a desirable and convenient function to our partners. We have also been working hard on strengthening our partnerships and expanding into new ones. Our strategic partnership with Xiaomi remains as strong as ever. We successfully launched Mi Band 6, the sixth generation of this popular product line, in March and achieved 1 million units in global shipments within 1 month of its launch date. The Mi Band 6 has, aside from its stylish design, some incredible health-related functionalities so that users can measure their physical conditions anytime, anywhere. The newly introduced functions include blood-oxygen saturation monitoring to measure breathing quality, and cardio health monitoring to detect irregular heartbeats. These functions are powered by our self-developed AI-based algorithms, OxygenBeats and RealBeats 2, respectively. We are very encouraged by the great sales results from the Mi Band 6 and, at the same time, we are also working with Xiaomi on one more exciting and groundbreaking new product. Together with continued strength in our self-branded products, we expect a very strong second quarter. Leon will provide more details momentarily. We also continued to expand our collaboration with leading research institutes as well as health care companies. We partnered with leading hospitals and institutions globally on a clinical study to examine the potential benefits of smart health monitoring equipment in improving the quality of life for outpatients with chronic heart failure and reducing their readmission rates. For example, one of our projects is collaborating with the Norwegian University of Science and Technology called NorEx. The NorEx project is a registry-based multicenter and multiregional randomized controlled trial for secondary prevention and rehabilitation of patients who have suffered myocardial infarction. The project will include 12,750 participants with myocardial infarction across Norway in the next 4 years. Our smartwatches' heart monitoring and overall health management platform are being used effectively as part of these clinical studies. A few comments on our data analysis business, which is an integral part of expanding our smart health ecosystem. Access to more than 42 million active users, combined with our AI and big data analysis capabilities as well as our powerful PAI algorithm, allows us to establish a cloud-based system that can provide insurers, care providers, and employers with aggregate health care-related information to make better decisions that promote wellness and expand our business boundaries further in the health care industry. In closing, we're looking forward to delivering robust results in the second quarter. And powered by the rising demand for our products, our effort to constantly innovate and enrich our product portfolio as well as the change from Mi Band 6, 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 first quarter financial results.

Leon Deng, CFO

Thank you, Wang. As I did last quarter, I want to focus on highlighting what I think are a handful of the most important metrics, starting with sales. Generally, from a seasonality perspective, Q1 has always been a soft quarter for us. However, we had an exceptional quarter in revenue this year from our own Amazfit and Zepp-branded products, which increased 84% in revenue year-over-year. Unit growth of self-branded products was even higher at 104%, emphasizing the impact and popularity of our higher-end products, such as the GT series. You cannot dismiss Zepp Health as just a maker of inexpensive watches and bands. We are a real global player, competing successfully at a wider range of price points. Given the continuing impact of COVID, I think the overall revenue growth of 5% in Q1 is very solid and reached the top end of our guidance range. In a few areas such as the U.S., COVID seems to be abating, but in many of our key markets, including many European countries, India, and South America, COVID spread and restrictions continue to have an impact on our business in the first quarter. Also affecting the quarter, in China, subsidies and exemptions from social insurance contributions ended, impacting our costs. As is often the case, the timing of new product introductions in this quarter for Xiaomi impacted the quarter. Xiaomi product revenue was down 40% year-over-year in the first quarter, largely driven by the anticipation of the introduction of the Mi Band 6 in the second quarter. The reviews have been positive, and expectations for shipping Mi Band 6 factor into our strong guidance for Q2. Q1 demonstrated continued strength of our high-end products. The premium GT series, that sells in the $180 to $200 range, comprised 48% of our smartwatch and band unit shipments in the quarter. The sales of Bip, Pop basic smartwatch also continued to be strong in Q1, as was T-Rex, including the new T-Rex Pro that launched during the quarter. We expect the trend of strong growth for our Amazfit and Zepp-branded products to continue as we expand globally. Now moving to gross margin. Gross margin can be affected by product mix, product launch timing, and product life cycles, including model upgrades. First quarter 2021 gross margin stayed at the same 22.5% rate as it was in the year-ago pre-COVID quarter. As we noted in today's press release, gross margin for our own Amazfit and Zepp-branded products varied over the last 5 quarters between 1.5x to more than double the margin on products built for Xiaomi. That trend continued in the first quarter. That highlights our focus on growing our company-branded products and our global expansion to enhance our overall profitability. Operating expenses have been a key focus of mine since joining the company in the third quarter last year. While we have to balance cost controls with fueling growth, we have decreased total operating expenses for 2 quarters in absolute amounts sequentially since last year's third quarter. First quarter 2021 total operating expenses was up year-over-year, reflecting our investments in new product development and global market expansion. Given the timing of investments also ahead of the sales result, we'll continue to manage some expenses on a percentage of sales basis over a longer window of the year. We don't want to stop critical timed investments that will pay off in future quarters. With that in mind, first quarter R&D expenses increased year-over-year, reflecting investments in products that will debut in the busier second half of the year. Sales and marketing expenses were up year-over-year, reflecting investment in global growth for our Amazfit and Zepp-branded products. R&D, sales, and marketing, and G&A costs were all down sequentially, either from the third quarter 2020 high point or from the fourth quarter. We reported a net loss for the first quarter based on the effects I have described above. With our guidance for Q2, we expect a return to GAAP profitability. The company's cash position continued to be strong, finishing the first quarter with cash and cash equivalents of RMB1.1 billion compared to RMB2.3 billion at December 31, 2020. The sequential decline was primarily driven by RMB8.6 billion used to complete the minority stake acquisition in Jiangsu Yitong High-Tech Co. in China. We also invested in some extra chip inventory as a partial hedge on chip availability for the rest of this year as well as some higher inventory for our company-branded products as we were short on some products several quarters last year. Looking forward to guidance. There remains much uncertainty globally about the pandemic, which we have factored into our guidance, along with some sequential seasonal improvements and contribution from the Xiaomi Mi Band 6. For the second quarter 2021, management currently expects net revenues to be between RMB1.7 billion and RMB1.8 billion. That range projects a growth rate of 50% to 58% year-over-year from the 2020 second quarter's RMB1.14 billion. That outlook is based on the current market conditions and reflects the company's management's current and preliminary estimates of market and operating conditions and customer demand, which are subject to change. This concludes our prepared remarks. We'll now open the call to questions.

Operator, Operator

The first question comes from Clive Cheung at Credit Suisse.

Clive Cheung, Analyst

My question is mainly about the OpEx structure, which Leon has already discussed. However, I would like some additional details. This structure represents 27% of total revenue, marking a historical high for the company. In terms of this level of intensity, particularly regarding R&D, is this a one-time occurrence? What should we anticipate for the remainder of the year concerning OpEx planning? Could you provide some insights on that?

Leon Deng, CFO

Sure, let me address your question. Looking at the operating expenses from Q3 2020, we began at approximately CNY380 million, then fell to about CNY310 million in Q4, and further down to CNY308 million in Q1, if my memory serves me correctly. Overall, operating expenses have been decreasing over the last three quarters. However, there is a fixed and variable component to these expenses. In Q1, what we're experiencing is largely due to seasonal factors. Last year, our revenue in Q3 and Q4 was around RMB2 billion, while in Q1 this year, it dropped to about CNY1.1 billion. Therefore, although operating expenses appear high as a percentage of sales in Q1, we expect that as sales increase in the coming quarters, this percentage will decrease significantly. In terms of absolute figures, we anticipate that operating expenses will stay around the same level as Q1 or possibly even lower. I hope this clarifies your question.

Clive Cheung, Analyst

Yes. Yes, that does. And I think I want to follow up, particularly on R&D. Obviously, we know we're investing a lot in kind of the health care technology. So do we have a budget for the full year in 2021?

Leon Deng, CFO

Yes, from a percentage of sales perspective, R&D has some seasonality, as I mentioned earlier. Overall, you can expect our R&D spending as a percentage of sales to be quite similar to what we expended in 2020. We have also stated that we do not want to halt any time-sensitive investments, as we believe they will yield greater benefits in the future.

Operator, Operator

The next question is from Andre Lin at Citi.

Andre Lin, Analyst

And given you have CNY1.7 billion to CNY1.8 billion revenue guidance, could you share with us some of the breakdown between Mi Band as well as self-branded products or any guidance on the unit growth there?

Leon Deng, CFO

So Andre, yes, I can give you a feeling for what it is, right? So if you look at our self-branded products, I think, as management, we're quite happy to see the trend continues. Actually, it started in Q3 last year. And in Q4, we had a good run-up of our self-branded products. I think it's around close to CNY1 billion revenue in Q4. But in Q1, I think that trend also continues, right? So if you remember, our seasonality on a full year sales weight perspective, Xiaomi has been the 70% of our revenue, and the self-branded has always been the 30%. I think starting from Q4, we see that trend structurally changing of more self-branded products taking the weight higher in that mix, right? So I think Q1 is probably a little bit to the extreme. Our self-branded products actually stand roughly 70% of the overall mix for us in Q1. But obviously, as I mentioned, the Xiaomi partnership has been close and very close for us because Mi Band 6, as we launched, I think, by the end of Q1, has received very good ratings. And also the sales have been very good. I think we achieved 1 million unit sales just a few days after we launched the product, right? So to answer your question, if you look at Q2, obviously, the Mi Band 6 sales are going to fuel some of that growth, which we projected. But also our self-branded products will also take the same shape, and it's going to be a strong growth for our self-branded products in Q2 as well. I hope that gives you some feeling on why we guided such a number for Q2.

Andre Lin, Analyst

Understood. And could you share a bit on the rough breakdown or on the shipment unit growth so that we can have a better feeling on the gross margin implication?

Leon Deng, CFO

In Q1 of this year, the breakdown for Xiaomi and self-branded products is 70% self-branded and 30% Xiaomi. For Q4, we expect this to shift to a range of 60% to 50% for Xiaomi, with the remainder being self-branded.

Andre Lin, Analyst

So that also applied to the second quarter revenue.

Leon Deng, CFO

Yes. So if you look at second quarter revenue, Andre, Xiaomi will be 50% to 60% of what we guided for Q2, and the rest will be self-branded.

Operator, Operator

The next question comes from Michelle Zhang at China Renaissance. Leon Deng, CFO, mentioned that in Q1 this year, the sales breakdown was 70% self-branded and 30% Xiaomi. He anticipated that by Q4, the ratio would shift to about 60% to 50% Xiaomi, with the remainder being self-branded. Analyst Andre Lin inquired if this also applied to the second quarter revenue, to which Leon Deng confirmed that Xiaomi would constitute 50% to 60% of the guided revenue for Q2, with the rest being self-branded.

Michelle Zhang, Analyst

So I'd like to understand about the GM guidance for both your Xiaomi and Zepp-branded products going forward. Like whether we should expect it to be stable or that there's still a trend for them to go up a bit?

Leon Deng, CFO

Michelle, we'd never guide our GM for our guidance going forward, but I can give you a feeling, right? So as I mentioned before, the self-branded products gross margin for the past 5 quarters have always been 1.5x to 2x the Xiaomi product margin, right? And the Xiaomi product margin, we have disclosed before is in the 15% to 17% range, I think, is around that range. So going forward, I think you can see this impact in the past quarters already gradually changing, right? Our gross margin has been going down from Q3 to Q4. And then now in Q1, it started to trend up. I think we're expecting this trend to continue in the second quarter as well as into the second half of this year.

Michelle Zhang, Analyst

Okay. And my second question is about your revenue breakdown, like in terms of your geography and also your online, off-line distribution channel.

Leon Deng, CFO

I beg your pardon?

Michelle Zhang, Analyst

Yes. My second question is about your sales breakdown in terms of geography and also the proportion of your online and off-line distribution. Also, the trend going forward.

Leon Deng, CFO

Thank you. Xiaomi represents a business-to-business aspect for us. Setting Xiaomi aside, when we focus on our self-branded products, Europe stands out as our largest market, followed by China, the U.S., and other regions. Due to ongoing restrictions and lockdowns in Europe, we experienced some challenges with offline sales there, which also affected various parts of the world where we operate. Regarding your second question, currently, most of our self-branded products are sold through online channels. However, we anticipate that as COVID-19 cases decrease in the United States and lockdowns in Europe ease, offline sales will increase significantly in the latter half of this year.

Operator, Operator

The next question comes from to Asyo Inch. Okay. At this time, there are no further questions. I'd like to turn the call back over to the company for closing remarks.

Grace Zhang, Director of Investor Relations

Well, thank you once again for joining us today. If you have further questions, please feel free to contact Zepp Health's Investor Relations department. This concludes this conference call. Thank you.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.