Earnings Call Transcript - ZEPP Q4 2020

Operator, Operator

Hello, ladies and gentlemen, thank you for standing by for Zepp Health's Fourth Quarter and Full Year 2020 Earnings Conference Call. 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.

Grace Yujia Zhang, Director of Investor Relations

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.

Huang Wang, CEO

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, reaching 45.7 million units, especially our self-branded products, which rose 20%, reaching 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, where we 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 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 of 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 three 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 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 upgraded versions. We also branched into new product categories, including earbuds, scales, and home fitness equipment, such as treadmills. Many of these new products will be presented at the Consumer Electronic Show, CES, in January, and several of our Amazfit and Zepp branded products received best in show distinction and accolades from reviewers in leading publications, including Wearables Tech Radar, 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 products at all price points. This has been the bedrock of our success in the wearable space, and you can expect more of 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 a shining example of our prowess in technology that distinguishes us from competitors. Now in its second generation, the Huangshan-2, introduced in 2020, is the most powerful AI smart chip for wearables of this kind, and we have already begun rolling it out in our products. In the meantime, we are also in the process of developing the new Huangshan-3. We believe we are in the leading position in the AI smart chips industry for wearables. Data analytics is the second pillar in our framework and is an integral part of 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, a U.S.-based leading insurance company cited study results using analytics from our PAI Health units as providing value beyond traditional tools in the underwriting process. Just last week, Gen Re had another announcement of a study documenting PAI's effectiveness at improving employee health and longevity. We see these as harbingers of growing recognition for the value that data analytics can bring to the industry. While the pandemic largely consumed the attention of the insurance industry in 2020, we are hopeful that 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 miniaturization 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 targeting initially urologic applications. Just two weeks ago, they received their FDA 510(k) clearance, which was a very exciting critical step. You should also have noted two 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 to integrate imaging data and imaging devices into our health technologies ecosystem. To better reflect our strategy of 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 and strengthens our presence across languages and cultures. Last but not least, in October, we extended our strategic cooperation agreement with Xiaomi Corporation for an additional three years. As part of the extended agreement, we will continue to receive most preferred partner status to develop Xiaomi wearable products and enjoy the same status for the research and development of AI chips and algorithms for wearable devices. We are currently working on the MI Band 6 and expect to launch it 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 solid proof points for our business. The soundness of our strategy and the broad-based appeal of our partners. Even though we foresee that COVID still impacts 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 the highlights of our fourth quarter and full year results.

Leon Cheng Deng, CFO

Thank you, Huang. I'm going to drill down from a full year view to talk specifically about the fourth quarter. As I did last quarter, I want to provide some specific color and commentary on just a few key metrics. Starting with sales. From my perspective, the company had a great quarter despite renewed impact from the COVID virus, reinstating 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 not as strong as we believe they could have been otherwise. In addition, a second COVID-related impact on the quarter was product delivery delays in China with some of our new products. 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, where the new model sells for USD 180, comprised 41% of the smartwatch and band unit shipments in the quarter. Sales of our basic smartwatch series, Bip and Pop, where 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 three 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 return 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 the 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 in our success. Given the uncertainties of the pandemic for the foreseeable future, we're going to continue to manage operating expenses as a percentage of sales, targeting about where we are now to drive profitability. Reported net income as a percentage of sales was 5.8% for the fourth quarter compared to 9.8% in the year-ago fourth quarter. Q4's net income benefited from a net year-over-year increase of RMB 56.5 million in gains from the deconsolidation of a subsidiary as a result of a 2017 partnership with the electric toothbrush company in China. The company's cash position continues to be strong, finishing the fourth quarter with 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 uncertainty globally about the pandemic. While vaccination rates are rising, risks from different strains are being discussed, and there are concerns about losing restrictions and resuming travel. Europe currently looks like it will stay largely closed for the near term. While in the U.S., a number of states have dropped mask mandates, and college spring breaks seem 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 of 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 as well as customer demand, which are all subject to change. This concludes our prepared remarks. We'll now open the call to questions.

Operator, Operator

The first question is from Clive Cheung from Crédit Suisse.

Ho Fung Cheung, Analyst

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

Leon Cheng Deng, CFO

Clive, I think I can take this question. The answer to your question is no. 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 are certain expectations for new products, which are going to be launched very soon. From that perspective, we believe what we experienced in Q4 is very much a seasonal pattern rather than a structural issue. Our forecast for 2021 and also Q1's outlook reflects that point. We believe we should have a solid 2021 based on what we prepared in Q4 and Q3 for the product introductions.

Ho Fung Cheung, Analyst

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

Leon Cheng Deng, CFO

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

Operator, Operator

The next question is from Andre Lin from Citigroup.

Ang-Chi Lin, Analyst

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

Leon Cheng Deng, CFO

Yes. Maybe I will answer this question. So there's a few things on Yitong. First, Yitong is actually a minority stake investment, which we had invested in January, so it's not a Q4 event; it's more of a Q1 event. We also don't consolidate Yitong in our financial results. Yitong has its own core business, and I'm not sure if you've noticed that they recently published their annual result, and the net income of Yitong actually grew by more than 20% versus 2019. The rationale behind taking this minority stake in Yitong is that we want to leverage that health's core capabilities as well as Yitong's access to the Chinese domestic capital market. By joining hands, Zepp and Yitong are going to expand the health care ecosystem for the China market in the longer term.

Ang-Chi Lin, Analyst

I have a follow-up question. And given you have provided your sales guidance for the first quarter, can you also share with us your unit forecast or current status in the first two months of this year? Also, when do you think the contribution of the new generation of products will start to drive seasonal sales this year?

Leon Cheng Deng, CFO

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, our turnover was around RMB 1.09 billion. This year, we guide around RMB 1 billion to RMB 1.15 billion. We think there's a high chance that our revenue is going to fall within this range. The first two months trend actually provides some confidence for this outlook. Regarding the Xiaomi's new product, I cannot say too much about the exact timing. But the only thing I can tell you is that the MI Band 6 is coming out very, very soon.

Operator, Operator

The next question is from Joe Lee from Investor Securities.

Meng Cao, Analyst

Congratulations on this quarter's 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.

Leon Cheng Deng, CFO

I could have Mike to answer.

Mike Yeung, COO

Yes. This is Mike Yeung, yes. Yes, let me try to answer the question. As Wang mentioned in the script, data analytics is one of our strength pillars, especially the PAI technology and algorithm that we acquired. When we work with the insurance companies, PAI can provide value in at least a couple of ways. First, PAI can help increase customer engagement for the insurance companies. Monitoring the PAI score can be a customer engagement tool to elevate customer engagement for the insurance company. Secondly, PAI is scientifically proven with many years of study and large calculations, insurance companies can use the PAI score as a factor in their actuarial formula to help in their underwriting, whether it's for health insurance or for life insurance; both can use a PAI score to improve their underwriting. So this is the second way that we are working with insurance companies to integrate the PAI technology. Gen Re has made a lot of studies and published that the PAI score is a highly effective tool for both of these services from insurance companies.

Meng Cao, Analyst

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

Leon Cheng Deng, CFO

That's a good question. As you've seen in our 20-F in 2019, the current weight between Xiaomi and self-branded products is around 70%/30% from an absolute revenue value perspective. Throughout the year, we are gradually seeing this trend moving towards more self-branded products over Xiaomi, although the move is gradual. Since Xiaomi has been such a big contribution factor to our top line, any move for our self-branded product to gain weight will require the self-branded product sales or revenue growth to be double or triple Xiaomi's growth rate to change that mix. To answer your question, starting from Q3 and going into Q4 and Q1, we see the self-branded product mix in the overall sales mix taking place. The self-branded products as part of the company's portfolio are gradually gaining weight. But as I just mentioned, significant structural changes would require several quarters to manifest.

Meng Cao, Analyst

Okay. Got it. My third question is about the paying rate of your health service. Could you share the current paying rate and how this rate would increase in the future? How would that contribute to our revenue mix?

Leon Cheng Deng, CFO

As we mentioned before, most of these services or health services are—there are two aspects. One is actually the PAI Health and the prudential and the Gen Re-type insurance technology-type cooperation. The revenue from these services is expected to emerge in the second half of 2021 based on our latest forecast. For industrial health, as mentioned early in the script, investments in x-ray machines and MRI machines will represent long-term investments. It will follow a self-sustaining business model, like white labeling. Significant revenue from that part of the business will likely surface a year from now; so probably you will see something in early 2022 or mid-2022.

Meng Cao, Analyst

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

Leon Cheng Deng, CFO

I think we cannot disclose specific information on a product line. But as we mentioned in the script early on, the Huangshan-2 is being rolled out to all the self-branded products as we go. That progress is underway as we speak. Yes, we have noticed a shortage of IC chips across the industry. For that reason, we are also stockpiling some inventories for the key components of the IC chips for our smartwatch products. You will see a little bit of that in the inventory number of our balance sheet probably in Q1.

Operator, Operator

The next question is from Jacky He from China Renaissance.

Jiayu He, Analyst

I only have one 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 products?

Leon Cheng Deng, CFO

Yes. I think we have already provided an outlook for Q1. Normally, we don't provide a full-year outlook. However, based on what we see and considering how badly COVID impacts the international market and how fast we can return to normal working patterns, we currently believe that full-year sales growth for the company overall, combining Xiaomi and self-branded products, should at least match the growth rate of 2020, if not exceed it. Regarding the ASP, it's affected by product launch timing, seasonality, and product mix changes. We want to be cautious about its use. For the full year, looking at combined ASP, it declined slightly versus last year. The ASP for Xiaomi products remained flat, while the ASP for our own branded products increased dramatically. We think the ASP trend for our own branded products will continue to expand in the coming quarters. I hope that somewhat addresses your question.

Operator, Operator

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

Grace Yujia Zhang, Director of Investor Relations

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.

Operator, Operator

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