Zepp Health Corporation

Ladies and gentlemen, thank you for standing by for the Zep Health Corporation Third Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. Today's conference call is being recorded. I will now turn the call over to your host, Ms. Grace Dunn, Director of Investor Relations for the company. Please go ahead, Grace.

Hello, everyone, and welcome to Zapp Health Corporation's third 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 in which we will refer on this call by visiting the IR section of the company's website at ir.com. Participating in today's call are Mr. Huang Wang, our Chairman of the Board of Directors and Chief Executive Officer, and Mr. Leon Chen 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 Yang, 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 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 20F 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 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 Wang. Please go ahead.

Hello, everyone. Thank you for joining our call. The first quarter was marked by continued strong performance from our Amazfit and Zepp-branded smartwatches. While Mi Band series sales weakened due to an earlier launch of the new generation Mi Band this year compared with last year, these factors drove our total net revenues to RMB 1.6 billion in the first quarter. 28.1% lower year-over-year. We should highlight that our self-branded products have quickly emerged as powerful engines preparing our growth. Sheemans of our self-branded products grew by 88.9% compared with the same period last year and accounted for 38.6% of our total net revenues. Clearly, the strategic initiatives we have put in place to actively expand our portfolio of self-branded Amazfit products enhance our sales channels and grow the The influence of our brand are delivering concrete results and extending our reach. Product traction in international markets is strong and growing. Over 80% of the self-branded products are overseas, and our overseas expansion momentum is growing. I will highlight some of our recent progress. In Southeast Asia, Amazfit now ranks number two in SOCPE's C-list of best-selling smart variable brands. And in the U.S., our self-branded products' shipment volume more than doubled in the first quarter as we continue to expand our rich products. through large retail channels like Walmart, Target, QVC, and others. We have also made significant achievements in Europe. According to our internal sales data, our shipments in Germany increased 150% in the third quarter as we newly entered Expert Plus and Euronics more than 150 offline stores. In Italy, our brand ranked number one in the adult smartwatch market, according to the September Italy GFK report. To further heighten our brand awareness in China, we formally introduced a Chinese name for Amazfit on the brand's sixth anniversary on October 12. It is called YueWu, which means rise up and surpass ourselves. It came with a redesigned logo and a new brand tagline, Up Your Game, reflecting our vision for the brand to become a partner with our users in their life explorations. Consumers are increasingly calling for smart wearable devices with improved fundamentals such as easy of use, better user experience, and longer battery life. We have heeded this call, launching new universally popular, attractive products and an advanced OS that meets growing market demand. Most recently, In early October, we launched two brand new Amazfit GTR3 and GTS3 series. Fully equipped with our newest internally developed smartwatch operating system, ZappOS, Both series bring next-generation capabilities to our smartwatches with an industry-leading BioTracker 3 PBG sensor that monitors blood oxygen level, heart rate, stress level, and sleep quality, providing users with easy-to-use enhanced health and sports experience. initial adoption of both our new product series have been strong, showing increasing momentum in multiple geographies. We are also extremely proud of our new Zepp OS and its enriched capabilities, including exciting energy efficiency and open architecture for developers to work seamlessly with our OS. We believe ZAP OS will become the cornerstone of our comprehensive health management platform. Along with the increasing sales volume of GTR3 and GTS3, ZAP OS will bring more enriched displays and apps. we continue to enrich our pipeline to offer customers new products that complements our current offerings. Before the year's end, we will also be introducing a new sleeveless block pressure measurement algorithm called POMBIS. Working with our Amazfit GTR3 Pro, This algorithm can measure block pressure in 30 seconds, providing users with easy, convenient, accurate readings anytime and anywhere throughout their busy day. Separately, we received broad market enthusiasm for our newly launched eBus, Amazee PowerBus Pro, and we are extremely honored to be named as CES 2022 Innovation Awards Honorary. These earbuds are not only a wireless active noise cancellation headset, but also a biosensor device users can wear that supports smart running recognition, ear canal, heart rate monitoring, hearing protection, and cervical spine protection. Adding to our accomplishments in growing our own capabilities, we believe in the power of collaboration to amplify various strengths. Our strategic partnership with Xiaomi continues to be important for both parties. and we hold our collaboration in high esteem. As the Mi Band series, designed and manufactured by us, delivers steady performance, we are continuing to actively grow our own brand, namely Amazfit and Zapp, to deepen our portfolio of self-developed offerings. Furthering our mission to connect technology and health is a driving force behind our innovation, which we hope can bring potential advancement for society at large. By steadily growing our portfolio of amazing products and services, we continue to make progress towards this goal. We are dedicated to creating quality products that make people's lives easier, enrich their pursuit of healthy living, and advance their health and fitness goals. By leveraging rich technology to create fruitful products and services, we are pursuing global health, one step at a time. Lastly, I am pleased to announce that today our board approved a 20 million share repurchase program. The share repurchase program demonstrates our confidence to achieve substantial long-term growth as we execute our strategy, supported by our strong balance sheet and cash generation capability. We are confident such a program will benefit the growth of the company and create value for all of our shareholders. I will now turn the call over to Leo to go over highlights of our third quarter financial results.

Thank you, Wang. As I did last quarter, I want to focus on highlighting what I think are the handful of the most important metrics. Starting with sales, we're especially pleased with the continuing growth of our own Amazfit and that branded products in the third quarter. For each of the first three quarters this year, we have driven year-over-year revenue growth in self-branded products of 84%, 81%, and now 38% in the third quarter, which was a quarter in which we launched no new products, and we had pre-announced the GT3 coming in the fourth quarter, This presents a strong demonstration that we're continuing to expand our brands globally. The timing of new product launches often impacts year-over-year quality sales comparisons. Last quarter, the pull forward of Xiaomi's new Band 6 gives an extra boost to Q2 because the new Mi Band 5 shipped in Q3 last year. So for Q3 this year, we had the opposite effect. Like many other companies, supply chain issues dampened our third quarter results in a number of ways. For example, we had some name-branded chip suppliers surprise us with last-minute supply cuts. At the same time, like everyone else, we have experienced higher shipping costs and uncertain deliveries, both inbound and out. Moreover, how the effects of the Delta and other variants will play out globally in Q4 is very unclear. These challenges have continued into the first part of the fourth quarter and factored into our guidance. While Xiaomi remains a valuable partner, we're pleased to be growing our way into less reliance on products from their channel. This year's flow of Xiaomi's business has been significantly different than 2020, which boosted our second quarter year-over-year numbers and was a drag on third quarter results. Third quarter 2021 revenue from Xiaomi products was down 45 percent year-over-year, or RMB 799 million, driving the 28 percent overall decline in total revenue. As Juan noted before, we are optimistic about the fourth quarter, given the new technology and products we're bringing to the market. Now, moving to gross margin. Gross margin can be affected by product mix, product launch timing, and product life cycles. including model upgrades. Third quarter 2021 gross margin of 20.2% was essentially flat, with only a 40 basis point difference from the third quarter last year. Operating expenses has been a key focus of mine since joining the company in the third quarter last year, both in absolute amounts as well as a percentage of sales. A portion of these expenses are fixed so it takes time to continue to gradually reduce expenses. While we have to balance cost controls with fueling growth, we have decreased total operating expenses sequentially since last year's third quarter. That continues to be my focus. Third quarter 2021 operating expenses and total OPEX all showed the effect of our cost control and balancing efforts. both in absolute amount and as a percentage of sales. In absolute currency, sales and marketing expenses was down 22%, R&D was down 37%, and G&A was down 32%. Balancing these costs drove a 30 basis point improvement in operating income as a percentage of sales. As mentioned before, we're continuing to invest in R&D, sales and marketing, and G&A costs to support growth, but in a more balanced way since Q3 of last year when I come aboard. We'll be maintaining this balanced approach to expense growth and control in Q4 for a similar round rate. Net income as a percentage of sales declined slightly year over year with lower interest income and higher interest expenses, and again in fair value of the investment in the third quarter last year. Our balance of cash and cash equivalents continue to be strong in the third quarter at RMB 1.2 billion. Our working capital ratio continues to strengthen. In the quarter, we retired our RMB 230 million short-term loan. We're confident in our strategy and financial trajectory as we finish 2021 and look ahead to 2022. The Board has approved up to 20 million U.S. dollars to repurchase shares. This is primarily to supply the employee incentive stock plan. Looking forward to guidance. Let me outline key factors we're taking into consideration. On the positive side, we have just launched our new GT3 products in the fourth quarter, which features our compelling new technologies and capabilities that we are seeing our consumers respond favorably to. Supply chain challenges, including chip shortages and higher freight costs and delivery uncertainties, remain significant questions and cause us to guide conservatively. For the fourth quarter 2021, management currently expects net revenues to be between RMB 1.75 billion and RMB 2.0 billion, compared to RMB 1.97 billion in the fourth quarter 2020. will continue to exercise good cost control and expect to continue to report a profit in the fourth quarter this year. That outlook is based on current market conditions and reflects the company management's current and preliminary estimates of market and operating conditions and customer demand, which are also subject to change. This concludes our prepared remarks. We will now open the call to questions. Operator, please go ahead.

Thank you. We will now begin the question and answer session. To ask a question, you may press star then 1 on your touch-tone phone. If you are using a speakerphone, we ask that you please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. And 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. And today's first question comes from Clive Chung with Credit Suisse. Please go ahead.

Clive Chung Hi, management. Thank you for taking my question. I have a couple. I'll ask one by one. First of all, I think given the continued improvement from AmazeFed in terms of revenue contribution, I want to check why the margin defined particularly significantly, you know, quarter on quarter against seasonality. Thank you. That's my first question.

Cliff, I mean, Actually, the margin doesn't move too much quarter on quarter, but I think it's more of a product mix issue, right? So as I mentioned in the previous remarks, this quarter the Xiaomi products actually stands for around 60% of our overall revenue, right? And our self-branded products stands for around 40%, 38% to be exact, right? And the margin differentiation between the Xiaomi and self-branded products is actually a value of 1.7 to 2 times. I think you can do the math. And that actually results into the gross margin number of this quarter.

Okay. Thank you. And I was wondering if there's more color for the low seasonality shipment. I think we already expected that, but I think 9.1 million was a little bit further below the expectation. I was wondering if this is from a demand perspective or from kind of supply bottlenecks, given the reasons you mentioned in the previous remarks. Thank you.

Yeah, okay. Thank you, Clive. That's a good question. Now, so there are a few issues that actually play into the numbers which we reported today. I think one of the most important ones is actually chip shortages and surprise last minute supply cuts from a few name branded chip makers. I have mentioned a few quarters ago that we already made a long lead time risk price of those key components. But still, I mean, since all the chip makers are prioritizing their supply towards the automakers at the quarter end, per se, that had an unexpected impact to us. But, of course, we're doing second sourcing on our key components, but last-minute changes like such still takes time for the supply chain to actually recoup on the situation. And also another issue play into the mix is the freight costs and also you know the sea shipments as well as the air shipments was very tight. in Q3 and going into Q4, right? These two place an important role into the lower sales value, which we reported this quarter. And so, to answer your question, it's more of a supply issue rather than a demand issue. And actually, our products have been sold very well globally.

Okay, thank you very much. I think that's it from me. Thank you.

And ladies and gentlemen, as a reminder, to ask a question, please press stars and one. Today's next question comes from Kevin Chen at China Renaissance. Please go ahead.

Hi, thank you management for taking my question. I have two questions. First, as mentioned, the company just mentioned the currently in terms of the revenue contribution has already reached an impressive 38%. I'm just wondering, ideally, do we have an internal target of how big this internal percentage will get maybe over the rest of this year or next year? And to get there, what is our strategy to meet such a goal? Thank you. Thank you.

Thank you, Kevin. That's a good question. Yes, you have mentioned correctly that in Q3 the weight of our self-branded products is already close to 40%. So to give you a quick answer to your question, I think this year we're aiming at a split of close to 40% self-branded and 60% Xiaomi or maybe a little bit better than that. And next year, it's too early to talk about it, but I think we're aiming at improving this ratio a little bit further, I think probably towards half-half. And to get to that number, I think it's a mixed bag of a few things which we need to execute very well. Number one is definitely the product, because we're a product and innovation-driven companies. We're very proud of our products, and especially the recent launched new product, the GT3 series. I would definitely recommend you to try it out. And the second thing, I think, is our distribution network. As we are expanding very fast overseas, as our CEO just mentioned, we have been very successful in Europe, in the United States, and in Southeast Asia. In some of the countries, we're already market share number one positions on the smart watch sector. And last but not the least, I would say it's definitely our people. And we have a very strong team on innovation and on supply chain working in different parts of China and also globally. So I think these three place into the confidence that we continue to believe that we can definitely execute better next year.

Thank you, Leon. Also, I'd like to follow up another question. I'm quite curious about the gross margin part. As you mentioned, this year, actually, a lot of hardware industry are getting hit by component shortage and various logistical challenges. I was just wondering, ideally, Do we have a figure of normalized growth margin of our cell phone brand in the future? And to get there, what are we still missing? Are we talking about the normalization of the supply chain or we have to reach a critical scale? What do you think that scale will be for us to reach a normalized margin?

Yeah, so let me try to answer the first part of your question. I think for our self-branded products, we're looking at somewhere a range between 25% to 35% of gross margin on our self-branded products. So that is the range we're looking at. Sometimes, I mean, it depends on the seasonality. This number may fluctuate, but this is actually the range we're looking at. And if you are looking at the things which is going to impact on that number, I think seasonal pattern plays into a role. If you look at the promotional period, for example, the double 11 in China and then the Christmas sales, et cetera, et cetera, then obviously you want to get rid of those products at a much cheaper price. So it may have an impact on the ASP, right? But on the other hand, it also couples with the new product launch and the In consumer electronics industry, when you launch a new product, a specific SKU or product will carry definitely a higher than a normalized gross margin number. So it's a mixed problem, and it's also a seasonal pattern which we're working towards. But obviously, it depends on the new product launch. It depends on the normalized supplier chain pattern. As what we mentioned, we experienced a lot of last-minute surprises, although we actually prepared for it to some extent. And thirdly, it's really also the uncertainty also lies on the COVID. I don't want to downplay this issue because in Q3, when we think the situation is really getting improved, all of a sudden you saw the cases soaring in China as well as in Europe, and I think the Netherlands recently went into a partially lockdown. So all that issues play into the gross margin outlook for next year, but I think I have given you enough color on the gross margin number for our self-rated product.

All right. Thank you, Leon. Very clear. I'll get back to you on question two. Thank you. Thank you.

And our next question today comes from Marcel Minch with Dongxi. Please go ahead.

Yes, thanks for taking my question. My first question would be around the hardware, particularly the new self-branded products like the GT3 Pro. And what would you say is the competitive advantage against, let's say, like the Huawei Watch 3, which seems to have a similar offering?

That's a good question, Marcel. Yeah, I'm not a... a product person per se, but I will try my best to answer your question. I think the most differentiating factor of our GT3 Pro is the ZAP OS, right? As Huang mentioned in his script, I mean, ZAP OS is really a cutting-edge operating system which allows a lot of third-party apps to be built on it, and also from a size perspective, It's really, really small compared with the other mainstream operating systems which you can find in the watch market. And that in turn translates into a longer battery life, which you know that we're pretty good at it with the low power Bluetooth connection and also the power consumption is actually prolonged in the GT3 series. And the last but not the least important one is the design. We have a beautifully designed GT3 Pro with a curved screen and it attracts a lot of consumers and it received very, very good reviews from the Chinese consumers, which are very critical per se on JD.com and as well as in the Tmall, which is Alibaba platform. So I think those are the key things which I would like to highlight, but also we have the pump beats functionality, which our CEO just mentioned as well. So that all plays into the product mix.

Okay, thank you. My second question would be, are there any updates on the value-added services, like the insurance part or something related to other B2B services?

For that question, I would like to ask our COO, Mike, to answer.

Yes. So we are still continuing our pilots with large insurance companies, and And at the same time, while these pilots are going, we're discussing with them about the long-term contracts and the revenue model. But the pilots will need to be finished beforehand. we will really truly engage in the long-term contract. But the pilots are going very, very well right now according to the criteria. Thank you.

Ladies and gentlemen, 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 ZAP's Investor Relations Department. This concludes this conference call. Thank you.

And, ladies and gentlemen, this concludes today's conference call. You may now disconnect your lines and have a wonderful day.