Hello, ladies and gentlemen. Thank you for standing by for Zepp Health Corporation second quarter 2021 earnings conference call. At this time, all participants are in a listen-only mode. Today's conference call is being recorded. I would now like to turn the call over to your host, Miss Grace Zhang, Director of Investor Relations for the company. Please go ahead, Grace.
Hello, everyone, and welcome to Zepp Health Corporation second quarter earnings conference call. The company's financial and operating results were issued in a press release by 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 at ir.zepp.com. 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 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 and other risks and uncertainties included in the company's annual report on 20-F for the fiscal year ended December 31st, 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 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 a reconciliation of the unaudited non-GAAP measures to the unaudited most directly comparable GAAP measures. I'll now turn the call to our CEO, Mr. Huang Wang.
Hello, everyone. Thank you for joining our call. Second quarter results demonstrated strong continued progress on Zepp Health's mission of connecting health with technology and in our strategic plan to build a company driven predominately by its own brands and powered by our own proprietary technology. Let me highlight some key examples from the quarter. In the second quarter, we modestly topped our guidance range. Our own Amazfit and Zepp-branded product revenue continued to grow at 81% versus last year same period. In June, in the IDC Worldwide Quarterly Wearable Device Tracker, Zepp Health self-branded Amazfit and Zepp watches were recognized as being among the leading shippers of other smartwatches in the first quarter of this year. This is a tremendous proof point for the progress of our own brands.
It is my strong conviction that the keys to that success are our proprietary smart device technology, a faster pace of innovation, and a broadening line of products at feature sets and price points that are attractive to many different customers around the world. We have not gotten to this point by being a me-too company, assembling devices with off-the-shelf parts. I know that being a relentless technology leader is the key path to success. Two weeks after the end of the quarter in July, we held our annual developers conference, Next Beat 2021. I view this as the most important event of the year, as we demonstrate and discuss our new proprietary technology and discuss future courses of development. It also serves as a key engineering recruiting event.
This year, we announced the next generation of our proprietary smart device AI chip, the Huangshan-2S, which offers substantial performance increases, such as reducing operating power consumption by 56%, reducing dormant power consumption by 93%, and improvement in graphic performance by 67%. We believe this provides many significant competitive advantages. We also made the much-anticipated announcement of a new operating system for our devices, Zepp OS, which also serves as the core of an open health management platform. To avoid the limitation of many other mobile or smart operating systems such as battery and memory usage, we developed a completely different, super efficient, and lightweight system that emphasizes health, user experience, and privacy protection. At 55 megabytes, the new Zepp OS is one-tenth the size of the company's previous Amazfit OS, and it's one-twenty-eighth the size of Apple Watch watchOS 8.
The new Zepp OS creates a strong platform for third-party developers and partners to create engaging and useful apps for our devices. While retaining the exceptional battery life for which our products are known, we expect to launch this new operating system in devices later this year. At the developers conference, we also previewed PumpBeats, a sleeveless blood pressure measurement system for our Amazfit products. The new blood pressure capability is a significant differentiator for our products, and I expect will be a driver of much interest in our products. Clinical testing at the First Hospital of the Peking University demonstrated excellent accuracy in both systolic and diastolic measurements. The timeframe for accepting applications for clinical trials from external customers of our smartwatch is the fourth quarter this year. This is particularly gratifying for me personally.
Three years ago, on the IPO roadshow, an investor asked me when a smartwatch would be able to measure blood pressure. I told him it would take three years, and I am very proud that we have now done it. If you know Zepp Health, you know that another key part of our strategy is to expand our range of smart products beyond watches. Recent announcements reinforce our progress on these fronts also. In July 2021, we launched Amazfit PowerBuds Pro earbuds featuring true wireless stereo with powerful multi-scenario active noise cancellation and advanced health monitoring functions, including cervical vertebra and hearing protection. We recently launched our brand-new children's smartwatch product line, which allow us to enter a niche market we have not addressed before.
Beyond providing basic children's smartwatch functionalities, our products focus on motivating children to go outdoors and participate in sports activities, which will also help prevent myopia for the next generation. This product will be sold in China. Combined with the policy guidance of Chinese education regulatory agencies, I believe this product focuses on health and sports characteristics, liberates primary school children from a large number of outside tutoring classes, and will be supported by users and government agencies. We do not pre-announce products, but I do want to say that we have many exciting things in store for later this year, and everyone at the company looks forward to surprising and delighting our users. Recent announcements also demonstrated continuing progress in our data analytics business.
While these recent announcements are primarily developmental pilots towards creating future revenue streams, recently announced agreements with Zurich Brazil suggest we are continue our progress on this front. What these second quarter developments add up is a company moving quickly in building its own brands that drive its financial performance. When we started the company, we leveraged partnerships to develop and build products for others.
While we have a way to go towards becoming less reliant on those products for Xiaomi and others, the progress of this quarter should give some good confidence in our path to having our own products driving our financial results. I am incredibly proud of what we have accomplished in just a few short years, and equally proud of my team, and I have strong confidence in our future as we continue to be leaders in key technology, pace of innovation, and creativity in designing products and functionality that customers find compelling. I will now turn the call over to Leon to go over highlights of our second 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 Zepp-branded products globally. The pandemic slowed that growth in 2020, but the year-over-year results for the first two quarters of 2021 showed year-over-year growth rates of 84% and 81% in the last two quarters for self-branded products. As Wang noted, the best is yet to come this year with new products and functionality that we believe will continue to drive our growth in this side of our business. Launch of the Mi Band 6 in the quarter provided strong growth in our Xiaomi product sales as well, as we are working with Xiaomi on the exciting next generation products as we speak.
In fairness, I do also want to point out the timing impact of the launch of the new Xiaomi Mi Smart Band 6 in the secondnd quarter this year instead of the third quarter, which it did last year. Xiaomi sales fluctuations over the quarters create some fluctuations in the company's overall sales, and that, to some extent, overshadows the self-branded product sales performance, which also affects our guidance for the third quarter. Overall, the trend we're seeing speaks to our long-term strategy to grow our self-branded products faster and shift the balance to our own products, lessening the reliance on products developed for others. On the pandemic, vaccinations and lifting of the COVID restrictions in some markets helped our second quarter.
How the effects of the Delta and other variants will play out globally in the second half of this year is still very uncertain. That reflects in our guidance as well. Product trends we discussed on last quarter's call continued in the second quarter. The GT series and the Amazfit Bip and Pop series, representing different ends of our product line, together comprised approximately 78% of the company's self-branded product revenue. Now moving to gross margin. Gross margin can be affected by product mix, product launch timing, and product life cycles, including model upgrades. Second quarter 2021 gross margin of 22% was essentially flat, with only a 30 basis points difference from the second quarter last year. Second quarter total gross margin was primarily kept in check by the larger increase in Xiaomi unit volume compared to our company-branded products.
Operating expenses have 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. It will take 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, and that continues to be my focus. Second quarter 2021 operating expenses, including R&D, sales and marketing, and G&A expenses, and total OpEx were all down on a percentage of sales basis. On an absolute amount basis, were up to meet the demands of the business and some additional long-term incentives for retaining key talent as the Chinese market has become incredibly competitive.
I view this as a good and reasonable partnership between finance operations to strive for efficiency, but to be flexible where it is in the best long-term interest of the business. Excluding those stock-based incentives, OpEx declined year-over-year. Net income attributed to Zepp Health Corporation for the second quarter was RMB 92.6 million, compared to RMB 13.3 million in the year ago second quarter. This benefited from a year-over-year increase of RMB 13.5 million of investment income and RMB 24.8 million of net income from equity method investments. Our balance of cash and cash equivalents continued to be strong in the second quarter, and we expect this trend to continue into the second half of this year. Looking forward to the guidance, let me outline key factors we're taking into consideration.
There remains much uncertainty globally about the pandemic, as we mentioned earlier, and we expect most of our new self-branded products introductions to occur in the fourth quarter. I've already noted the timing of the new Mi Band 6 product launch this year versus last year. We're also expecting somewhat lower Mi Band volumes for the year compared to 2020. IDC has been predicting lowering demand for band products as entry-level smartwatches prices come close to band prices. This transition was anticipated, and from founding of the company, we have focused on developing our own products and brand globally. The quarterly path may not always be smooth, but we have confidence in the longer-term vision of the company in which we're driving the company and its financial performance on the strength of our own branded products.
For the third quarter 2021, management currently expects net revenues to be between RMB 1.6 billion and RMB 1.8 billion, compared to RMB 2.2 billion in third quarter 2020. We'll continue to exercise good cost control and expect to continue to report a profit in the third and fourth quarter this year. The higher profitability of our self-branded products helps our cost coverage, and long term, helps us in this transition. That outlook is based on the current market conditions and reflects the company's management's current and primary estimates of market and operating conditions and customer demand, which are all subject to change. This concludes our prepared remarks. We'll now open the call to the questions. Operator, please go ahead.
We will now begin the question- and- answer session. To ask a question, you may press star then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. 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 today comes from Clive Chung with Credit Suisse. Please go ahead.
Hi. Good evening, management. Congratulations on the strong second quarter results. My first question is on the guidance. I think this came a little bit lower than expectation. I guess Leon already outlined some of the key reasons, but could you elaborate more on the second half plans in terms of products? Because it is always, I guess, my expectation that the product launches are more second half heavy, and how does that play out now, versus, I guess, macro conditions. My second question is on the investment incomes. I guess there is CNY 13 million on investment income and then CNY 24 million on equity method investments. Could you give us the background of these and then how we should expect these going forward, particularly in the second half of 2021? Thank you.
Hi, Clive. Thank you for your questions. Let me try to answer the easy ones. I'll start with the second question. The net investments income for the two things which you just mentioned, are in essence mainly coming from the toothbrush investments which we made in 2017, if I remember correctly. We still have a sizable stake left on this company, and then together with how this company is progressing, we'll try to dribble down on our stake of this company. I think you will still see some of that coming onto our way in the coming quarters. Coming back to the guidance of Q3. The value, it may look a little bit low compared with same period last year.
I just mentioned in the prepared remarks that a lot of that is driven by the new product sales, which happened last year on the Xiaomi Mi Band 5, and then this year, the new product introduction for Xiaomi is actually preponed by a quarter into Q2, right? On the other hand, our self-branded products are very much Q4 heavy this year, versus last year, I think we had a pace whereby there's a bit happened in Q3 and there was a bit happened in Q4. Yes, the first answer to that question is, it's very much driven by seasonality. The second reason I think, I also mentioned just now, is the uncertainty on the COVID Delta variant. We cannot predict to what extent that's going to impact ourselves for the second half of this year.
On a full year basis, we're still expecting that on a full year revenue, year-on-year basis, we're still going to grow versus last year. I hope that answers the question.
Yeah. Okay. Very clear. Thank you, Leon.
The next question comes from Andre Lin with Citi. Please go ahead.
Hi. Thank you for taking my question. I have a few questions regarding the non-GAAP adjustment. I have noticed that there is an RMB 74 million adjustment in the non-GAAP basis. How should we estimate that number in the next few quarters, will that level be a recurring level going forward? I also have a question regarding the third quarter breakdown. Given you have a RMB 1.6 billion-RMB 1.8 billion revenue guidance, how should we think about the breakdown between self-branded product and the Xiaomi Band? Thank you.
Okay. Thank you. On the R&D adjustment, I think you're referring to the share-based compensation amount, correct?
Yes.
Okay. Now, the share-based compensation amount actually happens on every single quarter. In certain quarters, it was a little bit lower. In certain quarters, it was a little bit higher. I think on average, you can, in your model, to plug in a number between CNY 15 million-CNY 20 million per quarter, on the SBC expenses. However, as I said, because this is very much linked to the bonus cycle to the payment of the employees. In certain quarters, probably we don't have any, and in certain quarters we'll have significant amounts. That's why we're talking about the non-GAAP adjustments in our financials as well.
Oh, thank you.
Does that answer it? Okay. On the third quarter split between our self-branded and Xiaomi products, I think what I can say at this moment is that our self-branded products will continue the growth rate, which we kind of see in the past quarters. I think from last year Q3, you saw the trend that our self-branded products start to accelerate. I think last year Q3, the base was around CNY 400 million-CNY 500 million, if I remember correctly by heart. In Q3, we'll continue a high double-digit percentage growth on our self-branded products, right? That speed and trend continue to go on in the second half of this year. On the other hand, the Xiaomi volume and revenue, it's still subject to certain market conditions. I have mentioned a few times that the fitness band product category is becoming a mature category.
Also, if you look at the IDC report, the overall market size on the fitness band market also is showing a decline rather than an increase quarter-on-quarter. There's going to be some limitations on how much we could grow on the Xiaomi band revenue per se. However, we have the self-branded products, which is the growth, and that should provide a good cost coverage for our profitability going forward.
Thank you. Very clear. Thank you very much.
The next question comes from Robert McKay with Blue Lotus. Please go ahead.
Hi there. Thanks for taking my questions. Just first of all, congratulations on your children's smartwatch launch in third quarter, and also those innovations that you made with Zepp OS and your SoC, Huangshan. I also look forward to seeing what's happening in fourth quarter. You mentioned that you have a lot of surprises coming in fourth quarter, and so I actually really want to ask about that is, right now you have a tie-up with Xiaomi on the Mi Band. I'm wondering if you have any other kind of tie-ups with Xiaomi on other types of products, because as you mentioned, smart bands are declining. What we want to see is other tie-ups, smartwatches, kids' watches. Is that something that might be possible, if not in fourth quarter, but in the future?
Yeah. No. Thank you for the question. I think it's a very good question. As we just mentioned in the prepared remarks, we also mentioned that we have some exciting products with Xiaomi, which is being developed as we speak, right? Unfortunately, these are under the confidentiality agreement, I cannot say too much about it. I think we have a good strategic partnership with Xiaomi on the wearable market. I have to ask you to just waiting to be surprised.
Okay. Thank you. I'm waiting to be surprised. I do have some other questions, if that's okay. As you know, Zepp kind of sees themselves as a health company, health isn't really limited to smart bands and smartwatches. We're wondering if there's any kind of other medical-grade products that you might have in store, and if so, the progress is like on that.
There are a few, right? I think what Wang just mentioned in his script, that apart from the smartwatch and band products, we also have a very interesting line of TWS headphones. It not only have the traditional noise-canceling, the mainstream functionalities people have, we also have the TWS headphones equipped with the PPG sensor, which can measure the heart rates on your headphones. There are a few of these coming to the market or in the pipeline, which are in the making. Regarding the medical devices, I think we also just mentioned in the July conference, the developer conference, that we have the cutting-edge non-squeeze blood pressure measurement capability, which is going to be put into our next generation watch later this year. That is a blood pressure functionality, by definition, that is a medical-grade product.
Similar to what Apple Watch is doing, we have to go through a medical certification on those things if we have to sell. This is just one of the examples, and I think we have a few of that, which is in the making, and which is on the product pipeline for the future quarters.
Okay, great. Thank you. Those are really great answers. Thank you. I do have one more question. Actually, in contrast to what Clive asked earlier, your third quarter guidance, I thought, was pretty strong, considering you don't have any new product launches this quarter. I'm wondering where you're seeing that strength coming from. I know you mentioned earlier that you're seeing a lot of growth from your self-branded products. I was wondering, what kind of growth are we seeing from your Xiaomi Mi Band in the third quarter?
Yeah. No, the Xiaomi Mi Band for third quarter probably is going to be in a decline. If you do the math, you probably can do that, because last year, same period, we had the Mi Band 5 launch. This year it has been preponed to Q2. The decline will be to a big extent made up by our self-branded products growth. I have just answered Clive on his question. It's going to be a high double-digit growth for our self-branded products.
Cool. That makes sense. You're seeing high double-digit growth. Is that quarter-over-quarter or year-over-year?
That's quarter-over-quarter.
Okay.
That Q3 versus last year Q3. Yeah.
Oh, okay. Q3 versus Q3 last year.
Yeah. That's Q3 2021 versus Q3 2020.
Okay, great.
Still, if you're talking about quarter-on-quarter growth, there should be.
Okay. If you're saying that if it's year-over-year double digit, doesn't that mean that quarter-over-quarter, maybe a slight decline?
Not necessarily.
No, not necessarily. Okay.
Not necessarily.
Okay. Thank you. Okay. Thank you very much.
As a reminder, if you have a question, please press star then one to be joined into the queue. The next question comes from Marcel Münch with DŌNGXii . Please go ahead.
Congrats, thanks for taking my question. My question is regarding the news around the insurance business and partnering with Zurich Brazil and ERGO China Life. Can you share or maybe elaborate what will be the revenue or business model around this? Connected to that, what makes you confident that the data from the wearables is useful for those insurance companies that you are partnering up with? Thanks.
For this question, I will refer to Mike.
Yes. Hi. Thanks for the question. Yes. Currently, with Zurich Brazil and other big insurance companies, we are conducting pilots with them. The big revenue will come after the pilots are finished. Zurich and us, for example, we have already made press releases about our cooperation, about the pilot content. The pilot is actually a great demonstration that the insurance companies feel that the data, including the PAI Health score, can really help them with their business to, for example, helping to make health insurance pricing based on the real-time health behavior through data collected by wearables. The pilot will help us to gain more insight and more improvements that the insurance companies may need for us to help them implement after the pilot. Again, the revenue impact will probably be after the pilots are finished.
The pilots range from 6 months-1 2 months in duration. We have multiple pilots with multiple insurance companies right now. Does that answer your question?
Yeah. Thanks. More specifically, I'm not so worried about when will be the first revenues showing up, but rather, on the business model side, what's the idea behind it in terms of, is there the idea to underwrite the business, that insurance, for instance, together, or would even Zepp consider launching their own insurance, and the insurance partner is kind of just partnering on that side? Is it, for instance, that Zepp Health is looking to feed the data into the systems and thereby getting a revenue stream for the data? Is there any specifics on that you can share at this point? Thanks.
We have different partnerships with different insurance companies. Some insurance companies look to use our data and our PAI Health technology to do better customer acquisition and generate more customer engagement with the insurance company's applications. Other pilots that we engage with, they are using our data to try to do better underwriting. Also set more appropriate health insurance pricing based on data that they gathered from our smart wearables. Different insurance companies actually have different objectives for our PAI Health data. We also, for example, engaging with some insurance companies to work on corporate wellness health. That is also leveraging the PAI Health data to monitor the health of the employees. There are different engagement and objectives that we can accomplish with PAI Health for the insurance company.
All right. That's really interesting. Sorry, my last question would be then.
No, no. Excuse me. Allow me to add one more thing to it.
Sure
As Mike just mentioned, on the business model, it's almost everything, which you just mentioned. There's one more thing we have, is that we also have a brokerage license in China, and we also would not rule out the possibility that in the future we'll do the insurance program ourselves. Right? I think the short answer to it is that different monetization ways we're exploring, and according to the outcome of those different pilot programs, we should be able to identify a key revenue stream coming out of the insurance program here.
Thanks a lot. That's really insightful and great answers. My last question to that is, where would you see Zepp Health is fitting in this new governmental regulations and strategies sphere? Also thinking about regulations around insurance or health data and so on.
Yeah, that's a good question. First, it's not my position to comment on the government policies and regulations. As a company, there are a few things I could comment on. Number one is we definitely position the security and privacy, the customer user data security and privacy, as the most important things in our day-to-day work. Right? For example, we're compliant with Europe, the GDPR, we're compliant in United States on HIPAA, and we do local data storage as well. Right? All those rules and regulations on data storage, we're compliant in almost every country we operate with. This is also quite key in our management agenda. That's number one. Number two, I think if you're looking at the Chinese regulation towards insurance, I think the government definitely wanted the technology to be part of, let's say, the traditional insurance industry, right?
Basically, there are different rules and regulations which have been published in the course of this year. For example, a traditional insurance company need and can buy a so-called third-party service on telehealth or something like a PAI Health, this type of digital health product or services to couple with a traditional insurance program. Right? Given our unique expertise and what Mike explained here, we think we're well-positioned to capture this opportunity going forward. I don't know whether or not you're referring to the latest regulation change in China on the online education business or the e-commerce online entertainment business per se. I think what draws us apart from those business is that we are a maker of smart health devices, right? Versus the other guys, they're just doing e-commerce and online entertainment stuff, right?
I think the long-term goal of the Chinese government and also governments around the world is to tackle the global aging problem, to give more tools and equipments towards the consumer, which is affordable, so they can do self-quantification, and then to monitor their health. Our strategy to connect health with technology also position us towards that part of the vision, like the governments of the global communities is going to do. I think that's just a few sentences from our side.
Let me also just add quickly that at our board level, we do have a board level committee composed of independent board directors. It's a big data and user privacy ethics committee. This helps provide corporate governance for our companies, again complying with all the different international user data privacy regulations where we operate. We have a very, very strong corporate governance regarding user privacy as well as data security. Thank you.
Thanks a lot.
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 Zepp's investor relations department. This concludes this conference call. Thank you.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.