Earnings Call: Q1 2021

May 13, 2021

Hello, ladies and gentlemen. Thank you for standing by for ZEP Health Corp's First 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 Zhang, Director of Investor Relations for the company, please go ahead, Grace. Hello, everyone, and welcome to 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.zap.com/investor. Participating in today's call are Mr. Huang Wang, our Chairman of the Board of Directors and Chief Executive Officer and Mr. Liang Deng, our Chief Financial Officer. The company's management will begin with prepared remarks And the call will conclude with a Q and A session. Mr. Mike Young, our Chief Operating Officer, will join us for the Q and 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 required under applicable law. Please also note that ZEP's earnings release and this conference call include discussions of unaudited GAAP show information as well as unaudited non GAAP financial information. ZEP'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. Hello, everyone. Thank you for joining our call. Our Q1 results demonstrate both the Resilience of our strategy and popularity of our brand, while at the same time, we are challenged by supply chain and the market channel dynamics that were in play due to the global pandemic. The highlight of the Q1 was the performance of our self branded products. Humans of self branded products more than doubled in the Q1 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, top, BIP and 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 Q1, our overseas market channels continued to be adversely impacted by COVID-nineteen, 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 continue to work their way through 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 brand's popularity as well as revenues out. First, executing on our mission to connect health with technology. In the Q1, we continued to build out our comprehensive health and fitness ecosystem by enriching our product portfolio. In March, we launched Yamaiswi TLX 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, For 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 functionality in Amazfit GTS 2 and GTR2 Smartwatches. Rolling this out to majority of our smartwatch portfolio adds 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 6th generation of its popular product line In March, AN achieved over 1,000,000 units in global shipments within 1 month of each launch date. The Mi Band 6 has, aside from its stylish design, some incredible health related functionalities so that users pay measurement of their physical conditions anytime, anywhere. The newly introduced functions include blood oxygen saturation monitoring to measure breathing These functions are powered by our self developed AI based algorithms, auction bids and realist 2, respectively. We are very encouraged by the growth sales results from the Mi Band 6 and at the same time we are also working with Xiaomi one more exciting and Groundbreaking new products. Together with continued strength in our self branded products, We expect a very strong Q2. Leon will provide more details momentarily. We also continued to expand our collaboration with leading research institutes as well as healthcare 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 The Norils project is a registry based, multi center and multiliginal randomized The project will include 12,750 Participants with myocardial inflection across Norway in the next 4 years, Our smartwatches, its heartbeat monitoring and overall health management platform are being used effectively as part of these clinical studies. A few comments on our data analytics business, which is an integral part In expanding our smart health ecosystem, access to more than 42,000,000 active users, Combined with our AI and big data analysis capabilities, as well as our powerful PIE algorithms, allows us to establish a cloud based system that can provide insurers, to make better decisions that promote wellness and expand our business boundaries further in the healthcare industry. In closing, we are looking forward to delivering robust results in the Q2 and powered by the rising demand for our products, Our experts to constantly innovate and enrich our product portfolio As well as the strength from Midland 6, I am confident that as we continue to execute and our strategy of connecting health with technology, we are well positioned to capture new and exciting I will now turn the call over to Leon to go over highlights of our Q1 financial results. Thank you, Wang. As I did last quarter, I want to focus on highlighting what I think a handful of 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 ZEP 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 ziphealth 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 a 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 American countries, COVID spread and restrictions continued to have an impact on our business in the Q1. Also affecting The quarter in China subsidies and exemptions from social insurance contributions ended, impacting our costs. As is often the case, timing of new product introductions in this quarter for Xiaomi impacted the quarter. Xiaomi product revenue was down 40% year over year in the Q1, largely driven by the anticipation of the introduction of the Mi Band 6 in the Q2. The reviews have been positive and expectations for shipping Mi Band 6 factors into our strong guidance for Q2. Q1 demonstrated continued strength of our high end products, the premium GT Series that sales in the $180 to $200 range comprised 48% of our smartwatch and band unit shipments in the quarter. The sales of BIPOP 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 ZEP 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. Q1 2021 gross margin stayed at the same 22.5 percent 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 Depp branded products varied over the last 5 quarters between 1.5 times to more than double the margin on products built for Xiaomi. That trend continued in the Q1. 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 Q3 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 Q3. Q1 2021 total operating expenses was up year over year, reflecting our investments in new products 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 critically timed investments that paid off in future quarters. With that in mind, 1st quarter R and 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 ZEP branded products. R and D, sales and marketing and G and A costs were all down sequentially either from the Q3 2020 high point or from the Q4. We reported a net loss for the Q1 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 Q1 with a 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 used to compete the minority stake acquisition in Jiangsu Yitong High-tech Company 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 Q2 2021, management currently expects net revenues to be between RMB1.7 billion and RMB1 point of 8,000,000,000. That range projects a growth rate of 50% to 58% year over year from the 20 22nd 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, please go ahead. The first question comes from Clive Cheung at Credit Suisse. Thank you, management, for taking my question. I think my Largely based on the OpEx structure, which obviously Leon already explained, but I just want to get a bit more color. Obviously, in terms of structure, it made up 27% of total revenue. This is, I think, a historical high for the company. So in terms of this kind of level of intensity, for example, in R and D, Is this a once off? What do we see what should we expect for the rest of the year in terms of OpEx planning. Can you share a little bit on that? Thank you. Yes, Clive, I mean, let me take this question. If you look at the absolute amount of OpEx Starting from Q3 2020, I think we're hovering around $380,000,000 to Q4 around 310,000,000 And then to Q1 at $308,000,000 if those are numbers which I remember, if those are correct. So from absolute amount perspective, the OpEx number kept on trending down over 3 quarters' time, right? But OPEX, there's a fixed and variable portion of it. What we are seeing in Q1 is largely a seasonality issue, if you may, right? Because the revenue, if you look at last year Q3, Q4, it was around RMB2 1,000,000,000 range. And then in Q1 this year, it's actually around RMB1.1 billion. So yes, From OPEC as a percentage of sales perspective, Q1 looks really high. But as the sales It's going to trend up in the upcoming quarters. We believe that this percentage OpEx as a percentage of sales is going to go down big time in the upcoming quarters. And if you look at the absolute amount, I think the OpEx amount is going to hover around the same level of Q1 or even lower than Q1. I hope that answers your question. Yes, that does. And I think I want to follow-up particularly on R and D. Obviously, we know we're investing a lot in kind of the Healthcare Technology. So do we have a budget for the full year in 2021? Yes. I think from as a percentage of sales perspective, R and D, There's a seasonality, as I just mentioned, right? But overall, I think you can look at the R and D as a percentage of sales Very much similar to what we spent in year 2020. And obviously, we just mentioned we don't want to stop any Time critical investments, which we believe that in the future we can reap more benefits on that. The next question is from Andre Yoon at Citi. Thank you for taking my question. And given you have a RMB1.7 billion to RMB1.8 billion revenue guidance, could you share with us some of The breakdown between Mi Band as well as your cell phone products or any guidance on the unit growth? 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 trends 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 $1,000,000,000 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 being 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, we are self branded products actually stands roughly 70% of the total 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 has been very good. I think we achieved 1,000,000 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 is 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. Understood. Thank you. And could you share a bit on the rough breakdown or on the shipment You need growth so that we can have a fair feeling on the gross margin implications. Thank you. I think that so Q1 this year, if you look at Xiaomi and self branded, it's 70% self branded and 30% Xiaomi. I think for Q4, probably you're going to be looking at 50% to 60% Xiaomi and the rest will be self branded. So that also applies to the 2nd quarter revenue? Yes. So if you look at 2nd quarter revenue, I'm saying Xiaomi will be stands for 50% to 60% of what we guided for Q2 and the rest will be self branded. The next question comes from Michelle Zhang at China Renaissance. Thank you, management, for taking my question. So I'd like to understand about like the GM guidance for both Xiaomi and the Michel, we never guide IGM 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, it has been always been 1.5x to 2x the Xiaomi product margin, right? And you know the Xiaomi product margin We have disclosed before it's in the 15% to 17% range of I think it's around that range, right? So going forward, And 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's start 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. Okay. Thank you. And my second question is about like your revenue break like in terms of your geography and also your online, offline distribution channel? I beg your pardon? Yes. My second question is about your sales breakdown in terms of like your Geography and also the proportion of your online and offline distribution, also the trend going forward. Okay, okay. Thank you. So now, so Xiaomi, it's a business, it's In our book, it's actually business to business for us, right? So I think Putting Xiaomi aside, if you look at the self branded products, so here I'm only talking about the self branded products, right? Europe is actually our biggest market and then I think follows by China, U. S. And the rest of the world, right? And as you know that there's certain restrictions and lockdowns in Europe and that So we were hampered a little bit by the sales or the offline channel sales in Europe, Right. And that also applies to many of the many parts of the world where we operate. So to answer your second part of the question, at this moment, majority of the self branded products are selling through the online channel, But we expect that as the COVID is abating in, for example, United States and also We see a good trend in Europe because the lockdown has been relaxed to a certain extent. We believe that the offline channel Sales will also play a bigger role in the second half of this year. The next question comes from Arceo Ench. Okay. At this time, there are no further questions. Okay. 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 Sap Health's Conference has now concluded. Thank you for attending today's presentation. You may now disconnect.