Zepp Health Corporation: FY2020 Form 20-F Summary
Business context and reporting period
Zepp Health Corporation, formerly Huami Corporation, filed its annual report for the fiscal year ended December 31, 2020. The filing does not provide a standalone fourth-quarter income statement or cash flow statement; the available financial data are annual FY2020 results. The company develops, manufactures and sells smart wearable devices, including Xiaomi-branded products and its Amazfit and Zepp self-branded products, primarily through PRC subsidiaries and consolidated variable interest entities.
The company shipped approximately 45.7 million smart wearable devices in 2020, including approximately 41.0 million Xiaomi devices and 4.7 million self-branded devices. It reported 38.0 million mobile-app monthly active users and 214.5 million registered users at year-end.
Financial performance and key metrics
| Metric | FY2019 | FY2020 | Change |
|---|---|---|---|
| Revenue | RMB5,812.3 million | RMB6,433.4 million | +10.7% |
| Gross profit | RMB1,467.7 million | RMB1,332.7 million | -9.2% |
| Gross margin | 25.3% | 20.7% | -4.6 percentage points |
| Operating income | RMB606.5 million | RMB174.2 million | -71.3% |
| Operating margin | 10.4% | 2.7% | -7.7 percentage points |
| Net income | RMB573.4 million | RMB229.7 million | -59.9% |
| Net income attributable to Zepp | RMB575.2 million | RMB228.8 million | -60.2% |
| Basic earnings per ordinary share | RMB2.35 | RMB0.92 | Decrease |
| Diluted earnings per ordinary share | RMB2.24 | RMB0.88 | Decrease |
Revenue from Xiaomi Wearable Products increased 5.8% to RMB4,438.1 million, representing 69.0% of total revenue. Revenue from self-branded products and others increased 23.3% to RMB1,995.3 million, or 31.0% of revenue. Segment gross margins were 16.5% for Xiaomi products and 30.1% for self-branded products.
| Expense or balance-sheet metric | FY2019 / 2019 year-end | FY2020 / 2020 year-end |
|---|---|---|
| Research and development expense | RMB430.8 million | RMB538.0 million |
| General and administrative expense | RMB248.5 million | RMB261.8 million |
| Selling and marketing expense | RMB182.0 million | RMB358.7 million |
| Cash and cash equivalents | RMB1,803.1 million | RMB2,273.3 million |
| Cash, cash equivalents and restricted cash | RMB1,804.0 million | RMB2,275.8 million |
| Inventories | RMB893.8 million | RMB1,217.5 million |
| Total liabilities | RMB2,677.2 million | RMB3,173.5 million |
| Short-term bank borrowings | None reported | RMB504.7 million |
| Long-term borrowing | None reported | RMB60.0 million |
Operating cash flow declined from RMB428.0 million to RMB157.3 million. Investing cash outflow increased from RMB112.7 million to RMB206.9 million, while financing cash inflow increased to RMB564.7 million, primarily because the company borrowed RMB1,207.8 million and repaid RMB643.1 million of bank borrowings. Capital expenditures were RMB84.8 million, compared with RMB46.1 million in 2019.
Management stated that cash and anticipated operating cash flow should be sufficient for current and anticipated needs for at least the next 12 months. However, 84.6% of cash, cash equivalents and restricted cash was held in China, and 57.6% was held by the consolidated VIEs. Access to VIE assets depends on contractual arrangements and applicable PRC regulations.
Material changes versus the prior comparable period
- Revenue grew, but cost of revenue increased faster than revenue, primarily because of higher unit costs for newly introduced Xiaomi products and changes in self-branded product mix.
- Gross margin contracted from 25.3% to 20.7%, and Xiaomi segment gross margin fell from 21.4% to 16.5%.
- Research and development expense increased 24.9%, reflecting personnel additions and expanded product-development activities.
- Selling and marketing expense nearly doubled, increasing 97.1%, as the company invested in global expansion of Amazfit and Zepp products.
- Operating income and net income fell sharply despite revenue growth.
- Inventory increased 36.2% to RMB1,217.5 million, contributing to working-capital usage. Management reported RMB4.4 million of inventory provision and RMB59.9 million of inventory write-offs during 2020.
- Related-party amounts due from Xiaomi and affiliates declined from RMB1,418.6 million to RMB833.2 million at year-end; the filing states that amounts due from Xiaomi at each year-end were collected in the following first quarter.
- The company acquired PAI Health in June 2020 and acquired an insurance brokerage license through the purchase of Guoxu assets. It also sold a 26.7% interest in Yunding and recognized a RMB56.5 million gain from deconsolidation.
- The strategic cooperation agreement with Xiaomi was extended in October 2020 through October 2023, while Xiaomi remained the exclusive distributor for Xiaomi Wearable Products.
Guidance, outlook, management commentary, risks and unusual items
The filing does not provide quantified FY2021 revenue, earnings or margin guidance. Management expects self-branded products to represent a larger share of revenue and plans continued investment in Amazfit and Zepp branding, international distribution, research and development, healthcare initiatives and data analytics.
- COVID-19: Factory shutdowns and supply-chain disruptions affected production in early 2020. A global resurgence late in the year caused production delays and reduced inventory availability for some new products. Component shortages and longer lead times continued, and management warned that the pandemic could negatively affect 2021 results.
- Xiaomi concentration: Xiaomi-related products represented 69.0% of FY2020 revenue. The relationship can be terminated under specified conditions, including product-quality failures and certain sales-performance shortfalls. Xiaomi also sells competing products and jointly determines pricing for Xiaomi Wearable Products.
- Margin and execution risk: The company faces intense competition, rapidly changing consumer preferences, pricing pressure, product-cycle risk and the need to launch successful new products on time.
- Supply-chain risk: The company outsources manufacturing and relies on limited or single sources for certain components, including chips and sensors.
- Data and regulatory risk: The company collects personal and biometric data and faces evolving PRC, U.S. and European privacy, cybersecurity and medical-device requirements. It received privacy-related rectification notices in 2019 and 2020 and passed the subsequent examination after corrective actions.
- VIE and PRC regulatory risk: Most operations, revenue and assets are held by consolidated VIEs controlled through contractual arrangements rather than direct ownership. Changes in PRC law or enforcement could restrict operations, invalidate arrangements or prevent consolidation.
- Capital allocation: Subsequent to year-end, the company completed a RMB959.7 million acquisition of a 29.99% stake in Jiangsu Yitong High-Tech. It also repaid RMB439.7 million of loans and borrowed approximately RMB990.0 million, including RMB540.0 million intended to fund the Yitong investment.
- Other unusual items: FY2020 included the RMB56.5 million Yunding deconsolidation gain, RMB12.3 million fair-value gain on long-term investments and RMB23.6 million of net other expense. Share-based compensation was RMB65.2 million under the financial-statement notes, while the selected operating-data discussion separately states no founder restricted-share vesting expense.
- Audit and listing risk: The auditor is based in China and was not subject to PCAOB inspection as described in the filing. The company disclosed potential risks under the Holding Foreign Companies Accountable Act, including possible future trading prohibition or delisting.
The filing states that management concluded internal control over financial reporting was effective as of December 31, 2020. The company is an emerging growth company and therefore did not include an auditor attestation report on internal control.
Most important facts for an investor to verify
- Whether the deterioration in gross margin, operating margin and operating cash flow persisted after FY2020 and into the reported fourth quarter or subsequent quarters.
- The sustainability and terms of the Xiaomi relationship, including termination triggers, pricing arrangements, profit sharing and Xiaomi’s competing products.
- Inventory aging, sell-through, write-down exposure and the effect of COVID-19-related component shortages on product availability.
- The amount, maturity, interest rate and security of bank borrowings, including the post-year-end borrowing used for the Yitong investment.
- Whether cash held by VIEs can be transferred to the Cayman Islands holding company when needed, including PRC dividend, foreign-exchange and statutory-reserve restrictions.
- The valuation, integration progress and expected returns from PAI Health, Yunding, other investments and the Yitong acquisition.
- Future privacy, cybersecurity, medical-device and PRC regulatory compliance developments.
- The filing contains an apparent presentation inconsistency: the cover-page checkbox indicates IFRS as the accounting basis, while the selected financial data, audited financial statements and auditor’s report state that the statements are prepared under U.S. GAAP. This should be confirmed against the filed financial statements and SEC record.