Zepp Health Corporation (NYSE:ZEPP) Q1 2024 Earnings Call Transcript

Zepp Health Corporation (NYSE:ZEPP) Q1 2024 Earnings Call Transcript May 21, 2024

Operator: Hello, ladies and gentlemen. Thank you for standing by for Zepp Health Corporation’s First Quarter 2024 Earnings Conference Call. [Operator Instructions] 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 Zhang: Hello everyone, and welcome to Zepp Health Corporation’s first quarter 2024 earnings conference call. The company’s financial and operating results were issued in a press release via the Newswire services earlier today and are posted online. You can also view the earnings press release and slides referred to on this call by visiting the IR Section of the company’s website at ir.zepp.com. Participating in today’s call are Mr. Wang Huang, 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 the 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 are included in the company’s annual report on Form 20-F for the fiscal year ended December 31, 2023, 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.

That 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 over to our CEO, Mr. Wang Huang. Please go ahead.

Wang Huang: Hello everyone, welcome and thank you for joining our call. Before delving into this quarter’s performance, I would like to recap our transformation journey and set stage for the year ahead. As we are shifting focus to self-branded products and diversifying our offerings today, our self-branded product sales contributed over 85% of total revenue. Our gross margin has nearly doubled over the past 2 years, with recent quarter showing 37% compared to 16% Q1 2023. Notably, the MAU of our Zepp application is over 10 million, making an early success in our transformation journey. Within our self-branded smartwatch category, we offer a diverse range of series tailored to various market needs. These include the Lifestyle series in featuring product lines such as Balance and Active.

The Adventure series encompassing product lines like T-Rex. The Performance series encompassing products such as Cheetah and Falcon. And lastly, the Essential series housing popular product lines like Bip and Band. Each of these series is strategically positioned with clear competitors and price range in mind. This strategic alignment enables us to compete effectively as a key player in the smart wearables market offering our customers a comprehensive suite of solutions tailored to their diverse needs. As we are heading into 2024 and 2025, to continue on our transformation journey towards a self-reliant company driven mainly by its self-branded product sales, we are adopting our product strategy at the same time. Today, I would like to draw your attention to a few of key elements being, to begin with, our flagship Balance model within the Lifestyle series has solidified a strong market share in the price range of $200 to $249 smartwatches in Europe and U.S. markets, marking a $50 increase from the original GT series $199 price point.

Although our price is increased, we noticed that many customers have switched from brands such as Samsung and Apple for the unique features of Balance. We are also delighted to observe that the Balance model has not only gained popularity among consumers, but has also received high praise from key opinion leaders on social media platforms demonstrated our cutting-edge product capabilities. Our customers are particularly impressed by the long battery life and the sleek attractive industry design of our watches. We were the pioneer in the smartwatch industry to incorporate large language model AI technology for handling interactions and responding to user messages. This is positioning us well ahead of our competitors. Our product differentiation and artificial intelligence has led consumers to recognize our product value at a high price band, which has built strong product momentum in the market.

This gives us an opportunity to realize an exponential growth in our revenue in the upcoming peak seasons through our marketing activities. In the first quarter, we show a considerable escalation in our brand visibility and outreach. Our dynamic digital marketing campaigns, including out-of-home advertisements in Magic Apple and sponsoring the recent Rotterdam Marathon has significantly expanded our audience reach, bolstering our market presence and driving our future sales. Next, our Active product line within the Lifestyle series has shown significant growth potential as well. It is an upgrade and continuation of our bestselling $99 Mini product line enhanced by Zepp Aura and Zepp Fitness health services along with the Zepp watch faces and apps ecosystem.

This innovation has delivered significant value to our users enabling us to position the product lines to achieve a $129 selling price and generate better gross margins. More recently, on May 2, we unveiled the new Amazfit Bip 5 unit within the Essential series through the stainless-steel appearance and bigger screen, we have brought many user favorite software functions from our mid-to-high-end Active and Balance product lines to Unity and brought richer apps and watch faces through Zepp OS 3.0 to Unity, strengthening our sub $100 market competitiveness and further expand our market share in markets such as India, Spain and South America. Our proprietary operating system, Zepp OS has been upgraded to version 3.5, integrating the large language model-based Zepp Flow AI system.

This brings large language model AI interaction and messaging capabilities to our entire product line, a unique functionality not available in other brands’ smartwatches. This has established our brand’s image as an innovator in the consumer electronics market. Together, we serve continuously over the air upgrade of the software used in our smartwatches. It greatly improves the competitiveness of our smartwatches. As I have mentioned in previous quarters, the rapid application and innovation of large language model AI technology provides us our smartwatches products with opportunities to surpass competitors, showcasing our company’s execution and creativity and preparing for new opportunities in the smart wearable market. During April, the fishing and running features on the Amazfit Falcon, T-Rex Ultra and Cheetah Pro received significant enhancements, enabling users to enjoy the prime season for fishing and running.

At the same time, we updated our operating system to AI powered Zepp OS 3.5 across different hardware platforms. All these updates are part of our commitment to providing personalized and advanced health support, empowering users to manage their well-being effectively. We will soon apply this AI capability to our sports and outdoor smartwatches within the Performance and Adventure series, bringing innovative experience to athletes and outdoor enthusiasts and significantly boosting the competitiveness and differentiation of our sports and outdoor product lines. Before this summer’s sports season arrive, we will launch advertisements in major global markets in to amplify our market presence. We will also collaborate with major global channels like the Decathlon, bringing our innovative full range products to users during this summer’s sports crazy to increase our sales for second half the year.

We have many exciting new products in the pipeline for the upcoming months, so stay tuned. Now turning to our exciting new innovative product line, the Helio Ring. Our smart ring represents a significant expansion of our user experience, allowing users who prefer not to wear watches while sleeping to obtain 24-hour comprehensive health data monitoring. This enhances recovery for athletes and provides readiness analysis for general users, ensuring a holistic user experience with both smartwatches and smart rings. This marks the beginning of a new era in the market, with us being the first smartwatch brand to offer such a solution, placing us ahead of competitors. Last but not the least, after several years of organizational transformation and streamlining our operations, our company has becoming more global with about 90% of revenue generated from outside China.

Our co-executives include myself, now oversee operations from offices based in Europe and North America, enabling swift decision making in response to market dynamics and to be more attuned to consumer and market demands. The diversity within our team and the globalization of our R&D and marketing efforts have empowered us to develop, sell, and market our products with greater speed and precision. We believe this consumer-centered approach will set us aside in longer run. Through the above-mentioned building blocks, we realize enhanced returns on our product sales, translating into elevated growth margins for the company. While we keep our overall operating costs in check, this financial fortification facilitates increased sales and profitability for our self-branded products.

And this will bring sustained profitability through self-branded products in the future. However, the ongoing transaction of the business is indeed longer and sometimes harder than our initial expectation. And patience is needed. However, we remain optimistic about our strategic direction on both our sales and marketing strategy and upcoming products. Our emphasis on cutting-edge products and operational excellence, combined with expanding our global reach and offering innovative and diverse products and services to our vibrant user community, prepares us for longer-term sustainable growth. We are confident this strategy will accept Zepp as a leading healthy growth self-reliant global smart wearable and healthcare solution provider in time.

I will now turn the call over to Leon to go over the highlights of our first quarter financial results.

Leon Deng: Thank you, Wayne Huang. Greetings, everyone. Thank you for joining our earnings call. I would like to start by discussing some of the key metrics from the first quarter before diving further into the financial results. In the past quarters, we have been making healthy investments in innovation and our investments remain focused on 2 things. With the first one on attracting new customers, and the second one on getting our existing customers to upgrade/adding more products to better themselves. There are 3 things I would like to highlight. First is to echo what Wayne just mentioned, that we launched the Helio Ring in our U.S. markets, and by mid-June, we’ll expand into other markets, and with a variation of the ring, which is tailored to the mass market.

This launch gave us a foothold into a new multi-billion-dollar category, which grows at a CAGR of 30% towards 2028, expanding the number of categories we play in and further diversifying ourselves. This has been a multi-year investment, and we expect it to pay off in space in Q3 and beyond. The second is increasing the brand awareness through more above-the-line marketing activities in Europe and USA to drive sales through. Most recently, we have the out-of-the-home advertising in Madrid International Airport in Spain, and there will be more TV commercials in Europe’s main sports channels coming up as we head into the EuroCup and the Summer Olympics. More consumers will get to know us, and we have seen some early data points on the conversion rates improving.

Last but not the least, this quarter we experimented some stimulating additional product sales in our in-store base by delivering limited time coupons/gift cards to some of our most loyal long tenured customers. We have always trying to explore how we can better use our unique data and insights to deliver more personalized experiences for our customers. The outcome of the promotion surpassed our expectations, affirming the value of our continuous investments in advancing data systems to effectively leverage and maximize our data resources. The strategy of offering both new and existing products to our current customer base presents a lucrative revenue potential. This instills confidence in the success of our upcoming product launch in new categories and strengthens our belief in our capacity to expand and elevate this business in the future.

I want to emphasize that we remain steadfast in concentrating on what is within our control. We are embarking on a multi-year product cycle where we will reap the rewards of our research and development efforts to attract new customers and increase sales to our current customer base. We are strategically positioning the company to enhance our growth trajectory while managing expenses effectively to achieve margin expansion in the upcoming years. Now turning to our first quarter 2024 sales performance, which broadly aligned with our guidance. Several factors influenced the decline in sales. Firstly, the seasonal patterns typically in our consumer-driven sector during Q1. Secondly, the ongoing decrease in Xiaomi product sales. And thirdly, the absence of any new product launches during Q1 2024, unlike the first quarter of 2023, when for instance, we introduced the new GTR Mini.

Moving on to gross margin, which can be influenced by various factors, such as product mix, product launch timing, and product life cycles, including model upgrades. As [Wayne] has highlighted, the company’s gross margin continued its impressive performance in the first quarter. At a robust 37%, our first quarter gross margin marks a new historical high, representing a sequential increase from the previous quarters achieved in third and fourth quarter of 2023. This growth in gross margin is predominantly attributable to the higher profitability of our self-branded products, as well as a more favorable product mix, including a higher proportion of new products and lower levels of clearance. Looking ahead, together with new product launches planned for the following quarters of 2024, we anticipate this positive trajectory to persist into Q2 and throughout 2024.

Now, let’s turn our attention to costs. As we have discussed, cost management remains as a critical area of forecasts for our company, both in terms of their absolute amount and as a percentage of sales. Hence, we continue to exercise disciplined control over our expenses during the quarter. Since Q3 2020, we have consistently reduced our overall operating costs while strategically investing in innovative products and technologies as well as geographical expansion. As a result, adjusted operating expenses for Q1 2024 were USD 28 million, decreased 11.4% compared with Q1 2023. Adjusted R&D expenses in the first quarter of 2024 were USD 12.4 million, a decrease of 15.4% year-over-year. This comprised 31.2% of the revenue. The decrease was primarily attributed to our refined R&D strategies as we consistently assess resources efficiently to maximize return on investment and productivity.

Also, we integrated an AI-based R&D platform to improve our efficiency. At the same time, we’re committed to investing in new technologies and suitable AI functions to maintain our competitive edge against our competitors. Our adjusted selling and marketing expenses for Q1 2024 were USD 10.5 million, down 10.9% year-over-year, and accounted for 26.3% of total revenue. The reduction in amount was mainly due to our ongoing efforts to improve profitability and refine our sales channel mix. Furthermore, we initiated out-of-home campaign in Madrid and sponsored the Rotterdam Marathon, actions that will contribute significantly to bolstering our brand presence, particularly among our target consumers. We are committed to making smart investments in marketing and branding activities that will fuel our longer growth.

Our adjusted G&A expenses in Q1 2024 were USD 5.3 million, lowered by 1.5% year-over-year, owing to disciplined cost-control initiatives. We have maintained a prudent approach with the overall adjusted operating costs at or below $28 million, consistent with Q3 and Q4 2023 levels and in line with our guidance. Looking ahead, we remain committed to cost management, anticipating that costs will stay at their current levels or lower in the coming quarters. We continue to invest in R&D activities and marketing expenses to bolster our long-term competitiveness while closely scrutinizing discretionary spending. We have a loss in our operating results in the first quarter, primarily due to seasonal driven cost coverage issues. This performance represents an improvement over 2023 Q1.

Adjusted loss narrowed by 20.4% versus Q1 2023. Now, turning to the balance sheet, at March 31, 2024, our overall cash balance stands at USD 132.3 million, providing us ample runway to invest and capitalize on potential market opportunities. On the working capital management front, we remain steadfast in our commitment to practicing disciplined working capital management. Despite the P&L loss, we have achieved positive operating cash flow for the seventh consecutive quarter. In Q1 2023, we have initiated the retirement of portions of our short/long-term debt portfolio. Since then, and including Q1 2024, we have successfully retired USD 46.7 million of debt. As our operating cash flow continues to strengthen, we intend to do more in the coming quarters.

In keeping with our commitment to delivering long-term value to our shareholders, we’ll continue our buyback program throughout 2024. In conclusion, while we face some challenges in Q1, our focus on optimizing our revenue structure, reducing our reliance on a single customer, expanding our self-branded products, and diversifying our product offering positions, as well to become a self-reliant global smart wearable and healthcare solution provider, driving our long-term sustainable growth. In Q2 2024, we anticipate revenue to range between USD 40 million to USD 55 million, with an uptick quarter-over-quarter expected in sales on our self-branded products. We’ll continue the stock repurchase program to demonstrate the confidence of our strategy.

Thank you once again for your time. I would now like to open the call for any questions. Operator, please go ahead.

Q&A Session

Operator: [Operator Instructions] Your first question comes from Sid Rajeev with Fundamental Research Corp.

Sid Rajeev: Pleased to see the growth in gross profit and improvement in EPS. I have a few questions. You’re expecting growth in full year revenue from self-branded units with results back and loaded. But Leon just mentioned that you might see an uptick in revenue in Q2, but just to give — I was wondering if you could give more color. Would we see self-branded units softer in Q2, Q3, and a spike in Q4? Or you would start seeing improvement earlier on?

Leon Deng: Now, let me take this question. So I think, you would — normally our business follows a seasonal pattern whereby Q1 is always the lowest in the year for us. And then from Q2 onwards, the business will start to recover. And Q3 and Q4 are traditionally the high seasons for us. So you will see uptick of the revenue in Q2. That’s why we also guided the higher range than Q1. And then the — I think, you will see a material increase of the revenue starting from Q3 and Q4 because number one, this also head into the traditional high seasons for Europe and USA. And also, it couples with our new product launch window which is also around the June, July, all the way towards the September months.

Sid Rajeev: Since you don’t provide segmented revenue, I was wondering if you could give or if you’re able to share the top 2 revenue generating product lines? And what percent of revenue do they contribute?

Leon Deng: I think majority, as [Wayne] just mentioned, so we have a few different theories which covers different type of products ranges where we play, right? I think, if you are thinking about the biggest revenue contributor, it’s definitely the Essential products ranges, which are the Bips and the Band, which are also from a quantity perspective, the best-selling product series for us, right? That should account for around 40% of the total revenue base for ourselves. And then the next one to it would be the Balance and the Active line, which are in essence our Samsung and Apple competitors. These are the — also the biggest portion of our revenue where it’s coming from. And I think Wayne just mentioned we were able to increase the ASP of these products by roughly USD 30 to USD 50 on average over the past 1 year and 1.5 year period.

And these part of the product sales would account for roughly another 30% to 40% of our total revenue. And the remainder, 20% to 30%, actually goes to our so-called Performance and Adventure theories, which are the running watches, for example, the Cheetah Pro, and also our outdoor ranges, the famous T-Rex ones. So these are also our very high ASP product ranges, which we use to compete with, for example, the Apple Watch Ultra and the Garmin Watches. So I think that overall should give you some feeling of our product mix.

Sid Rajeev: How about geographical distribution? I think last year, you had 25% of revenue from North America. Europe accounted for 50%. Is it similar? Or has it screwed more to North America?

Leon Deng: I think at this moment, if you look at Q1, that still is the case. Europe stands for 50%, Asia Pacific and North America stands for another 50% in general. But we do see growth potential in Asia Pacific and U.S. coming up this year. Although, I think, the impact of that you will see more clearly towards the second half of the year. That’s why we say also our result is a little bit back-end loaded. We do see probably we’re going to fortify Europe and then the growth will be more coming from Asia Pacific and North America.

Sid Rajeev: Just one question. Any updates on the non-compliance letter from the NYSE? I know you’re doing your buybacks. Of course, you have the reverse split that you can do anytime and resolve this issue. Anything else that you have in the pipeline? Any updates?

Leon Deng: No, I think the only thing which I can say is that the non-compliance letter is just a technical thing. And as you just mentioned, there’s definitely technical ways which can resolve that. But the management where I’m representing is actually very confident in maintaining our U.S. main Board listing status. So I think this is a thing which we also mentioned in our press release that we will try to tackle that in time.

Operator: Your next question comes from [Nicolette Jones] with Brookfield Investments.

Unidentified Analyst: I have a number of questions. So I’d like to start off firstly, regarding the high gross margin levels, can management provide insights into whether these margins are sustainable in the upcoming quarters?

Leon Deng: Yes, Nicolette. So yes, let me take this question because it’s about the gross margin, right? So what you can see is that starting from Q3 2023, our gross margin for the overall company has been consistently above the line of 30%. So if I remember clearly, Q3 2023, our gross margin was 33%, and then it turned up to 35% in Q4 2023, and then now we stand at around 37% in Q1 2024. So we have shown 3 quarters of a gross margin improvement trend because of our transformation journey which is more focusing on the self-branded products. And, of course, there’s a product mix issue. There’s also a channel mix issue, which allow us to actually delivering higher than what we achieved in the previous years on the gross margin percentage as a sales.

So if you look at Q1 2024, our gross margin is at 37%. That is more than doubly the gross margin performance which we achieved in Q1 2023 last year, right? And we’re confident that through the new product launches which we have lined up, in the upcoming months. We also launched a few new products in May, right? And also in June, there’s going to be also new products, as we mentioned in the presentation earlier, all the way towards Q3, Q4, together with the new product launches. And you know that new product launches actually cover or offer a higher gross margin both from an absolute amount perspective, also from a percentage perspective than the old ranges. So that’s why we say it actually gives us the confidence that together with the new product launches, and our consistent effort in refining our product mix and channel mix, we’re confident that our gross margin percentage is going to expand in the quarters to come.

Unidentified Analyst: So moving on, given that the start of 2024 was slower than expected, could the management share more color on your perspective for the full year outlook?

Leon Deng: Yes. Normally we don’t guide for our full year performance and also our revenue number, but I think what we’re looking at is that, yes, it’s a slow start for Q1 and we hope that we’re going to — and you already see in the guidance that we actually guide a little bit higher for Q2. And then, as I just explained to Sid, in Q3, Q4, normally these are our high seasons. So last year, full year, if I remember clearly, our total revenue actually stands at around $350 million for the full year. So I think this year we’re also looking at a range somewhere between $200 million to $300 million for our top-line. So we — and we’re looking at doing our best to actually turning, because we have told you and others that we — the ultimate goal which we would like to achieve is to actually sustain the company’s probability through the self-branded product sales, right? So actually, we hope by the end of this year, we’re going to deliver on that target.

Unidentified Analyst: Again, referring to a question that Sid asked, I’d like to understand more about the recent non-compliance notice on the New York Stock Exchange due to the trading price of your ADS is falling below the required threshold. Could you elaborate on the steps that Zepp is planning to take during the cure period to regain compliance?

Leon Deng: Yes.

Unidentified Analyst: And are you considering a reverse share split or other options?

Leon Deng: Yes. I think I have already explained it quite clearly to Sid. We believe that this is a technical thing and there’s a technical solution to it. And the company and the management is actually working very hard on resolving that. And we don’t think that’s going to be any issue per se. And our commitment to continuing with the U.S. main Board listing status is there. So I think we are very confident that during the cure period, we’re going to resolve this matter.

Unidentified Analyst: And then now moving on to new developments with the Helio Ring. Could you elaborate on its updates regarding product features and sales volumes?

Leon Deng: Yes, so I think Helio Ring obviously is a new form factor of the wearable devices, which we launched — we actually announced this product in CES beginning of this year. And by May, we start shipping the product. So we’re still at the earlier stage of ramping up the sales as we go. And I also mentioned before that we’re going to launch this product in Europe and Asia Pacific regions in the coming month as well. So what you will see is that we should be able to start shipping this rate in volume more towards the end of June, and then potentially this one could slip into July, which is going to be Q3 sales. We do have high hopes on this product because the Helio Ring because of the form factor, because a lot of people don’t like to sleep with a watch, right?

They don’t like the feeling of something which is on their wrist, but wearing a ring would give you or would resolve that issue and still allow you to actually monitor your vitals 24/7. So during the day, you can wear the watch and the ring. And we also offer infusion functionalities that both data would combine and merge and become more accurate. And then at night, if you are not wearing your watch, you can just do with only the ring. So we’ll be the only smartwatch brand who is going to offer that solution, couples the ring, and the watch together. So basically, you’re actually getting into a one stop shop to monitoring your vitals to take care of your health and actually, to get a readiness analysis through our app. So actually, more and more, we would like to actually provide this type of new innovative products to the consumers so they can actually better control and prevent any issues of their health in the future.

Unidentified Analyst: I have just one last question for management. Could you clarify if the reported MAUs of 10 million include users from your Xiaomi collaborations?

Leon Deng: No. So this number, the 10 million which has been mentioned by Wayne in before was only talking about the MAUs for our Amazfit branded so which is our self-branded product. And including Xiaomi, that would add another 20 to 25 million to it. So basically, our total MAU at this moment for the company is actually around 30 to 35 million users MAU.

Operator: As there are no further questions, now I’d like to turn the call back over to company’s IR Director, Grace Zhang, for closing remarks.

Grace Zhang: Thank you once again for joining us today. If you have further questions, please feel free to contact Zepp’s Investor Relations Department through the contact information provided on our IR website. This concludes this conference call. You may now disconnect your line. Thank you.