Zepp Health Corporation (NYSE:ZEPP) Q2 2023 Earnings Call Transcript

Zepp Health Corporation (NYSE:ZEPP) Q2 2023 Earnings Call Transcript August 21, 2023

Operator: Hello, ladies and gentlemen. Thank you for standing by for Zepp Health Corporation’s Second Quarter 2023 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 second quarter 2023 earnings conference call. The company’s financial and operating results were issued in our 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. Participating in today’s call are Mr. Wang Huang our Chairman of the Board of Directors and Chief Executive Officer; and Mr. Leon Cheng 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 the Q&A session.

Before we continue, please note that today’s discussion will contain forward-looking statements made 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 are included in the company’s annual report on Form 20-F for the fiscal year ended December 31, 2022, and other filings as filed with 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 GAAP earnings press release and this conference call includes 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 to Zepp Health’s second quarter 2023 earnings conference call. In the second quarter, we maintained our momentum through the successful execution of our strategic transformation. This shift in works moving away from a business model heavily relied on a single customer for the majority of our revenues and in fact establishing ourselves as a self-reliant global smart wearable and health care solution provider. While Mi Band sales were heavily affected by the overall smart-brand market decline, our self-branded products continue to gain traction during the quarter generating 12.7% higher revenues quarter-over-quarter and contributing to apposite rate 70% of our top line. In this transformative space, we have come to recognize that enhancing our revenue streams quality is paramount.

Our strategy has undergone refinement, centering around the utilization of our self-branded product sales to effectively offset the company’s fixed costs. This transition marks a deliberate from the pursuit of sheer growth to the steadfast commitment to attain – attaining profitability. Notably, this shift in approach has been particularly successful in the Chinese and Indian markets, where we have converted our earth vile love insurer incurring ventures into sources of profit. This strategic focus is aimed to improve our gross margin and ultimately steer us back towards sustained profitability. We have refined our product mix and strategically streamline our sales channels. As a result, our overall gross margin has surged to 22% compared to 17.9% at the same period last year.

This achievement most the highest level we have attained since the second quarter of 2021 even in the face of several total revenues year-over-year and margin pressure seeing from Xiaomi products. Our ROI-driven strategies, spending the supply chain, R&D, product development and marketing has significantly posed our brand image within the premium smart valuable device market. These initiatives have not only elevated our brand influence and garnered increased consumer recognition but have also optimized our cost efficiencies. As a result, our products and services have experienced heightened adoption across various global regions. This growth is particularly evidenced in the high-end product segment, where we offer a comparing value proposition delivering premium features and a more accessible price point than our competitors’ premium offerings.

This is especially true in the North American market, where we capped our market position in terms of market value in the top 5 for smart watches according to NPD with an increased gross margin. We continue to enrich our offerings to adjust the preferences of our customers. On June 21, we unveiled a Amazfit Cheetah, our first smartwatch series dedicated to runners featuring a light weight design for runners. It can optimize the users running experience with industry-leading GPS technologies to deliver enhanced positioning, accuracy and upgraded AI-powered coaching to generate personalized training plans. Leveraging last language model and generative AI technologies, we also rolled out an AI chat feature in the Amazfit Cheetah to facilitate to coach to act interactions for users.

Additionally, we have also been striving to refresh users experience and better meet their fitness and lifestyle needs through firmware updates. On July 10, we released a major update for our popular Amazfit T-Rex 2, which added support for cadence sensors, upgraded [waterproof] such as surfing, kitesurfing and the newly added wake surfing, as well as the long-awaited Zepp Coach feature allowing users to enjoy their favorite summertime activities with our AI-powered training guidance. We have enhanced our entry-level product line by introducing the new Bid Fast, featuring and expensive 1.91 inch ultra large display. With the inclusion of cutting-edge for satellite positioning system, this device empowers users with accurate location tracking and locking a comprehensive range of possibilities, the Bid Fast supports over 120 sports models complemented by intelligent recognition technology.

Moreover, it comes with monitoring capabilities on 24-hours bitrate at pO2 levels and stress levels, ensuring a holistic view of our users well-being. Additionally, we are planning to build several new products in the second half and are excited about how their advanced features can help more users better manage their health. We will save the details for their upcoming product launches, please stay tuned. Our commitment to enhancing our offerings for users through application of cutting-edge technologies across our products, services and business is built into our DNA. As our AI-powered, Zepp Coach is providing more interactive, informative and customized training experience to our users through products like Amazfit Falcon, Amazfit T-Rex, [indiscernible] and now Amazfit T-Rex 2 as well as Amazfit Cheetah.

We are also integrating GPT technology into our several development process to enhance our R&D efficiency. We believe these will inventory benefit users as they will enjoy premium products and services at a low cost while also contributing to our bottom line games. Lastly, and to share that [indiscernible] renowned [indiscernible] and better for Amazfit Cheetah product. In Latin Macias a San Francisco Marathon from July 21 to 23, where it demonstrated the exceptional functionalities of our premium learning smartwatch. This partnership has introduced Amazfit to more running in services and showcased our ability to craft leading products, helping amplify our reputation as a premium smartwatch manufacturer across the international sports community.

Looking ahead, we remain optimistic about our company’s prospects as the market continues to present huge post-pandemic opportunities. According to IDC, global smartwatch shipments are forecast to increase from 157.3 million in 2023 to 206.2 million in 2027. This CAGR of 6.8% despite the challenging macroeconomy. As we hone our value proposition with AI-powered products and services to provide the industry’s tailwind, we expect our self-branded products to continue to grow. We will continue to optimize our inventory levels and preventing control cases, while maintaining our competitive edge and building long-term product pipeline through targeted investment in R&D and marketing. Departed by our vertical integrated supply chain and efficient platform-based R&D, we are confident that these efforts will forecast margin expansion and a prompt return to profitability ultimately, filling our growth and business success.

Thank you again for joining us today. I will now turn the call over to Leon to go over the highlights of our second quarter financial results.

Leon Cheng Deng: Thank you, Wang. Greetings, everyone, and thank you for joining our earnings call today. I would like to review some of the key metrics from our financial results the second quarter of 2023. In the second quarter, the consumer electronics categories that we participate in remains challenged by factors such as foreign exchange headwinds and persistently subdued consumer spending power, among others. The conditions have not yet returned to what we could consider normal and we continue to see unprecedented levels of discounting by our competitors. We saw a reduction in channel inventory in the first half of the year, consistent with our expectation for activations to outpace selling, and we expect this to continue through the third quarter particularly in Europe and Asia Pacific, where retailers continue to tighten up.

As for underlying demand, strength in the Americas helped offset the impact of the tough economic climate in Europe and Asia Pacific. Despite this, our brand and product portfolio continued to perform well. Our second quarter revenue amounted to RMB 648.3 million within the expected guidance range for a decline of 41.5% year-over-year, primarily attributed to lower Xiaomi sales. During the quarter, our revenue generated from Xiaomi-branded products declined by 67.2%, largely influenced by market deterioration in smart bands category, while our self-branded products experienced a 7% decrease mainly due to limited new product introductions during the quarter. Moving on to our gross margin, which can be influenced by various factors such as product mix, product launch timing, and product life cycles, including model upgrades.

As we continue to make our ROI oriented approach to optimize our product and sales channel portfolio, the gross margin for our self-branded products remained healthy. Despite a slight decrease in revenue for our Amazfit brand, we are delighted to report a remarkable 51% year-over-year expansion on our Amazfit brand gross margin. This significant growth has played a crucial role in driving our overall Q2 gross margin to an impressive 22%. Notably, this is the highest level we have achieved since Q2, 2021, even withstanding a year-over-year decline of 42% in Xiaomi products gross margin during the quarter. This outstanding performance speaks volumes about the strength and resilience of our Amazfit brand. Despite the market challenges we faced, our dedication to delivering high quality products and optimizing our operations that yield exceptional results.

We’re confident that with this positive momentum, alongside new product introductions planned for the second half of the year, as well as the moderated level of clearance activity, we should be able to expand the gross margin of our company even further. Now let’s look at costs, as we have always mentioned in our past earning calls, controlling costs remains as a top priority for the company both in terms of their absolute amount and as a percentage of sales. Since Q3, 2020, we have been pleased to see a downward trend in total operating expenses while we’re still making strategic investments in new products technologies and footprint expansions to fuel our long-term growth. In Q2 2023, we delivered on our quarterly run rate target and successfully managed to reduce our adjusted operating costs to RMB204 million, the lowest level since Q2, 2019.

Our second quarter R&D expenses were RMB84.7 million lowered by 31.4% year-over-year set to enhanced efficiency driven by our platform based R&D strategy. However, as a percentage of sales, R&D costs still remain at a relatively high level, demonstrating our commitment to further building our product strength, and our long- term competitive edge. As we continue to prune our retail channels to maximize returns on every penny we spend our selling and marketing expenses declined by 33.9% year-over-year, reaching RMB70.7 million. However, as a percentage of sales were at 10.9% versus 9.7% in the second quarter of last year. We’ll continue to invest strategically in our brand, adopting a ROI-based marketing strategy to ensure our ongoing growth and success.

Second quarter G&A expenses were RMB48.9 million down by 25.9% year-over-year, benefiting from our effective cost control measures. Looking ahead, we will persist with our prudent stance on towards costs and expect cost levels to maintain at current levels or lower in the upcoming quarters, while investing responsibly, and with great discipline to fuel our business growth. With our enhanced gross margin and carefully managed costs, our non-GAAP net loss has narrowed to RMB59.2 million in Q2. Despite facing a cost coverage issue in Q2, I’m delighted to share that we’re optimistic about returning to profitability in Q3, 2023. Now turning to the balance sheet, cash and cash equivalents restricted cash and term deposits as of June 30, 2023, totaled RMB10 billion providing ample runway for us to invest and capitalize on potential marketing opportunities.

Efficient working capital management remains a priority for us. In Q2, we reduced our inventory to RMB743 million nearly at the lowest level in several quarters. We’ll persist in carefully managing inventory levels in order to optimize our operations. Despite a modest P&L loss in Q2, we sustained positive operating cash flow for the fourth consecutive quarter. We utilized this to reduce our debt levels, and will continue to do so in coming quarters. Now turning to our share repurchase program. To recap in November 2021, the Board authorized the allocation of up to US$20 million towards our buyback program. By the end of June 30, 2023, we had repurchased shares worth US$11.7 million and we intended to carry out with this buyback program in Q3 reflecting our confidence in the company’s future, and underscoring our commitment in delivering long-term value to our shareholders.

Regarding our outlook for Q3, we expect our net revenue to range from RMB600 million to RMB800 million. We anticipate that the trend of quarter-over-quarter growth in self-branded product sales revenue will continue positioning us to achieve higher overall gross margin and return to profitability. Please note that this outlook reflects ongoing, uncertainties around lower discretionary consumer spending, especially in our key markets, and global macroeconomics weakness. In conclusion, despite the challenges, we faced during the second quarter, we’re proud of significant strides we made in enhancing our self-branded product sales, improving gross margin, and implementing efficient cost management efforts. In our continued forecast – with our continued focus on expanding our product margin, and carefully managing our inventory levels and operating costs as well as upcoming new product launches.

We remain confident that we’re on the right track to continue to deliver value for customers, and investors over the long-term. There’s no doubt in my mind that we will emerge from this challenging period as a stronger company that creates substantial shareholder value. With that, I will now open the call for any questions you may have. Operator, please go ahead. Thank you.

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Q&A Session

Operator: Thank you. [Operator Instructions] The first question comes from Nicolette Jones with [Brooks] Investments. Please go ahead.

Unidentified Analyst: Hi. And thank you management for taking my questions. I had three questions. Firstly, could you give, some more details on the expected profitability in Q3 and Q4? And then, secondly, what do you see as the margin trend in Q3 and Q4? And then finally, could you provide some more details on the new products in the second half of the year? Thank you.

Leon Cheng Deng: Thank you. I think I would, I would start with the easy questions on the new project launches and I will go into the gross margin and profitability questions in a bit. So, if you look at the new product launches, where we have I mean, Wang mentioned that in his script as well, we launched, quite a few new products in July/August time take, for example, the big five watch, which is actually our value segment a mainstream product line. And then, we are actually going to launch our latest flagship products, our famous GT series and bear with me I think, we’re going to have new names for that in the coming days which we are going to launch in Berlin as well. And then, also we will launch a few new products, which are the new versions of our famous Mini and the GT Sports range in the second half of the year.

So we do have many new product launches, as we mentioned in our script in the second half of the year, especially in September, October frame, which is on the way, right? Related to that, I think that would naturally brings me to the margin trend for Q3 and Q4. I think as you can see, and we also mentioned in our Q2 numbers that we see a clear jump in our self-branded products, the Amazfit brand margin increasing in Q2, and we see this continuing into Q3 and Q4. So I think in the previous calls, I have alluded to a rule-of-thumb number that our gross margin for our self-branded products is in the range of around 30% in – for our self-branded products. And I think given the new product launches, which we have under way, we see this number would further improve in Q3 and Q4.

And then coming to the profitability questions you have, I believe that’s your first question. We are reporting a narrower loss so be it that we have — we still have a loss in Q2 this year. But you can see that we are clearly making progress on, number one, on the gross margin, we actually returned to the highest level in past three years on the gross margin percentage, which is 22%. It’s not a small number per se. But as I just mentioned, we expect this number to further improve in the upcoming quarters to more go into the 30th of May. And on the other hand, we also managed to cut our operating costs from a run rate of $300 million per quarter to $200 million a quarter. And we’re also going to be very prudent on how we manage the cost. Number one, we should not sacrifice the future growth of the company.

Number two, we are actually benefiting from the AI from the push on using the ChatGPT alike AI models in our day-to-day work and also the platforming approach in our R&D development process to actually – to do more or less the same or even more as what we did before with a lower spending level, which we have demonstrated in the past quarters. So with a higher gross margin overall on the company and a lower run rate on the cost, I think we’re heading towards this breakeven point, which we also alluded in our prepared script that we are very confident that in Q3, our transformation journey from what our CEO, Wang just mentioned, that we will very much reliant on a big – single big customer sales to a company whereby we should be able to justify our profitability based on a majority of our self-branded product sales, that type of company, right?

And we see that is happening – going to happen in Q3. And then given the high seasonality of Q4, and I don’t want to jump the gun here too much. But I think we are relatively confident that we should be able to return profitability starting from Q3, which is next quarter.

Unidentified Analyst: Thank you.

Operator: [Operator Instructions] The next question comes from [Lisa Lee with Elsa Research]. Please go ahead.

Unidentified Analyst: Hi. Thank you, management for taking my questions. I also have three questions. The first one is on overseas market. Can you share more color about the situation in overseas? And what are you seeing in July and August? What do you think about the trend for the remainder of the year? And the second one is on potential new partnerships for Zepp Health. Any specific directions you’re considering? And last one is your relationship with Xiaomi and what’s your forecast of Xiaomi’s products going forward? Thank you.

Leon Cheng Deng: Okay. Thank you, Lisa. So, very good questions. So let me also start it with your third question on the Xiaomi relationship. I think Xiaomi, stands at where – the so called, we started from the so called Xiaomi ecosystem company. But I think over the time, this term has changed, for a lot of companies, but we still have very good relationship with Xiaomi. So number one, Xiaomi remains as the one of the biggest shareholders of our company. Number two, we still have the wearables cooperation with Xiaomi, on various product categories, and that is not changing for us. However, you, also noticed that we have embarked on a transformation journey, from changing the company from a reliance on one single big customer type of a situation.