Zepp Health Corporation (NYSE:ZEPP) Q2 2024 Earnings Call Transcript

Zepp Health Corporation (NYSE:ZEPP) Q2 2024 Earnings Call Transcript August 22, 2024

Executives: Grace Zhang – Director of Investor Relations Wayne Wang Huang – Chairman and Chief Executive Officer Leon Deng – Chief Financial Officer

Analysts: Sid Rajeev – Fundamental Resource Corp

Operator: Hello, ladies and gentlemen. Thank you for standing by for Zepp Health Corporation’s Second Quarter 2024 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.

Grace Zhang: Hello, everyone. And welcome to Zepp Health Corporation’s second 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. Wayne 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 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 US 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 US 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.

Wayne Wang Huang: Hello, everyone. Welcome and thank you for joining our call. To begin, I would like to provide an update on our strategic transformation. Our second quarter results aligned with expectations with an increase in Amazfit branded product sales and achieving a high gross margin. Despite a year-over-year decline in sales, our net loss for the first half narrowed. With several new products slated for launch in the second half of the year, we firmly believe that the worst time of our transformation is behind us. The progress we have achieved is centered on three key pillars. First, we are investing in new technologies, including AI, to meet the needs of our customers and maintain a competitive advantage against our peers.

Second, we focus on product innovations and profitable growth. We plan to launch our hit products during the upcoming IFA events. In addition, we are enhancing the global visibility of our Amazfit branded products through sponsorship of major sports events and partnerships with renowned athletes to expand our roster of international representatives. Now let’s delve into the three pillars as we witness the transformative impact of AI applications in the industry. According to the latest analyst reports, AI is both enhancing existing use cases and creating new ones, significantly boosting user loyalty. Zepp Health is leveraging AI to transform sports and health experiences. This quarter, we launched Zepp OS 4.0 in integrating OpenAI’s GPT-4 into our Amazfit smartwatches for safer and more useful responses, enhancing their role as wellness companions.

Key features of Zepp OS 4.0 include an upgraded Zepp Flow with intelligent language interactions and new health-focused mini apps. Zepp OS 4 is now available for Amazfit Balance and Amazfit Active, with support for other models coming later in 2024. Moreover, our R&D team has made significant breakthroughs in AI technology using Zepp Flow platform as a foundation. We plan to release a new form of AI hardware within the next six months, making a new chapter in our journey in smart wearable technology. These upcoming releases not only demonstrate our technological strengths, but also highlight our long-term approach to product innovation and market strategy. As we prepare for the upcoming IFA in Berlin, we are excited to introduce several innovative products, including the highly anticipated T-Rex 3 outdoor smartwatch and our new line of Open Wearable Stereo, OWS, earbuds.

In recent years, we have observed a growing demand for comfort in headphone design, which had led to increased interest in open type headphones. Market research indicates that the open headphone segment is poised for substantial growth, presenting a promising opportunity within the Bluetooth headset market. These new offerings will highlight our latest advancements in hardware development. Additionally, I am pleased to announce that the smart chip jointly designed with Whale Microchip [ph], a subsidiary of Jiangsu Yitong, which we invested in 2021, has successfully entered mass production. This state-of-the-art chip will support Zepp OS 4.0 and will be featured in the smartwatches we launch at IFA. In our commitment to innovation, we are thrilled to introduce the Amazfit Helio Ring, our first smart ring, which complements our smartwatch lineup.

Launched at CES 2024, it has received critical acclaim and will soon be available in more countries. The Helio Ring is ideal for those who prefer not to wear watches while sleeping. Pairs seamlessly with Amazfit smartwatches like the Cheetah Pro and T-Rex Ultra for continuous 24/7 health monitoring. It offers advanced recovery insights. And the Zepp app integrates data from both devices, empowering athletes to optimize their performance. With additional sizes, the Helio Ring is expanding to a broader market, driving further sales growth. By integrating smartwatches, rings, and the upcoming OWS earbuds, to launch at IFA, we have crafted a seamless user experience loop, establishing a comparing competitive advantage in bundled sales. We anticipate these offerings will further strengthen our market position and drive growth in the second half of the year.

On the marketing front, around the time of the IFA release, we will announce a major partnership with HYROX in Europe and North America. Moreover, we have expanded our roster of athlete ambassadors. In the second quarter, we welcomed US Olympic medalist Morgan Pearson, Italian national endurance icon, Yemaneberhan Crippa, and Chinese marathon runner Xiao Dong Wu [ph] to our team Amazfit family. These partnerships enhance our presence in the running and endurance sector and demonstrate their performance advantages of our cutting-edge smart wearables. This also will be a significant step in our brand strategy, further enhancing our influence in global markets. These efforts are part of our broader strategy to increase the global visibility of our brand and products.

By aligning with prominent athletes and sports events, we continue to build a strong, recognizable brand identity and create meaningful connections with consumers worldwide. Through those brand and marketing investments, we have solidified our influence in major populous countries such as China, India, and Brazil. Additionally, we achieved a breakthrough in Germany recently, deepened our partnership with Decathlon in France, and steadily improved our global gross margin. In conclusion, our transformation journey highlights the effectiveness of our strategic direction with a strong focus on AI and expanding self-branded products. These efforts, combined with increased brand visibility, position us for sustainable growth. As we head towards IFA in Berlin with new product releases and rising brand awareness, we anticipate continued growth momentum in the second half of the year.

Thank you for your continued support and confidence in Zepp Health. I will now turn the call over to Leon to go over the highlights of our second quarter financial results.

Leon Deng : Thanks, Wayne. Greetings, everyone. Let me walk you through some of the key metrics of our second quarter financial results. Over the past two years, the entire consumer electronics sector has been facing significant challenges. We have observed that the pressure of discretionary spending, especially in an inflationary environment, is also creating headwinds for our operations. Additionally, major brands like Apple and Samsung offered larger-than-usual discounts during the past prime day in certain regions, highlighting the competitiveness of the industry landscape. However, we are cautiously optimistic to see that, according to IDC Research, overall smart wearable market will return to growth in this year, with AI-enabled health insights and GenAI services as the growth drivers.

Our focus has always been on positioning ourselves effectively in the current market. This is why we are prioritizing profitability, aiming to maximize profits from our self-branded product sales, and continuing with the cost transformation initiatives we implemented in previous quarters. It’s also worth highlighting that we entered the smart ring category recently, as it represents a $2 billion plus market that is growing at a high-double-digit rate in the upcoming years. Simultaneously, we’ll be entering into the Open Wearable Stereo earbud segment, which will deliver substantial growth in the Bluetooth headphone market. Now turning to sales, echoing Wayne’s statement, we believe the most challenging phase of our transformation is behind us.

The three key pillars driving our progress are applying new technologies, particularly with a focus on AI, product innovations with profitable growth, and enhancing global visibility through major sports sponsorship and marketing efforts. We are particularly excited about our expanding self-branded product offerings, which position us for long-term growth as a global leader in smart wearables and health care solutions. For the second quarter, our overall sales aligned with our guidance with a 6% sequential increase in our self-branded products more than offset the decline of Xiaomi branded product sales. This positive development is a testament to the progress we have made in our transformation efforts and we anticipate continued sequential growth in the quarters ahead.

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. Despite a year-over-year decline in sales, which were in part due to the timing of new launches skewed towards the second half of 2024 and the broader macro challenges, our gross margin for the quarter reached 40.3%. This marks a continuation of the margin expansion we initiated in the third quarter of 2023 and represents the highest gross margin in our company’s history. Driven primarily by the increased probability of our self-branded products, contributing factors include that improved product mix, a higher proportion of new products, and a reduction of clearance activities.

Looking ahead, together with the new product launches in second half of the year, we are confident that this positive trend in gross margin will persist into the second half of the year, with full year margins expected to remain at similar levels. This outcome underscores our strategic decision to prioritize profitability over scale, leveraging the revenue from our self-branded products to sustain the company’s overperformance. Now, let’s turn to costs. We remain steadfast in our commitment to cost management, continuing with the program which we began in Q3 2020 on reducing overall operating costs. In the second quarter, we maintained a rigorous approach on discretionary spending while investing in research and development activities and marketing expenditures to preserve our long-term sustainable growth.

As a result, operating costs for the quarter were $25.3 million, the lowest level in the past year, and is in line with our previous guidance. Our R&D expenses for the second quarter of 2024 were $10.4 million, reflecting a 13.8% decrease year-over-year. This represented 25.6% of our revenue compared to 13.1% during the same period in 2023. The reduction in R&D spending was a result of our ongoing efforts to optimize resource allocation, ensuring we achieve maximum return on investment and productivity. At the same time, we’re committed to investing in new technologies and suitable AI functions to maintain our competitive edge against our competitors. Selling and marketing expenses for Q2 amounted to $10.5 million, a modest increase of 3.9% year-over-year.

This accounted for 25.8% of our revenue, up from 10.9% in the previous year. The rise was primarily driven by our strategic investments in outdoor marketing and television commercials across Europe, aimed at boosting brand awareness ahead and during the UEFA 2024 and Summer Olympics in Paris. In parallel, we have been enhancing retail profitability and refining our channel mix by carefully optimizing our retail channels and strategically managing our sales teams. We’re committed to making smart investments in marketing and branding initiatives that will fuel our long-term growth. G&A expenses were $4.4 million in Q2, marking a 36.3% decrease year-over-year. These expenses represented 10.9% of our revenue compared to 7.5% in the same period last year.

This reduction reflects our successful personnel optimization initiatives and strict control over discretionary costs. Looking ahead, we remain committed to prudent cost management, aiming to keep costs at or below current levels in the upcoming quarters. Despite reporting the operating loss this quarter, largely attributable to cost coverage issues, when we consider the first half of 2024 as a whole, despite lower sales and thanks to higher gross margin and tightly controlled cost levels, we have narrowed the net income loss by 15% versus the same period last year. Now turning on to balance sheet, we continue to manage our working capital effectively. Our inventory levels at the end of Q2 were lower than Q1, marking the lowest level in the company’s history.

We will maintain this disciplined working capital approach in subsequent quarters. Our cash balance stands at $129 million by the end of Q2, consistent with the first quarter’s cash level, despite the quarterly losses. This strong cash position equips us with the necessary resources to seize potential market opportunities and invest strategically in future growth. In Q1 2023, we have initiated the retirement of our short/long-term debt portfolio. Since then, and including Q2 2024, we have successfully retired $55.2 million of debt. As our operating cash flow continues to strengthen in second half, we will continue to optimize the capital structure for the company. In line with our commitment to deliver long-term value to our shareholders, we’ll proceed with our share buyback program throughout 2024.

This initiative underscores our confidence in the company’s future and our dedication to enhancing shareholders’ value. Looking ahead on the third quarter of 2024, we’re guiding a revenue in the range of $45 million to $60 million. It represents 18% to 59% growth on the revenue of self-branded products compared with actual Q2 2024. We’re confident in our ability to build on the momentum we have generated to drive further growth and profitability in the quarters to come. Thank you once again for your time and continued support. I will now open the line for any questions. Operators, please go ahead.

Q&A Session

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

Sid Rajeev: First of all, great to see the spike in sequential sales growth of self-branded units. But I guess the real surprise was the continued improvement in gross margins. What’s really driving this? Is it higher product prices, cost optimization or something else? I know you gave some reasons. I was trying to find out what exactly or what’s the main reason for this increase. And the second thing is with new product launches, can you bring it up to the 45% to 50% range?

Leon Deng: Let me start with the easy ones. As you heard from Wayne’s script, we have a lot of exciting new product launches lined up for the upcoming month, especially in IFA. You heard about the OWS earbuds. You heard about the new T-Rex watches, and you also heard about the ring. And we also have some exciting innovations on the way. And all of these products will carry a very healthy gross margin to the magnitude of over 45% or 50%, depends on the product line we’re talking about. So these are the new product launches, which is due for the second half of this year. Coming back to your first question, that’s also one of the reasons which drives the gross margin of the company, continuously improved quarter on quarter for the past four quarters.

I think to a big part, this is coming from optimizing the product mix. But also, it’s like I said, more new products, which has been launched recently, less products which is on clearance. That definitely helps our overall gross margin performance. On the other hand, we’re also doing retail channel mix. For example, we cut the bleeders on those channels, which doesn’t make money. And by doing so, through optimizing the retail channel mix as well as our product mixes, together with the new product launches, which is lined up in the second half of the year, we’re confident that we can continue on the gross margin improvement trend for the upcoming quarters.

Sid Rajeev: My next question is, you have a lot of new products planned. So to make it easier for us to track, are you able to give us a number, as in how many new products or updated products planned this year versus last year?

Leon Deng: I think we have at least three, if not four, products which are scheduled to be launched in the second half of the year. And last year, same period, I think we have two products, if I remember clearly.

Sid Rajeev: The first half of this year, you had two, right?

Leon Deng: No, the first half of this year, we only had one. You can count one and a half because we launched the Bip 5 Unity which is a different variable of the Bip 5.

Sid Rajeev: I know you don’t provide segmental revenue by region, but did you notice any material change in sales in any region, particularly, last quarter?

Leon Deng: No, I think we have told you before that United States still remains as a region whereby we see a lot of potential growth from. And also, we have seen some breakthroughs in Europe, like what Wayne mentioned in Germany and France. And we have worked with the key accounts such as Decathlon in those countries. And in Asia Pacific, specifically in China, we have seen a very good growth from China, and we have put in a lot of marketing efforts to promote that as well.

Sid Rajeev: Just one question finally. Could you provide an update on the status with NYSE given the non-compliance notice you received a few months back?

Leon Deng: We have ultimately until October 31st to rectify this issue. And as we have communicated before, we are committed to resolve this through either organically the share price to push above $1 or, if needed, a reverse split. So we’re confident that before that date, we’ll be regaining the compliance.

Operator: The next question comes from Nicolette Jones [ph] with Brooks Investments [ph].

Unidentified Participant: I just have two questions. I’d also like to just dig in a little bit more about the new product map and some of your thinking behind your product decisions. And then in addition, I’d like to find out more information on the net income trend.

Leon Deng: Maybe I take the easy ones, Nicolette. Obviously, the net income trend, you have noticed that it has been on uptrend. Quarter on quarter, it’s improving. If you look at the first half of this year, the net income obviously is much better than the same period of last year. I think it was an improvement of 15%, to that magnitude. And we are actually looking or targeting at improvement also for a second half of this year. So hopefully, throughout the year, we can come back to profitability. That’s always the target which we have been striving for. And coming back to your first question on the new products and the thinking behind it, I think you have heard us saying that in the upcoming IFA, which is in September, we’re going to launch a new watch.

Our most popular outdoor smartwatch, T-Rex, is up for an update. Actually, a lot of new functionalities will be added to that watch. And we are also going to launch a new OWS earbuds. OWS is a very popular concept. It’s basically talking about open-end headset, which you can wear without feeling it. It’s very different from the AirPods, which is made by Apple. And according to the market research, the OWS earbuds is going to be a fast growing segment in the Bluetooth headset market in the upcoming years. So, we are quite excited to have that product add to our lineup. And you also heard that we have the Helio Ring, and we’re going to put Helio Ring into more geographies and also into more sizes, especially the smaller sizes, which are more tailored for the mass market and mass consumers.

So I think we are going to be one of the only players, if not the only players, who have the smartphone coupled with the ring coupled with the OWS headphones and maybe some other form factors, because we have always been saying that we’re trying to offer a full suite of wearable devices, smart wearable devices, so that our users can have a one-stop shop on better controlling and understand their health conditions. So I think this is always the concept what we try to bring this company to. So we want to be smart wearable player not only restricted to smart watch, per se, and we want to offer a complete suite of health care services to the users. So that’s the whole theme behind the new products which we are going to launch. I’m not sure if I answered your question correctly or…?

Unidentified Participant: No, that’s really informative actually. It’s much more color.

Operator: As there are no further questions, I’d like to turn the call back over to the company’s IR director, Grace Zhang, for any closing remarks. Thank you once again for joining us today. If you have further questions, please feel free to contact Zepp Health investor relations department through the contact information provided on our IR website. Thank you.

Operator: The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.