Zepp Health Corporation (NYSE:ZEPP) Q3 2024 Earnings Call Transcript

Zepp Health Corporation (NYSE:ZEPP) Q3 2024 Earnings Call Transcript November 19, 2024

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

Zepp’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. Wayne Wang Huang. Please go ahead.

Wayne Wang Huang: Hello, everyone. Welcome, and thank you for joining our call. Despite a slowdown in discretionary consumer spending across the globe, we sustained our sales momentum through the focused execution of our strategic transformation in the third quarter of 2024. I am pleased to share that this quarter marked our highest sequential growth in Amazfit product sales for the year. Furthermore, this marks the third consecutive quarter of overall company’s sales expansion with self-branded sales increasing by 10% quarter-over-quarter and contributing more than 95% of the company’s total revenue. Thanks to a better mix of products with higher gross margins, we also hit the highest gross margin in our history. These achievements signal that the most challenging phase of our transformation is now behind us.

And we are optimistic about maintaining this momentum into the upcoming quarters. Our commitment to product innovation remains central to our growth strategy as demonstrated by the market’s positive reception of our recent launches, especially the newly introduced Amazfit T-Rex 3, which we launched at IFA Berlin in September. It is a rugged smartwatch tailored for modern explorers. It features advanced GPS accuracy, extended battery life of fly map for snowing the weather, enriched outdoor features and extensive health monitoring, idea for users who seek resilience and high performance in extreme environments. The T-Rex 3 launch was met with robust demand, selling out in multiple locations, encouraged by excellent reviews from consumers and KOLs. This success showcases the product design as well as the effectiveness of our expanding sales channels in reaching a broader audience.

However, due to its strong-than-expected popularity across various markets, we are currently experiencing some supply constraints, which has had a negative impact on our top line in Q3. Our team is working tirelessly to resolve this, and we expect the situation to improve in Q4. Turning to complementing devices like the Amazfit Helio Ring and newly introduced Amazfit UP Open Wearable Stereo earbuds. This not only extended our product ecosystem, but also further enhanced the user experience. Amazfit UP earbuds when paired with an Amazfit smartwatch provide users with real-time workout updates then Zepp can interact with voice assistance using the AI-powered Zepp Flow functionality. They also use AI algorithms to reduce background noise during calls, improving sound clarity in noisy environments.

The showcase product, Amazfit UP earbuds is paving the way for us to tap into a market with a 20% year-over-year growth. And we have already received some early positive feedback, especially in the Europe region. The Amazfit smartwatches as well as the earbud and Helio Ring provide a 24-hour health tracking ecosystem for wellness-focused users. Beyond new product launches, our core products like Balance and Active have seen continued popularity and growth in demand. These advancements reflect our position as a leader in fitness-focused technology and further establish Amazfit as a trusted name in wearable innovation. Technological innovation remains a core driver at Zepp Health, empowering us to push boundaries in wearable technology. Our latest Zepp OS 4.0 is an advanced operating system that integrates OpenAI’s GPT 4, making our Amazfit smartwatches more intuitive and responsive with upgrades in language processing and an array of health-focused mini apps.

Zepp OS 4.0 turns our devices into comprehensive wellness companions, providing users with a richer, more personalized experience. Recently, we also enhanced our redesigned Zepp App. This latest version of the app is designed to deliver a better wellness experience, empowering users worldwide to understand their health trend and make informed lifestyle decisions. The app has been updated with a more user-friendly and newly streamlined interface and comprehensive features. Users can view top scores on their home page and dive deeper into their fitness subsequent more in-depth pages. Enhanced smart analytics offers real-time data analysis and personalized health recommendations with actionable insights, including Zepp Aura sleep music, meditation support and AI sleep assistance, along with Zepp Coach for general workout guidance.

For example, exertion and health and heart health monitoring includes a dynamic exertion score that adapts on a daily basis to guide users towards optimal fitness with targeted workout recommendations. Furthermore, the heart health dashboard provides a comprehensive overview of cardiovascular metrics like heart rate, HRV and blood oxygen to effectively support the users’ heart health. Moreover, we recently partnered with Wild.AI to integrate its wellness app into Amazfit smartwatches. This collaboration offers women personalized health insights, including checking their menstrual cycle, delivering a uniquely effective on watch experience regarding female health. On the marketing front, we are expanding our Amazfit athlete team. In addition to those announced previously, we recently partnered with e Bea Gonzalez, a top Padel player from Spain, Hunter and Meg, U.S. Hyrox Champion, and [Indiscernible], a renowned outdoor adventurer.

These partnerships are helping us build brand recognition among sports insurances and strengthen our brand image. The positive reception of our T-Rex 3 reflects the success of these campaigns and the strong market response. Moreover, in Q3, we partnered with HYROX for the World Series of Fitness Racing in Chicago, Dublin and Beijing, exemplifying our innovation focus. As the official wearable and timekeeping partner, we have integrated a dedicated HYROX app that offers athletes key health metrics tailored to HYROX endurance challenges, enabling real-time performance monitoring, we are the only smart watch that can offer this functionality. By embedding our wearable into the HYROX experience, we are supporting athletes at all levels and reinforcing Amazfit’s presence in competitive fitness.

In conclusion, our third quarter results and ongoing transformation highlights the strength of our strategic focus on technology, product innovation and expanding international visibility. Looking ahead, we are focused on broadening our global footprint and diversifying our product offerings to meet evolving customer needs by tailoring our market entry strategies to local consumer preferences and forging strategic partnerships, we aim to strengthen our global influence and drive international sales growth. In addition, we are exploring opportunities to expand our product lines beyond traditional wearables. Recognizing the increasing consumer demand for comprehensive health and fitness solutions, we are investing in the development of integrated health platform that combines hardware, software and services.

This strategic direction aligns with industry trends towards personalized wellness and preventative health care, positioning us to capitalize on new market opportunities. This quarter, we also expanded our buyback program from the next 24 months, reflecting our confidence in our long-term strategy, and we look forward to delivering more to all of our stakeholders. 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 third quarter financial results.

Leon Cheng Deng: Thank you, Wang, and greetings to everyone. I would like to start by highlighting some of the key metrics from the third quarter before diving further into the financial results. Self-branded products revenue grew 10% over previous quarter to USD 40 million, primarily driven by ASP growth of 44%. Q3 gross margin reached 41%, the highest in our history. Despite this directionally positive Q3 developments, the operating results in the third quarter somewhat fall short of our expectations as we navigate global macroeconomic headwinds impact consumer discretionary spending, the supply constraints on our newly launched T-Rex 3 model and competition offering larger-than-usual discounts to acquire users. However, we’re cautiously optimistic to see that, according to Canalys, smart wearable market is growing and especially faster in the outdoor and sports segment.

We believe our product road map positions us to participate in these growth areas and more. At the same time, in order to better position us to participate in the growth of the market, as a profitable company in 2025 and beyond, we continue to take aggressive approach to reduce our operating expenses significantly. To date, we have brought down our overall operating expenses from around RMB 180 million in 2022 to around RBM 100 million per year by the end of 2024. To be clear, we’re not cutting our way into profitability. We are continuing on our journey to operate in a leaner, more focused manner that we believe will be sustainable and strategic for long-term success and improved financial performance. We want to do so while pursuing a product roadmap we believe will drive innovation, differentiation and growth, demonstrated by our new product launches such as T-Rex 3, the OWS earbuds and many more.

Once again, according to third-party market research firms, the global wearable technology market is projected to grow from USD 70 billion in 2024 to USD 150 billion by 2029, with a CAGR of 16.8%. Canalys data also shows that product segment priced under $200 represented 40% of the market in 2022, rising to around 60% by 2024. This data indicates a rapidly expanding market with strong growth potential for wearable technology that we’re placed in. As we move through the next quarter, we are better positioned than ever to capitalize on emerging opportunities and drive shareholder value through sustained growth and profitability. Echoing Wang’s statements, we believe the most challenging phase of our transformation is behind us. Overall sales for the third quarter come in line with the low end of the guidance range.

We saw a 10% increase in self-branded sales versus Q2, marking the strongest quarter-on-quarter growth this year. At the same time, the decline in year-on-year sales compared with last year was driven by a few key factors: reduced Xiaomi product sales plays a role, but also supply constraints on long lead time components from our newly launched T-Rex 3 product line. However, new product launches, notably the T-Rex 3 and the increasing popularity of our mainstream products such as Balance and Active as well as our Smart greens drove the sales growth from Q2 to Q3. Looking ahead to Q4, we anticipate much higher sales of self-branded products. Turning to gross margin, which can be influenced by various factors such as product mix, product launch timing and product life cycles, including model upgrades.

In Q3, our gross margin continues the expansion trend, which begins in Q3 of last year, marking the highest gross margin in our history and reflecting our ongoing focus on building profitability. This success is driven by the higher gross margins of our self-branded products, thanks to a favorable product mix, a higher portion of new products and reduced clearance activities. Together with the new product launches in the pipeline, we’re confident to continue on this margin expansion journey into the next quarters. Now let’s turn to costs. We remained steadfast in our commitment to cost management, continuing with the program which we began in Q3 2020 on reducing overall operating costs. Our overall operating costs for the quarter stood at USD 29 million, which includes a foreign exchange loss of USD 1 million due to a sharp RMB to dollar exchange rate appreciation, which we couldn’t fully hedged.

Excluding this, our operating costs were USD 28 million, just below RMB 200 million threshold and in line with our previous guidance. Research and development expenses in the third quarter of 2024 were USD 10.6 million, an increase by 11.7% year-over-year. This accounted for 24.9% of revenue compared to 11.4% for the same period in 2023. The increase was a result from our investment in new technologies, including AI, to maintain our competition edge against our peers. At the same time, we focused on refined research and development approaches as we consistently evaluated resource efficiency to ensure maximum return on investment and productivity. Selling and marketing expenses in the third quarter were USD 11.9 million, an increase by 23.9% year-over-year.

This accounted for 27.9% of the revenue compared to 11.5% for the same period in 2023. The increase was primarily as a result of the investments in marketing campaigns for newly launched products to boost our brand awareness. At the same time, we consistently pushed on retail profitability and channel mix improvement, which included meticulous refinement of our retail channels and strategic staffing arrangements across the regions. We are committed to investing efficiently in marketing and branding to ensure our sustained growth. G&A expenses were USD 6.7 million in the third quarter of 2024, an increased by 14.7% year-over-year. This accounted for 15.7% of revenue compared with 7% in the same period in 2023. The increase was largely attributed to negative foreign exchange rate fluctuations.

Normalizing this FX impact, G&A expense has a year-over-year decline of 18%. Despite reporting an operating loss this quarter, largely attributed to cost coverage issues, our performance showed an improvement throughout the year. Stripping off the foreign exchange result in the previous quarters, we’re on track to improve the financial profitability of the company sequentially and narrow the loss further in the third quarter of 2024. Looking ahead, we’ll continue to adhere to our prudent cost management approach, and we expect cost levels to remain at their current level or lower. At the same time, we’ll maintain our investment in R&D and marketing activities to sustain our long-term capabilities while strictly controlling discretionary spending.

Now turning to the balance sheet. We maintained effective working capital management, delivering an inventory level within a relatively low level since Q2 2019. We’ll continue to exercise tight inventory controls in the coming quarters. Our overall cash balance stands at USD 128 million, the same level as Q2 despite a loss. This provides us with ample runway to invest and seize potential market opportunities. Starting Q1 2023, we have initiated the retirement of our short/long-term debt portfolio. Since then, and including Q3 2024, we have successfully retired USD 52 million of debt. As our operating cash flow continues to strengthen, we’ll continue to optimize the capital structure for the company. As part of our commitment to deliver long-term value for the shareholders, we will continue our share buyback program throughout 2026.

I’m also pleased to share that we have regained compliance with the NYSE in October, reinforcing our market standing. Looking ahead to the fourth quarter, we’re guiding revenue in the range of USD 55 million to USD 70 million, with the self-branded products expected to contribute over 90% of our revenue base, representing a 29% to 65% growth for revenue compared to the third quarter of 2024. To conclude, our focus on delivering profitable growth remains steadfast, and we are confident in our ability to build on the ongoing momentum demonstrated during this quarter and in the quarters to come. Thank you once again for your time and continued support. I will now open the line for any questions. Operator, please go ahead.

Q&A Session

Operator: The first question today comes from Sid Rajeev from Fundamental Research Corp.

Sid Rajeev: You’re expecting a major spike in revenue in Q4. I realize that the T-Rex 3 will be a major contributor. But could you please provide some more details on other avenues or other products where you expect real growth?

Leon Cheng Deng: This is Leon. Yes, you might hear from our prepared remarks that T-Rex 3, we kind of experienced a supply constraint in Q3 because the product itself is a good product and then it’s, to some extent, comparable to the Garmin Fenix 8. And then it’s actually the demand of that is shooting to the roof whereby we cannot produce that much. But we are working day and night to actually resolve the supply constraints, which we had on T-Rex 3. So hopefully, in Q4, you will see an increase of the sales level for T-Rex 3 because of that. So I think that is actually one of the levers for our Q4 sales spike. And on top of that, you also heard that we launched the OWS earbuds, which is actually an open ear system, which allows you to exercise better while you can still hear the ambulance environment some.

It’s actually a very good companion for the smart watch. And actually, we are providing a one-stop shop to the consumers who want to have a good understanding of their health and well-being with the help of smart watches, the OWS earbuds and also our Helio Ring, the Smart Ring, right? So we are actually providing consumers a comprehensive solution, which also contributes to the higher sales you’re going to see in Q4. And then not to mention, Q4 is traditionally the best selling season for us, not — in China, you have the — just finished Double 11 event, whereby our T-Rex 3 stand out in every single board on the outdoor and sports watch segment. And then in Europe, you have the Prime Day 2, and we’re heading into the Black Friday and the Christmas sales.

So we’re actually quite confident on delivering the Q4 number. And also, we’re actually shooting for an even higher number than what we put forward over there.

Sid Rajeev: Thank you, Leon. Where exactly is the bottleneck in terms of the supply constraints?

Leon Cheng Deng: Sorry Sid, I missed you for…

Sid Rajeev: Where exactly is the bottleneck in terms of the supply constraints? The supply constraints you mentioned?

Leon Cheng Deng: Yes. The supply constraints, it’s the following. I think it’s not — it’s more a demand issue than a supply issue, right? So I think we have encountered a spike in the demand of the T-Rex 3, whereby on the other hand, we didn’t anticipate that demand to come in, not in that volume because, to be honest, the T-Rex 3 is not a cheap product, it’s MSRP $300 product, right? So we do prepare some stock for it. But then with the spike in the demand, we couldn’t satisfy that demand, which is coming from all over the world. But as we’re heading into Q4, the factories are running 24/7 to produce as many T-Rex 3 as they can. So I think that will be one of the key levers for the sales increase in Q4 for us.

Sid Rajeev: Okay. And you reported a ForEx loss this year, this quarter, when historically, you’ve been reporting gains. What really happened? And how do you expect this ForEx to play a role in the next quarter?

Leon Cheng Deng: Yes. We have a few currency pairs, all of which U.S. and Euros are one of the major currencies and also the U.S. dollars to RMB is another pair because we procure a lot in China and so are the other consumer electronics companies. And you might notice or you might know that RMB to dollars actually appreciate a huge time in the last 15 days of the quarter in Q3. No matter how you can hedge it, you can never hedge it in full, right? And then throughout the year, if you look at it, every quarter, we have a so-called tailwind on the currency and then that flipped into a headwind for us in Q3. But as we are navigating through it and then with the recent currency movement, we’re also expecting a tailwind in Q4. And so I think net-net, if you strip out the FX fluctuations and you compare the numbers without FX number or the FX impact for every single quarter in this year, you will notice that our profitability, albeit the loss has narrowed to its lowest level in Q3.

So I think we’re more having a cost coverage issue, which we’re working and we expect it to resolve it very soon as we’re heading into Q4.

Sid Rajeev: Just one more question, if I may. Your cash position, you’re sitting on a lot of cash, $128 million. Market cap is a third of that. So obviously, in terms of how you plan to deploy this cash M&A? Or what can we think you might do in the coming 12 months, 24 months?

Leon Cheng Deng: I think we’re – I’m not going to rule out on small bolt-on M&As. But I think one of the bigger thing, and we’re continuing to do that is the share repurchase program, which we initiated two years ago. And actually, we’re going to extend this program by another two years. So I think for sure, you will see that we’re going to be more aggressive in buying back our shares. And secondly, we’re going to look at how to deploy the cash and how to use that cash to drive and seize the marketing opportunities when it arises so that we are better positioned in this competition versus our competitors.

Operator: The next question comes from Nicolas Jones from Brooks Investment.

Nicolas Jones: I have several questions. But firstly, I’d like to start off with some sort of a better understanding on the Q3 net loss situation. Could you provide some more color around that? And how does that compare to previous quarters as well as to last year?

Leon Cheng Deng: Nicolas, this is Leon. So I guess I will take this question again. So yes, so as I said, and then I also kind of alluded to it with Sid is that there are a few issues in Q3. Number one is that we have the supply constraints on the newly launched product, which is T3. So the T-Rex 3, if you look at it, one month of sales because we launched it only in September, it is already higher than the previous generation T-Rex for a quarter of sales. So that actually gives you a feeling on how popular this product is and how successful this product is. So I think that sits a lot on our product innovation capabilities and our ability to develop and to give the best functionality product to the users. But we cannot manufacture them enough in Q3 so that there’s demand we couldn’t satisfy and we need to actually pull it into Q4.

But that also explains why we’re confident on delivering a higher sales quarter for Q4. So I think that’s number one, which also impact on the revenue expectations for Q3, which leads to a cost coverage issue for us in Q3. So that’s — I think that’s the first thing I would like to call out. And the second thing, I just mentioned is that we have experienced an FX headwind in Q3, while we — for the other quarters of the year, we had a tailwind. I think in Q4, the FX is going to swing into a tailwind again for us so that the negative FX impact is not going to hit us that hard like it was in Q3. And then the third one is that we also front-loaded some of the marketing expenses. Wang mentioned higher-ups and there’s also athletes which we signed up in Q3, which are preparing us for better brand awareness and also for the high seasons as we’re heading into Q4.

So I think all those 3 things, i.e., the supply constraints, the front-loaded on the expenses, the negative FX impact, impacted us in Q3. And if you strip out the negative FX impact, what I just posted, and you do an apple-to-apple comparison, I think Q3, from a profitability perspective, we are actually heading into the lowest loss situation in the year. And with the revenue start to pick up in Q4, we’re confident that we’re going to turn this wheel very fast, and it’s just upcoming on the horizon.

Nicolas Jones: That sounds great. And you’ve also given a lot of details around the Q4 sales. I suppose looking further ahead, can you give some sort of indication about how sustainable the expected growth in sales?

Leon Cheng Deng: Yes. I think that’s a good question. I’m not going to jump the gun here, but I can give you some feeling and flavor on it. So number one, I think T-Rex stands out as a very successful product. And actually, it would be account for a big part of our revenue for Q4 and going into Q1 and Q2, right? And then apart from T-Rex, and we are also – as you may notice that we didn’t launch too many new products this year. So majority of our product portfolio is up for renewal, for example, the Bip series, the Active series and the Balance series for next year. So – and this year, I’m more referring to 2025, we’re going to have a more balanced new product launch window and cadence versus 2 years ago, whereby everything is concentrated into Q4 and then you kind of have a spike and then it stays up, right?

So now we’re going to have, for example, a product – one significant product review of one of our Bip product line in a quarter, i.e., probably a renewal of the Active series in Q1, the Bip series in Q2 or the Balance in Q3, something like that. The sequence might change. But I think with that, and plus the successful launch of T-Rex 3, we’re quite confident that next year, every quarter, the revenue will be much bigger than what you saw this year.

Operator: As there are no further questions, now I’d like to turn the call back over to the 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. You can now — this now concludes the call. Thank you.

Operator: The conference has now concluded. Thank you for attending. You can now disconnect your lines.