Earnings Call Transcript - ZEPP Q1 2024

Operator, Operator

Hello, ladies and gentlemen. Thank you for joining Zepp Health Corporation's First Quarter 2024 Earnings Conference Call. 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 proceed, Grace.

Grace Yujia Zhang, Director of Investor Relations

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. 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 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. Wayne Wang Huang. Please go ahead.

Wayne Wang Huang, CEO

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 the 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 the recent quarter showing 37% compared to 16% in Q1 2023. Notably, the MAU of our Zepp application is over 10 million, marking 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 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 ranges 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 head into 2024 and 2025, to continue 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 key elements. 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 has 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, demonstrating our cutting-edge product capabilities. Our customers are particularly impressed by the long battery life and the sleek attractive industrial design of our watches. We were the pioneers in the smartwatch industry to incorporate large language model AI technology for handling interactions and responding to user messages. This positions us well ahead of our competitors. Our product differentiation in artificial intelligence has led consumers to recognize our product value at a higher price band, which has built strong product momentum in the market. This gives us an opportunity to realize exponential growth in our revenue in the upcoming peak seasons through our marketing activities. In the first quarter, we witnessed 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, have 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 enriched our apps and watch faces through Zepp OS 3.0 to Unity, strengthening our sub-$100 market competitiveness and further expanding 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 provide continuous over-the-air upgrades of the software used in our smartwatches, greatly improving the competitiveness of our products. As I have mentioned in previous quarters, the rapid application and innovation of large language model AI technology provides our smartwatch 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 experiences 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 arrives, we will launch advertisements in major global markets to amplify our market presence. We will also collaborate with major global channels like Decathlon, bringing our innovative full range of products to users during this summer's sporting events to increase our sales for the second half of 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 least, after several years of organizational transformation and streamlining our operations, our company has become more global, with about 90% of revenue generated from outside China. Our co-executives, myself included, now oversee operations from offices based in Europe and North America, enabling swift decision-making in response to market dynamics and being more attuned to consumer and market demands. The diversity within our team and the globalization of our R&D and marketing efforts empower us to develop, sell, and market our products with greater speed and precision. We believe this consumer-centered approach will set us apart in the long 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 will bring sustained profitability through self-branded products in the future. However, the ongoing transition of the business is indeed longer and sometimes harder than we initially expected. Patience is needed, but we remain optimistic about our strategic direction regarding both our sales and marketing strategy as well as 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 long-term sustainable growth. We are confident this strategy will establish Zepp as a leading self-reliant global smart wearable and healthcare solution provider.

Leon Cheng Deng, CFO

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 two things: attracting new customers and getting our existing customers to upgrade or add more products to better themselves. There are three things I would like to highlight. First is to echo what Wayne just mentioned: we launched the Helio Ring in our U.S. markets, and by mid-June, we'll expand into other markets, with a variation of the ring 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 Q3 and beyond. The second is increasing brand awareness through more above-the-line marketing activities in Europe and the USA to drive sales. Most recently, we have had out-of-home advertising in Madrid International Airport in Spain, and there will be more TV commercials on 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 least, this quarter, we experimented with stimulating additional product sales in our in-store base by delivering limited-time coupons or gift cards to some of our most loyal long-tenured customers. We have always tried 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 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 the 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 a critical area of focus 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, a decrease of 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 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. 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 an 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 long-term 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 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 reported a loss in our operating results in the first quarter, primarily due to seasonal-driven cost coverage issues. This performance represents an improvement over Q1 2023. The adjusted loss narrowed by 20.4% compared to 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 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 us 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 of our self-branded products. We'll continue the stock repurchase program to demonstrate the confidence we have in our strategy.

Operator, Operator

Your first question comes from Sid Rajeev with Fundamental Research Corp.

Siddharth Rajeev, Analyst

I am 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-loaded. However, Leon just mentioned that there might be an uptick in revenue in Q2, and I was wondering if you could provide more details. Will we see self-branded units soften in Q2 and Q3, with a spike in Q4? Or will we start to see improvement earlier?

Leon Cheng Deng, CFO

Let me take this question. 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. Q3 and Q4 are traditionally the high seasons for us, so you will see an uptick in revenue in Q2. That's why we also guided a higher range than Q1. I believe you will see a material increase in revenue starting from Q3 and Q4 because this also heads into the traditional high seasons for Europe and the USA, coupled with our new product launch window around June, July, all the way through September.

Siddharth Rajeev, Analyst

Since you don't provide segmented revenue, I was wondering if you could share the top two revenue-generating product lines and what percent of revenue they contribute?

Leon Cheng Deng, CFO

The biggest revenue contributor is definitely the Essential product ranges, which are the Bips and the Band, accounting for around 40% of our total revenue base. The next would be the Balance and the Active line, which roughly account for another 30% to 40% of our total revenue. The remainder, 20% to 30%, goes to our so-called Performance and Adventure series, which includes the running watches, such as Cheetah Pro, and our outdoor ranges like the T-Rex. These are high ASP product ranges that compete with products from Apple and Garmin.

Siddharth Rajeev, Analyst

How about geographical distribution? I think last year, you had 25% of revenue from North America, and Europe accounted for 50%. Is it similar? Or has it skewed more towards North America?

Leon Cheng Deng, CFO

At this moment, if you look at Q1, that still holds true. Europe accounts for 50%, while Asia Pacific and North America make up the other 50%. We do see growth potential in Asia Pacific and the U.S. coming up this year, but the impact will be clearer in the second half of the year. That’s why we anticipate our results to be somewhat back-end loaded.

Siddharth Rajeev, Analyst

Any updates on the non-compliance letter from the NYSE? I know you're doing your buybacks. Of course, you have the reverse split available to resolve this issue. Anything else that you have in the pipeline? Any updates?

Leon Cheng Deng, CFO

The non-compliance letter is just a technical issue, and there are definitely ways to resolve that. Management is confident in maintaining our U.S. Main Board listing status. This is something we mentioned in our press release that we will tackle in due time.

Operator, Operator

Your next question comes from Nicolette Jones with Brookfield Investments.

Unknown Analyst, Analyst

I have a number of questions. Firstly, regarding the high gross margin levels, can management provide insights into whether these margins are sustainable in the upcoming quarters?

Leon Cheng Deng, CFO

Yes. Starting from Q3 2023, our gross margin has been consistently above 30%. Q3 2023 was 33%, Q4 2023 increased to 35%, and now we stand at around 37% in Q1 2024. We have shown a trend of gross margin improvement due to our transformation journey and a more favorable product mix and channel mix. We are confident that with new product launches lined up, our gross margin percentage will expand in the quarters to come.

Unknown Analyst, Analyst

Could management share more color on your perspective for the full year outlook considering the slow start in 2024?

Leon Cheng Deng, CFO

We normally don’t guide for full-year performance. While Q1 started slowly, we have guided higher for Q2. Q3 and Q4 are typically our high seasons, and last year our total revenue was around $350 million. This year, we expect to range between $200 million to $300 million. We aim to sustain the company’s profitability through self-branded product sales.

Unknown Analyst, Analyst

Could you elaborate on the steps that Zepp is planning to take during the cure period to regain compliance?

Leon Cheng Deng, CFO

As explained before, we believe this is a technical matter and there are solutions. Our management team is working diligently to resolve this matter and expresses confidence in maintaining our U.S. Main Board listing status.

Unknown Analyst, Analyst

Could you elaborate on updates regarding product features and sales volumes for the Helio Ring?

Leon Cheng Deng, CFO

The Helio Ring is a new form factor of wearable devices, which we launched in CES at the beginning of this year. We started shipping the product in May and will launch it in Europe and Asia Pacific in the coming months. We have high hopes for the Helio Ring because it caters to users who prefer not to wear watches while sleeping but still want to monitor their vitals 24/7. By combining data from the ring and watch, we provide a comprehensive solution for health monitoring.

Unknown Analyst, Analyst

Could you clarify if the reported MAUs of 10 million include users from your Xiaomi collaborations?

Leon Cheng Deng, CFO

No, the 10 million MAUs mentioned by Wayne refer only to our Amazfit branded self-branded products. Including Xiaomi, we have around 30 to 35 million total MAUs.

Operator, 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 Yujia Zhang, Director of Investor Relations

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.