Earnings Call Transcript - ZEPP Q3 2024

Operator, Operator

Hello, ladies and gentlemen. Thank you for standing by for Zepp Health Corporation's Third 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 go ahead, Grace.

Grace Zhang, Director of Investor Relations

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, CEO

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 for mapping snow and weather, enriched outdoor features and extensive health monitoring, ideal 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 key opinion leaders. 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 stronger-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 complementary 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 while 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 European 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 trends 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 on 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, 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 have recently partnered with Bea Gonzalez, a top Padel player from Spain, Hunter and Meg, U.S. Hyrox Champion, and a renowned outdoor adventurer. These partnerships are helping us build brand recognition among sports enthusiasts 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 smartwatch 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 highlight 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 an 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 for 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, CFO

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 the previous quarter to USD 40 million, primarily driven by ASP growth of 44%. Q3 gross margin reached 41%, the highest in our history. Despite these directionally positive Q3 developments, the operating results in the third quarter somewhat fell short of our expectations as we navigate global macroeconomic headwinds impacting 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, the smart wearable market is growing, especially faster in the outdoor and sports segment. We believe our product roadmap positions us to participate in these growth areas and more. At the same time, in order to better position ourselves to participate in the growth of the market as a profitable company in 2025 and beyond, we continue to take an 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 RMB 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 segments 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 positioned 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 came 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 played 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 continued the expansion trend which began 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 hedge. Excluding this, our operating costs were USD 28 million, just below the 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 of our investment in new technologies, including AI, to maintain our competitive 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 improvements, 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 increase 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 expenses have 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 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, Operator

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

Sid Rajeev, Analyst

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, CFO

This is Leon. Yes, you might hear from our prepared remarks that T-Rex 3, we 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. The demand is shooting through the roof, whereby we cannot produce that much. But we are working day and night to actually resolve the supply constraints that we had on T-Rex 3. So hopefully, in Q4, you will see an increase in 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, allowing you to exercise better while you can still hear the ambient environment. It's actually a very good companion for the smartwatch. And actually, we are providing a one-stop shop to consumers who want to have a good understanding of their health and well-being with the help of smartwatches, the OWS earbuds, and also our Helio Ring, the Smart Ring. 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. In China, we have just finished the Double 11 event, whereby our T-Rex 3 stood out in every single board in the outdoor and sports watch segment. In Europe, you have the Prime Day 2, and we're heading into Black Friday and the Christmas sales. So we're quite confident in delivering the Q4 number. And also, we're shooting for an even higher number than what we put forward.

Sid Rajeev, Analyst

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

Leon Cheng Deng, CFO

Sorry Sid, I missed you for… Where exactly is the bottleneck in terms of the supply constraints? The supply constraints you mentioned? Yes. The supply constraints are as follows. I think it's not more a supply issue but a demand issue. We have encountered a spike in the demand for 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. So we prepared some stock for it. But then with the spike in 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, Analyst

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, CFO

Yes. We have a few currency pairs, all of which U.S. and Euros are major currencies, and also the U.S. dollars to RMB is another pair because we procure a lot in China and so do other consumer electronics companies. You might notice that RMB to dollars appreciated a huge amount in the last 15 days of the quarter in Q3. No matter how you can hedge it, you can never hedge it in full. Throughout the year, if you look at it, every quarter, we have had 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 with the recent currency movement, we're also expecting a tailwind in Q4. So I think net-net, if you strip out the FX fluctuations and you compare the numbers without the FX impact for every single quarter this year, you will notice that our profitability, albeit the loss, has narrowed to its lowest level in Q3. So I think we're mainly facing a cost coverage issue, which we're working on and we expect to resolve it very soon as we head into Q4.

Sid Rajeev, Analyst

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, CFO

I think we’re—I’m not going to rule out small bolt-on M&As. But I think one of the bigger things we’re continuing to do is the share repurchase program, which we initiated two years ago. We’re going to extend this program by another two years. For sure, you will see us being more aggressive in buying back our shares. 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 they arise so that we are better positioned in this competition versus our competitors.

Operator, Operator

The next question comes from Nicolas Jones from Brooks Investment.

Nicolas Jones, Analyst

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, CFO

Nicolas, this is Leon. So I guess I will take this question again. Yes, as I said, and then I also kind of alluded to it with Sid, there are a few issues in Q3. Number one is that we have the supply constraints on the newly launched product, which is 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 whole quarter of sales. So that actually gives you a feeling of how popular this product is and how successful this product is. This 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 could not manufacture enough in Q3, so there’s demand we couldn’t satisfy and we need to pull it into Q4. However, that also explains why we're confident about delivering a higher sales quarter for Q4. So that’s number one, which also impacted the revenue expectations for Q3, leading to a cost coverage issue for us. Second, we experienced an FX headwind in Q3, while for the other quarters, we had a tailwind. I think in Q4, the FX is going to swing into a tailwind again for us, so the negative FX impact is not going to hit us as hard as it did in Q3. The third 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, preparing us for better brand awareness and also for the high seasons as we head into Q4. So I think all those three things, i.e., the supply constraints, the front-loading of expenses, and the negative FX impact, impacted us in Q3. If you strip out the negative FX impact, what I just posted, and 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. With revenue starting 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, Analyst

That sounds great. Can you also give some sort of indication about how sustainable the expected growth in sales is?

Leon Cheng Deng, CFO

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. Number one, I think T-Rex stands out as a very successful product. It accounts for a big part of our revenue for Q4 and going into Q1 and Q2. Apart from T-Rex, we did not launch too many new products this year. So the majority of our product portfolio is up for renewal, for example, the Bip series, the Active series, and the Balance series for next year. We’re going to have a more balanced new product launch window and cadence versus two years ago, whereby everything was concentrated into Q4 and then you had a spike and then it stayed up. We’re going to have, for example, one significant product review of one of our Bip product line each 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. With that, 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, 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, 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 now concludes the call. Thank you.

Operator, Operator

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