Zepp Health Corporation

And gentlemen, thank you for standing by for ZEPP Health Corporation's second quarter 2023 earnings conference call. At this time, all participants are in 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.

Hello, everyone. and welcome to Zapp Health Corporation's second quarter 2023 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. Participating in today's call are Mr. Wang Huang, our Chairman of the Board of Directors and Chief Executive Officer, and Mr. Liu Chengdeng, 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 Yang, our Chief Operating Officer, will join us for the Q&A session. Before we continue, please note that today's discussion will contain forward-looking statements. made under the safe harbor provision of the U.S. Private Securities Litigation Reform Act of 1995. Forward looping 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 31st, 2022, and other filings as filed with U.S. Securities and Exchange Commission. The company does not assume any obligation to update any forward-looking statements except as required under applicable law. Please also note that ZEPP's earnings press release and this conference call include discussions of unaudited ZAP financial information as well as unaudited non-ZAP financial information. ZAP's press release contains a reconciliation of the unaudited non-ZAP measures to the unaudited most directly comparable ZAP measures. I'll now turn the call over to our CEO, Mr. Wang Huang. Please go ahead.

Hello, everyone. Welcome to ZAP Health second quarter 2023 earnings conference call. In the second quarter, we maintained our momentum through the successful execution of our strategic transformation. This shift involves moving away from a business model heavily relying on a single customer for the majority of our revenues. And instead, establishing ourselves as a self-reliant global smart variable and healthcare solution provider. While Mi Band sales were heavily affected by the overall smart band market decline, our self-branded products continue to gain traction during the quarter, generating 12.7% higher revenues quarter over quarter and contributing to approximately 70% of our top line. In this transformative phase, we have come to recognize that enhancing our revenue streams quality is paramount. Our strategy has undergone refinement. Centering around the utilization of our self-branded product sales to effectively offset the company's fixed costs. This transition marks a deliberate pivot from the pursuit of sheer growth to the steadfast commitment to attaining profitability. Notably, this shift in approach has been particularly successful in the Chinese and Indian markets, where we have converted erstwhile loss-incurring ventures into sources of profit. This strategic focus is aimed to improve our growth margin ultimately steer us back towards sustained profitability. We have refined our product mix and strategically streamlined our sales channels. As a result, our overall gross margin has surged to 22% compared to 17.9% at the same period last year. This achievement marks the highest level we have attained since the second quarter of 2021. Even in the face of software total revenues year-over-year and margin pressure stemming from Xiaomi products, Our ROI-driven strategies spanning the supply chain and the product development and marketing has significantly furthered our brand image within the premium smart wearable device market. These initiatives have not only elevated our Brands influenced and garnered increased consumer recognition, but have also optimized our cost efficiencies. As a result, our products and services have experienced heightened adoption across various global regions. This growth is particularly evidence in the high-end product segment, where we offer a comparing value proposition, delivering premium features at a more accessible price point than our competitors' premium offerings. This is especially true in the North American market, where we kept our market position in terms of market value in the top five for smartwatches, according to NPD with an increased gross margin. We continue to enrich our offerings to adjust the preferences of our customers. On June 21, we unveiled Amazfit Cheetah, our first smartwatch series dedicated to runners. Featuring a lightweight design for runners, it can optimize users' running experience with industry-leading GPS technologies to deliver enhanced positioning accuracy and upgraded AI-powered coaching to generate personalized training plans. Leveraging last language model and generative AI technologies, we also rolled out an AI chat feature in Amazfit Cheetah to facilitate true coach to athlete interactions for users. Additionally, We have also been striving to refresh users' experience and better meet their fitness and lifestyle needs through firmware updates. On July 10, we released a major update for our popular Amazfit QLX2, which added support for cadence sensors. upgraded water sports modes, such as surfing, kite surfing, and the newly added wake surfing, as well as the long awaited Zap Coach feature, allowing users to enjoy their favorite summertime activities with our AI powered training guidance. we have enhanced our entry-level product line by introducing the new BIP5, featuring an expensive 1.91-inch ultra-large display. With the inclusion of a cutting-edge full satellite positioning system, this device empowers users with accurate location tracking. Unlocking a comprehensive range of possibilities, the BIP5 supports over 120 sports modes complemented by intelligent recognition technology. Moreover, it comes with monitoring capabilities on 24-hour bit rate, and stress levels, ensuring a holistic view of our users' well-being. Additionally, we are planning to build several new products in the second half and are excited about how their advanced features can help more users better manage their health. We will save the details for their upcoming product launches. Please stay tuned. Our commitment to enhancing our offerings for users through application of cutting edge technologies across our products, services, and business is built into our DNA. As our AI cloud, Zap Coach is providing more interactive, informative, and customized training experience to our users through products like Amazfit Falcon, Amazfit T-Rex Ultra, and now Amazfit T-Rex 2, as well as Amazfit Cheetah. We are also integrating GPT technology into our software development process. to enhance our R&D efficiency. We believe this will eventually benefit users as they will enjoy premium products and services at a low cost, while also contributing to our bottom line gains. Lastly, I'm thrilled to share that we teamed up with renowned ultra-medicine and fitness icon, and appointed him head ambassador for Amazfit Cheetah Pro. He led team Amazfit at the San Francisco MadSong from July 21 to 23, where he demonstrated the exceptional functionalities of our premium running smartwatch. This partnership has introduced Amazfit to more running insurances and showcased our ability to craft leading products, helping amplify our reputation as a premium smartwatch manufacturer across the international sports community. Looking ahead, we remain optimistic about our company's prospects as the market continues to present huge posts from 157.3 million in 2023 to 206.2 million in 2027. with a CAGR of 6.8% despite the challenging microeconomy. As we hone our value proposition with AI-powered products and services to ride the industry's tailwind, we expect our self-branded products to continue to grow We will continue to optimize our inventory levels and prevent control causes while maintaining our competitive edge and building long-term product pipeline through targeted investment in R&D and marketing. Supported by our vertical integrated supply chain and efficient platform-based R&D. We are confident that these efforts will propel margin expansion and a prompt return to profitability, ultimately fueling our growth and business success. Thank you again for joining us today. I will now turn the call over to Liam to go over the highlights of our second quarter financial results.

Thank you, Wang. Greetings, everyone, and thank you for joining our earnings call today. I would like to review some of the key metrics from our financial results for the second quarter of 2023. In the second quarter, the consumer electronics categories that we participate in remains challenged by factors such as foreign exchange headwinds and persistently subdued consumer spending power, among others. The conditions have not yet returned to what we could consider normal, and we continue to see unprecedented levels of discounting by our competitors. We saw a reduction in channel inventory in the first half of the year, consistent with our expectation for activations to outpace selling, and we expect this to continue through the third quarter, particularly in Europe and Asia Pacific, where retailers continue to tighten up. As for underlying demand, growth in the Americas helped offset the impact of the tough economic climate in Europe and Asia Pacific. Despite this, our brand and product portfolio continue to perform well. Our second quarter revenue amounted to RMB 648.3 million within the expected guidance range for a decline of 41.5% year over year, primarily attributed to lower Xiaomi sales. During the quarter, our revenue generated from Xiaomi branded products declined by 67.2%. largely influenced by market deterioration in smart bands category, while our self-branded products experienced a 7% decrease, mainly due to limited new product introductions during the quarter. Moving on to our gross margin, which can be influenced by various factors such as product mix, product launch timing, and product life cycles, including model upgrades. As we continue to make an ROI-oriented approach to optimize our product and sales channel portfolio, the gross margin for our self-branded products remained healthy. Despite a slight decrease in revenue for Amazfit brands, we are delighted to report a remarkable 51% year-over-year expansion on our Amazfit brands' gross margin. This significant growth has played a crucial role in driving our overall Q2 gross margin to an impressive 22%. Notably, this is the highest level we have achieved since Q2 2021, even withstanding a year-over-year decline of 42% in Xiaomi products' gross margin during the quarter. This outstanding performance speaks volumes about the strength and resilience of our Amazfit brand. Despite the market challenges we faced, our dedication to delivering high-quality products and optimizing our operations has yielded exceptional results. We're confident that with this positive momentum, alongside new product introductions planned for the second half of the year, as well as a moderated level of clearance activity, we should be able to expand the gross margin of our company even further. Now let's look at costs. As we have always mentioned in our past earning costs, controlling costs remains as a top priority for the company, both in terms of their absolute amount and as a percentage of sales. Since Q3 2020, we have been pleased to see a downward trend in total operating expenses while still making strategic investments in new products, technologies, and footprint expansions to fuel our long-term growth. In Q2 2023, we delivered on our quarterly round rate target and successfully managed to reduce our adjusted operating costs to RMB 204 million, their lowest level since Q2 2019. Our second quarter R&D expenses were RMB 84.7 million, lowered by 31.4% year-over-year, thanks to enhanced efficiency driven by our platform-based R&D strategy. However, as a percentage of sales, R&D costs still remain at a relatively high level, demonstrating our commitment to further building our product strength and our long-term competitive edge. As we continue to prune our retail channels to maximize returns on every penny we spent, our selling and marketing expenses declined by 33.9% year over year, reaching RMB 17.7 million. However, as a percentage of sales, we're at 10.9% versus 9.7% in the second quarter of last year. We'll continue to invest strategically in our brand, adopting an ROI-based marketing strategy to ensure our ongoing growth and success. Second quarter G&A expenses will earn the $48.9 million, down by 25.9% year-over-year, benefiting from our effective cost control measures. Looking ahead, we will persist with our prudent stance towards costs, and expect cost levels to maintain at current levels or lower in the upcoming quarters, while investing responsibly and with great discipline to fuel our business growth. With our enhanced gross margin and carefully managed costs, our non-GAAP net loss has narrowed to 59.2 million in Q2. Despite facing a cost coverage issue in Q2, I'm delighted to share that we're optimistic about returning to profitability in Q3 2023. Now turning to the balance sheet, cash and cash equivalents, restricted cash and term deposits as of June 30, 2023 totals RMB 10 billion, providing ample runway for us to invest and capitalize on potential marketing opportunities. Efficient working capital management remains a priority for us. In Q2, we reduced our inventory to RMB 700.3 million, the lowest level in several quarters. We'll persist in carefully managing inventory levels in order to optimize our operations. Despite a modest P&L loss in Q2, we sustained positive operating cash flow for the fourth consecutive quarter. We utilize this to reduce our debt levels and will continue to do so in coming quarters. Now turning to our share repurchase program. To recap, in November 2021, the board authorized the allocation of up to US dollars 20 million towards a buyback program. By the end of June 30th, 2023, we had repurchased shares worth US dollars 11.7 million. and we intended to carry on with this buyback program in Q3, reflecting our confidence in the company's future and underscoring our commitment in delivering long-term value to our shareholders. Regarding our outlook for Q3, we expect our net revenue to range from RMB 600 million to RMB 800 million. We anticipate that the trend of quarter-over-quarter growth in self-branded product sales revenue will continue, positioning us to achieve higher overall gross margin and return to profitability. Please note that this outlook reflects ongoing uncertainties around lower discretionary consumer spending, especially our key markets and global macroeconomics weakness. In conclusion, Despite the challenges we faced during the second quarter, we're proud of significant strides we made in enhancing our self-branded product sales, improving gross margin, and implementing efficient cost management efforts. With our continued focus on expanding our product margin and carefully managing our inventory levels and operating costs, as well as upcoming new product launches, we remain confident that we're on the right track to continue to deliver value for customers and investors over the long term. There's no doubt in my mind that we'll emerge from this challenging period as a stronger company that creates substantial shareholder value. With that, I will now open the call for any questions you may have. Operator, please go ahead. Thank you.

Thank you. We'll now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then 2. For the benefit of all participants on today's call, If you wish to ask your question to the company's management in Chinese, please immediately repeat your question in English. At this time, we will pause momentarily to assemble our roster. The first question comes from Nicolette Jones with Brook Investments. Please go ahead.

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

Thank you. I think I would start with the easy questions on the new product launches, and I will go into the gross margin and profitability questions in a bit. So if you look at the new product launches, we have, I mean, Wayne mentioned that in his script as well. We launched quite a few new products in July, August time. Take, for example, the BIP5 watch, which is actually our value segment mainstream product line. And then we are actually going to launch our latest flagship products, our famous GT theory. And bear with me, I think we're going to have new names for that in the coming days, which we're going to launch in Berlin as well. And then also we will launch a few new products, which are the new versions of our famous Mini and the GT sports range in the second half of the year. So we do have many new product launches, as we mentioned in our script, in the second half of the year, especially in September-October frame, which is on the way, right? And linking to that, I think that would naturally bring me to the margin trend for Q3 and Q4. I think, as you can see, and we also mentioned in our Q2 numbers, that we see a clear jump in our self-branded product, the Amazfit brand margin increasing in Q2, and we see this continuing into Q3 and Q4. I think in the previous course, I have alluded to a rule of thumb number that our gross margin for our self-branded products is in the range of around 30% for our self-branded products. And I think given the new product launches which we have underway, we see this number would further improve in Q3 and Q4. And then coming to the probability questions you have, I believe that's your first question. We are reporting narrower loss, so be it that we still have a loss in Q2 this year, but you can see that we are clearly making progress on number one, on the gross margin, we actually returned to the highest level in past three years on the gross margin percentage, which is 22%. It's not a small number per se, but as I just mentioned, we expect this number to further improve in the upcoming quarters to more go into the 30s domain. And on the other hand, we also managed to cut our operating costs from a run rate of 300 million per quarter to 200 million a quarter. and we're also going to be very prudent on how we manage the cost. Number one, we should not sacrifice the future growth of the company. Number two, we are actually benefiting from the AI, from the push on using the chat GPT-alike AI models in our day-to-day work and also the platforming approach in our R&D development process to actually to do more or less the same or even more as what we did before with a lower spending level, which we have demonstrated in the past quarters. So with a higher gross margin overall on the company and lower run rate on the cost, I think we're heading towards this break-even point. which we also alluded in our prepared script that we are very confident that in Q3, our transformation journey from what our CEO Wei-En just mentioned, that we were very much reliant on a single big customer sales to a company whereby we should be able to justify our profitability based on a majority of our self-branded product sales, that type of company. And now we see that is going to happen in Q3. And then given the high seasonality of Q4, and I don't want to jump the gun here too much, but I think we are relatively confident that we should be able to return to probability starting from Q3, which is next quarter.

Thank you.

Thank you. Again, if you have a question, please press star then 1. The next question comes from Lisa Lee with ELSA Research. Please go ahead.

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

Okay. Thank you, Lisa. So very good questions. So let me also start it with your third question on the Xiaomi relationship. I think Xiaomi stands where the so-called, we started from the so-called Xiaomi ecosystem company, but I think over the time, this term has changed for a lot of companies, but we still have very good relationship with Xiaomi. So number one, Xiaomi remains as one of the biggest shareholders of our company. Number two, we still have the wearables cooperation with Xiaomi on various product categories, and that is not changing for us. However, you also notice that we have embarked on a transformation journey from changing the company from a reliant on one single big customer type of situation, let's put it in a different way, from an OEM or ODM supplier type of situation, to more a company which is dependent on its own self-branded products, whereby we hope that we can come to a situation whereby our self-branded product sells is good enough to cover for our fixed cost to start with. And then I think the past six quarters, we have reported six quarters of losses. And then that was also part of the reason we are actually going through a SoCal transformation journey to go from a reliance on a Xiaomi single big customer to a MaceFit self-reliance company, as what our CEO just mentioned. So to assure you that where our relationship with Xiaomi is actually very strong and it will continue to be strong, but we will do more and more risk return on investment type of analysis on the products categories we are cooperating with Xiaomi, right? So we'll set a very clear threshold on the gross margin on the probability of which are bringing by the Xiaomi projects and we'll We'll work with them on those projects, which also have a mutual benefit to our company, because in the end, I have a due responsibility towards our shareholders. So I think that is the Xiaomi partnership. And then with regard to your second question, whether or not we have any plans of the new partnerships other than Xiaomi, I think there's always plans from the company in the making, but I would not comment too much on this. I mean, if we're going to have or if there's such a B2B relationship materializing, you will definitely hear from us in our IR website. And then I'll come back to your first question, which is on the overseas market performance. I think, put aside the Xiaomi revenues of the company, which in the meantime has been becoming a small portion of the company's overall sales, on our self-branded product, it has always been having a different characteristics or a dependence on the Chinese cells we're making in China. I think I've mentioned this many times in the previous course that majority of our self-branded products cells is actually coming from the so-called overseas markets or international markets the company has. The biggest part is coming out of Europe, and then the second biggest part is coming out of Asia Pacific countries, and the third one is coming out of United States, and then with a small portion of that mix coming out of China. What we noticed in Q2 is that we're actually growing in all these regions except for China and India. whereby we also mentioned in our prepared remarks that we pivot from looking at the scale in these markets towards profitability. So we first want to manage for profitability so that the overall company is positioned for a health profitability. And then we're going to, as the next step, we're going to look at whether or not we can actually make profitable growth. in that sequence. And if you look at our overseas markets, we see that US market actually presents itself as a very lucrative and a growth potential market for us because we are well positioned in that market to compete with big brands like Garmin, Samsung, and Fitbit. And we have this unique positioning that we have the made-in-China mass manufacturing production capabilities in China, which we can address more the demand of the value segment. And in the meantime, we're actually competing with Garmin on the high-end premium segment in the United States. And then within a year and a bit, I think our market share, according to NPD, which is a third-party market share research company, our market share, according to them, has come up from zero to 10 or 11%, if I remember correctly. So I think that's, in a nutshell, our performance in the international markets. And I hope that gives you a feeling for what it is.

Yes, that's very helpful. Thank you, Leon.

As there are no further questions now, I'd like to turn the call back over to Grace Zhang for closing remarks.

Thank you once again for joining us today. If you have further questions, please feel free to contact ZEPS Investor Relations Department through the contact information provided on our IR website. This concludes this conference call. Thank you.

Again, this concludes the conference call. You may now disconnect your line. Thank you.