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Operator
Hello, ladies and gentlemen. Thank you for standing by for ZEP Health Corporation's second quarter 2024 earnings conference call. At this time, all participants are in a listen-only mode. Safe 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 ZEP Health Corporation's second quarter 2024 earnings conference call. The company's financial and operating results were issued in a press release by 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 session of the company's website at IRZEP.com. Participating in today's call are Mr. Wan Huang, our Chairman of the Board of Directors and Chief Executive Officer, and Ms. Liang Zheng, 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 Young, 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 US Private Securities Mitigation 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 20F for the fiscal year ended December 31st, 2023, and other filings as filed with the US Securities and Exchange Commission. The company does not assume any obligation to update any forward-looking statements except as required under applicable law. Please also note that SEP's earnings press release and this conference call include discussions on audited GAAP financial information as well as audited non-GAAP financial information. SEP's press release contains a reconciliation of the audited non-GAAP measures to the audited most directly comparable GAAP errors. I will now turn the call over to our CEO, Mr. Wang Huang. Please go ahead.
Wang Huang
Hello, everyone. Welcome and thank you for joining our call. To begin, I would like to provide an update on our strategic transformation. Our second quarter results aligned with expectations with an increase in Amazfit branded product sales and achieving a high growth margin. Despite a -over-year decline in sales, our net loss for the first half narrowed. With several new products slated for launch in the second half of the year, we firmly believe that the worst time of our transformation is behind us. The progress we have achieved is centered on three key pillars. First, we are investing in new technologies including AI to meet the needs of our customers and maintain a competitive advantage against our peers. Second, we focus on product innovations and profitable growth. We plan to launch our hit products during the upcoming EFA events. In addition, we are enhancing the global visibility of our Amazfit branded products through sponsorship of major sports events and partnership with renowned athletes to expand our roster of international representatives. Now, let's delve into the three pillars as we witness the transformative impact of AI applications in the industry. According to the latest KanaList reports, AI is both enhancing existing use cases and creating new ones. Significantly, boosting user loyalty, ZAP Health is leveraging AI to transform sports and health experiences. This quarter, we launched ZAP OS 4.0 in integrating OpenAI GPT-4 into our Amazfit smartwatches for safer and more useful responses, enhancing their role as wellness companions. Key features of ZAP OS 4.0 include an upgraded ZAP flow with intelligent language interactions and new health-focused mini apps. ZAP OS 4.0 is now available for Amazfit Balance and Amazfit Active with support for other models coming later in 2024. Moreover, our R&D team has made significant breakthroughs in AI technology using ZAP Flow Platform as a foundation. We plan to release a new form of AI hardware this in the next six months, making a new chapter in our journey in smart wearable technology. These upcoming releases not only demonstrated our technological strengths, but also highlight our long-term approach to product innovation and market strategy. As we prepare for the upcoming EFA in Berlin, we are excited to introduce several innovative products, including the highly anticipated T-Rex 3 outdoor smartwatch and our new line of open wearable stereo OWS earbuds. In recent years, we have observed a growing demand for comfort in headphone design, which has led to increased interest in open type headphones. Market research indicates that the open headphone segment is -to-point for substantial growth, presenting a promising opportunity within the Bluetooth headset market. These new offerings will highlight our latest advancements in hardware development. Additionally, I am pleased to announce that the smart chip jointly designed with Vail MicroTip, a subsidiary of Jiangshu Yitong, which we invested in 2021, has successfully entered mass production. This -the-art chip will support ZAP OS 4.0 and will be featured in the smartwatches we launched at EFA. In our commitment to innovation, we are thrilled to introduce the Amazfit Helio Ring, our first smart ring, which complements our smartwatch lineup. Launched at CES 2024, it has received critical acclaim and will soon be available in more countries. The Helio Ring is ideal for those who prefer not to wear watches while sleeping. Pairs seamlessly with Amazfit smartwatches like the Cheetah Pro and Cheelex Arctur for continuous 24-7 health monitoring. It offers advanced recovery insights and the ZAP app integrates data from both devices, empowering athletes to optimize their performance. With additional sizes, the Helio Ring is expanding to a broader market, driving further sales growth. By integrating smartwatches, rings, and the upcoming OWS earbuds to launch at EFA, we have crafted a seamless user experience loop, establishing a comparing competitive advantage in bundled sales. We anticipate these offerings will further strengthen our market position and drive growth in the second half of the year. On the marketing front, around the time of the EFA release, we will announce a major partnership with Hydrox in Europe and North America. Moreover, we have expanded our roster of athletes and ambassadors. In the second quarter, we welcomed US Olympic medalist Morgan Pearson, Italian national endurance icon, Yemen Baham Crepper, and Chinese marathon runner Xiaodong Wu to our team Amazfit family. These partnerships enhance our presence in the running and endurance sector and demonstrate their performance advantages of our cutting edge smart wearables. This also will be a significant step in our brand strategy, further enhancing our influence in global markets. These efforts are part of our broader strategy to increase the global visibility of our brand and products. By aligning with prominent athletes and sports events, we continue to build a strong recognizable brand identity and create meaningful connections with consumers worldwide. Through those brand and marketing investments, we have solidified our influence in major popular countries, such as China, India, and Brazil. Additionally, we achieved a breakthrough in Germany recently. Deepened our partnership with the Kasselon in France and steadily improve our global growth margin. In conclusion, our transformation journey highlights the effectiveness of our strategic direction with a strong focus on AI and expanding self-branded products. These efforts, combined with increased brand visibility, position us for sustainable growth. As we head towards ether in Berlin with new product releases and rising brand awareness, we anticipate continued growth momentum in the second half of the year. Thank you for your continued support and confidence in ZAP Health. I will now turn the call over to Leon to go over the highlights of our second quarter financial results.
Leon
Thanks, Wei-Yen. Greetings, everyone. Let me walk you through some of the key metrics of our second quarter financial results. Over the past two years, the entire consumer electronics sector has been facing significant challenges. We have observed that the pressure of discretionary spending, especially in an inflationary environment, is also creating headwinds for our operations. Additionally, major brands like Apple and Samsung offered larger than usual discounts during the past prime day in certain regions, highlighting the competitiveness of the industry landscape. However, we're cautiously optimistic to see that, according to IDC research, overall smart wearable market will return to growth in this year, with AI-enabled health insights and GenAI services as the growth drivers. Our focus has always been on positioning ourselves effectively in the current market. This is why we're prioritizing profitability, aiming to maximize profits from our self-branded product sales and continuing with the cost transformation initiative we implemented in previous quarters. It's also worth highlighting that we entered the smart ring category recently, as it represents a $2 billion plus market that is growing at a high double digit rate in the upcoming years. Simultaneously, we'll be entering into the open wearable stereo earbud segment, which will deliver substantial growth in the Bluetooth headphone market. Now, turning to sales, echoing Wayne's statement, we believe the most challenging phase of our transformation is behind us. The three key pillars driving our progress are applying new technologies, particularly with a focus on AI, product innovations with profitable growth, and enhancing global visibility through major sports sponsorship and marketing efforts. We are particularly excited about our expanding self-branded product offerings, which position us for long-term growth as a global leader in smart wearables and healthcare solutions. For the second quarter, our overall sales aligned with our guidance, with a 6% sequential increase in our self-branded products, more than offset the decline of Xiaomi branded product sales. This positive development is a testament to the progress we have made in our transformation efforts, and we anticipate continued sequential growth in the quarters ahead. Moving on to growth margin, which can be influenced by various factors, such as product mix, product launch timing, and product life cycles, including model upgrades. Despite a -over-year decline in sales, which fall apart due to the timing of new launches skewed towards the second half of 2024, and the border macro challenges, our growth margin for the quarter reached 40.3%. This marks a continuation of the margin expansion we initiated in the third quarter of 2023, and represents the highest growth margin in our company's history. Given primarily by the increased probability of our self-branded products, contributing factors include that improved product mix, a higher proportion of new products, and a reduction of clearance activities. Looking ahead, together with the new product launches in second half of the year, we are confident that this positive trend in growth margin will persist into the second half of the year, with full-year margins expected to remain at similar levels. This outcome underscores our strategic decision to prioritize probability over scale, leveraging the revenue from our self-branded products to sustain the company's overall performance. Now, let's turn to costs. We remain steadfast in our commitment to cost management, continuing with the program which we began in Q3 2020 on reducing overall operating costs. In the second quarter, we maintained a rigorous approach on discretionary spending while investing in research and development activities and marketing expenditures to preserve our long-term sustainable growth. As a result, operating costs for the quarter were US dollars 25.3 million, the lowest level in the past year, and is in line with our previous guidance. Our R&D expenses for the second quarter of 2024 were US dollars 10.4 million, reflecting a .8% decrease year over year. This represented .6% of our revenue compared to .1% during the same period in 2023. The reduction in R&D spending was a result of our ongoing efforts to optimize resource allocation, ensuring we achieve maximum return on investment and productivity. At the same time, we're committed to invest in new technologies and suitable AI functions to maintain our competitive edge against our competitors. Selling and marketing expenses for Q2 amounted to US dollars 10.5 million, a modest increase of .9% year over year. This accounted for .8% of our revenue, up from .9% in the previous year. The rise was primarily driven by our strategic investments in outdoor marketing and television commercials across Europe, aimed at boosting brand awareness ahead and during the UEFA 2024 and Summer Olympics in Paris. In parallel, we have been enhancing retail profitability and refining our channel mix by carefully optimizing our retail channels and strategically managing our sales teams. We're committed to making smart investments in marketing and branding initiatives that will fuel our long-term growth. DNA expenses were US dollars 4.4 million in Q2, marking a .3% decrease year over year. These expenses represented .9% of our revenue compared to 7.5 in the same period last year. This reduction reflects our successful personnel optimization initiatives and strict control over discretionary costs. Looking ahead, we remain committed to prudent cost management, aiming to keep costs at or below current levels in the upcoming quarters. Despite reporting the operating loss this quarter, largely attributable to cost coverage issues, when we consider the first half of 2024 as a whole, despite lower sales and thanks to higher gross margin and tightly controlled cost levels, we have narrowed the net income loss by 15% versus the same period last year. Now turning onto balance sheet, we continue to manage our working capital effectively. Our inventory levels at the end of Q2 were lower than Q1, marking the lowest level in the company's history. We will maintain this disciplined working capital approach in subsequent quarters. Our cash funds stands at US dollars 129 million by the end of Q2, consistent with the first quarter's cash level, despite the quarterly losses. This strong cash position equips us with the necessary resources to seize potential market opportunities and invest strategically in future growth. In Q1, 2023, we have initiated the retirement of our short slash long-term debt portfolio. Since then, and including Q2, 2024, we have successfully retired US dollars 55.2 million in the capital structure of debt. As our operating cash flow continues to strengthen in second half, we will continue to optimize the capital structure for the company. In line with our commitment to deliver long-term value to our shareholders, we'll proceed with our share by back program throughout 2024. This initiative underscores our confidence in the company's future and our dedication to enhancing shareholders value. Looking ahead, on the third quarter of 2024, we're guiding revenue in the range of US dollars 45 million to US dollars 60 million. It represents 18% to 59% growth on the revenue of self-rendered products compared with actual Q2, 2024. We're confident in our ability to build on the momentum we have generated to drive for the growth and profitability in the quarters to come. Thank you once again for your time and continued support. I will now open the line for any questions. Operators, please go ahead.
Operator
Thank you. We will now begin the question and answer session. To ask the question, you may press star then one on your touchtone phone. If you are 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 two. At this time, we'll pause momentarily to assemble our roster. The first question today comes from Sid Rajeev with Fundamental Research Corp. Please go ahead.
Sid Rajeev
Hi, so first of all, great to see the spike in sequential sales growth of self-branded units, but I guess the real surprise was the continued improvement in gross margins. What's really driving this? Is it higher product prices, cost optimization, or something else? I know you gave some reasons, but I'm trying to find out what exactly, or what's the main reason for this increase. And the second thing is with new product launches, can you bring it up to the 45 to 50% range?
Leon
Yeah, Sid, thank you very much. I think, let me start with the easy ones. I think where we have, as you heard from Wei-An's script, we have a lot of exciting new product launches lined up for the upcoming month, especially in IFA. You heard about the OWS earbuds, you heard about the new T-Rex watches, and you also heard about the Ring. And we also have some exciting innovations on the way, right? So yes, and all of these products will carry a very healthy gross margin to the magnitude of over 45 or 50%, depends on the product line we're talking about. So these are the new product launches, which is due for the second half of this year. And that's also coming back to your first question, that's also one of the reasons which drives the gross margin of the company continuously improved quarter on quarter for the past four quarters, right? I think to a big part, this is coming from optimizing the product mix, but also it's like I said, I mean, more new products, which has been launched recently, less products, which is clearance, that definitely helps our overall gross margin performance. On the other hand, we're also doing retail channel mix. For example, we cut the bleeders on those channels, which doesn't make money, right? And by doing so through optimizing the retail channel mix as well as our product mixes, together with the new product launches, which is lined up in the second half of the year, we're confident that we can continue on the gross margin improvement trends for the upcoming quarters.
Sid Rajeev
Okay, so my next question is, you have a lot of new products planned. So to make it easier for us to track, are you able to give us a number as in how many new products or updated products planned this year versus last year?
Leon
I think we have at least three, if not four products, which are scheduled to be launched in the second half of the year. And last year, same period, I think we have two products, if I remember clearly.
Sid Rajeev
Okay, and then the first half of this year, you had two versus right? Was it
Leon
that? No, the first half of this year, we only had one. Yeah, you can count one and a half because we launched the BIT5 Unity, which is a different variable of the BIT5.
Sid Rajeev
Yeah, yeah. Okay, and then I know you don't provide segmental revenue by region, but did you notice any material change in sales in any region particularly last quarter?
Leon
No, I think we have told you before that United States still remains as a region whereby we see a lot of potential growth from. And also we have seen some breakthroughs in Europe, like what William mentioned in Germany, in France. We have worked with the key accounts such as Deconel in those countries. And in Asia Pacific, specifically in China, we have seen a very good growth from China. And we have putting a lot of marketing efforts to promote that as well.
Sid Rajeev
Thank you, Leon. And just one question finally, do you provide an update on the status with NYC given the non-compliance notice you received a few months back?
Leon
Oh yeah, so we have ultimately until October 31st to rectify this issue. And as we have communicated before, we are committed to resolve this through either organically the share price to push above $1 or if needed, a reverse split. So we're confident that before that date we'll be regaining the compliance.
Sid Rajeev
I appreciate it, thank you, Leon.
Leon
Thank you,
Operator
Sid. The next question comes from Nicolette Jones with Brooks Investments, please go ahead.
Helio
Hi, management, thank you for taking my questions. I just have two questions. I'd also like to just dig in a little bit more about the new product map and some of your thinking behind your product decisions. And then in addition, I'd like to find out more information on the net income trend.
Leon
Okay, maybe I take the easy ones, Nicolette. Obviously the net income trend, you have noticed that it has been on uptrend quarter on quarter, it's improving. If you look at the first half of this year, the net income obviously is much better than the same period of last year. I think it was a improvement of 15% to that magnitude. And we are actually looking or targeting at improvement also for a second half of this year. So hopefully throughout the year, we can come back to possibility. That's always the target which we have been striving for. And coming back to your first question on the new products and the thinking behind it, I think you have heard us saying that in the upcoming EFA, which is in September, we're going to launch a new watch. Our most popular outdoor smartwatch, T-Rex, is up for an update. I mean, it's actually a lot of new functionalities will be added to that watch. And we are also going to launch a new OWS earbuds. OWS is a very popular concept. It's basically talking about open end headset which you can wear without feeling it. It's very different from the AirPods which is made by Apple. So we think, and according to the market research, the OWS earbuds is going to be a fast growing segment in the Bluetooth headset market in the upcoming years. So we are quite excited to have that product add to our lineup. And you also heard that we have the Helio array and we're going to put Helio array into more geographies and also into more sizes, especially the smaller sizes which are more tailored for the mass market and the mass consumers. So I think we are going to be one of the only players, if not the only players, who has the smartphone couples with the ring, couples with the OWS headphones and maybe some other phone factors because we have always been saying that we're trying to offer a full suite of wearable devices, smart wearable devices. So that our users can have a one-stop shop on better controlling and understand their health conditions. So I think this is always the concept what we try to bring this company to. So we want to be smart wearable player, not only restricted to smart watch per se and where we want to offer a complete suite of healthcare services to the users. So that's the whole theme behind what we, the new products which we're going to launch. I'm not sure if I answered your question correctly or?
Helio
Yeah, no, that's really informative actually, it's much more color. Okay,
Operator
thank you. As there are no further questions, I'd like to turn the call back over to the company's IR director, Grace Shon for any closing remarks.
Grace Zhang
Thank you once again for joining us today. If you have further questions, please feel free to contact the Health Investor Relations Department through the contact information provided on our website. Thank you.
Operator
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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