Zepp Health Corporation (ZEPP) Q2 2022 Earnings Call

Zepp Health Corporation (NYSE:ZEPP) Q2 2022 Earnings Conference Call August 25, 2022 8:00 AM ET

Company Participants

Grace Zhang - Director, IR

Wang Huang - Chairman of Board of Directors & CEO

Leon Cheng Deng - CFO

Conference Call Participants

Operator

Hello, ladies and gentlemen. Thank you for standing by for Zepp Health Corporation's Second Quarter 2022 Earnings Conference Call. At this time, all participants are in listen-only mode. Today's conference is being recorded.

I'd now like to turn the call over to your host, Ms. Grace Zhang, Director of Investor Relations for the company. Please go ahead, Grace.

Grace Zhang

Hello, everyone and welcome to Zepp Health Corporation's second quarter 2022 earnings conference call. The company's financial and operating results were issued in our press release via the News Wire Services earlier today and are posted online. You can also view the earnings press release and slides we refer 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. Huang Wang, 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 under the Safe Harbor Provision 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 is included in the company's Annual Report on Form 20-F for the fiscal year ended December 31, 2021, 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 contain 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. Wang Huang. Please go ahead.

Wang Huang

Hello, everyone. Thank you for joining our call. For the second quarter of 2022, we forged ahead countering the challenges brought about by the ongoing pandemic and a weakening consumer settlement underscored by regional conflicts and microeconomic factors across a number of our markets globally.

Our second quarter revenue was in line with our guidance at RMB1.1 billion, down 39.6% year-over-year compared with RMB1.84 billion in the second quarter of 2021. On a positive note, we presented an improvement of 46.4% quarter-over-quarter from RMB757 million of revenue in the first quarter of 2022. This year-over-year decline in revenue was primarily attributable to the later timing of our Mi-band launch this year.

The new generation Mi-band contributed to just 1 month of sales in the second quarter of 2022 versus the full quarter sales in the second quarter of 2021. That said, we were pleased to see our top line improved from the first quarter. This occurred despite the subdued retail spending on discretionary items owing to the rising cost of living, worldwide geopolitical events, lockdowns and other pandemic control measures in China impacting our business.

We expect further sequential improvement in sales going forward, particularly given the positive sales impact from the launch of several innovative, self-branded smartwatches, including Amazfit Trex 2. Amazfit Bip 3 and Amazfit Bip 3 Pro towards the end of the second quarter. Furthermore, in the third quarter, we will launch new products in our most popular line, the Amazfit GT series.

Before we further elaborate on our new products and regional achievements. I'd like to share some updates on our business operations. Earlier this year, we optimized our organization structure to improve our operational effectiveness and enhance our customer facing capability.

We also found an IMCC, Information and Management construction committee to oversee the development of a new generation information management system which better serves the post-COVID era working style, including working from home and collaborating across time zones. This also strengthens our advantages in AI, chip technology, our cloud service in Europe and North America, build through R&D collaboration and our manufacturing and production capabilities in China. This approach of systematic automation makes our organization more flexible, effective and better shoot for the comprehensive operational needs of our business units.

We continue strengthening and elaborating our brand identity on the global stage, accomplishing significant progress in multiple markets. For example, in North America, we enjoyed impressive effects during the recent July Amazon Prime Day events with sales going over 100% compared with the same events in 2021.

Our outdoor smartwatch product line is gaining increasing consumer recognition. For example, Amazfit Trex 2, our latest, largest outdoor GPS smartwatch designed with outdoor adventures and sports enthusiasts in mind. Its equipped with comprehensive outdoor exploration features, including high precision positioning, ultra-low temperature operating capability, military-grade toughness and optimized route navigation. At well-known outdoor events taking place globally such as Escape from Alcatraz Triathlon, Spartan Race, participants speaks highly and share their enthusiasm of our products.

At the same time, our Amazfit Bip product lines continue to be popular in Southeast Asia, LatAm, America and Southern Europe, owing to its best value, best price product philosophy, despite a microeconomic downturn occurring in many of those markets. Recently, we launched our Zepp quality [ph] product in North American market. This is invisible-in-the-canal hearing aid for people who have mild to moderate hearing impairment. Our mission is to make [indiscernible] and normalize the use of hearing aids empowering those with hearing limitations to take control of their own audio health.

As some of you may have seen that this August, the U.S. FDA finalized a rule change that will create a class of over-the-counter hearing aids available for purchase without prescription of fitting from audiologists, many have pared [ph] the news as a great relief from millions of heart of hearing Americans who often find these expensive medical devices out of reach. The U.S. FDA finally allows Americans with mild to moderate hearing impairments to easily purchase hearing aids from community pharmacies or online retails, potentially making hearing aids a new digital blockbuster.

We also introduced a new AI-based sleep aid music subscription service. Our app utilize the real-time biometric data, in particularly heart rate grasping from our wearable devices to automatically compose high-quality customized rhythms to help our users fall asleep faster and holistically improve their sleep quality. This is the first time that our products have pivoted from being data checking devices to being health care solution providers. We have already launched this service in North American region.

Before I conclude, I must briefly mention our Zepp OS ecosystem, an important strategic asset, central to our open health management platform. We have a completely different design philosophy from Apple Watch IOS and android. It prioritize longer battery life from 10 to 30 days depending on the device, so that users can continuously monitor their health conditions, giving Zepp OS focus on designing for continuous health monitoring. This OS will evaluate into new forms in the future, such as supporting the invisible-in-the-canal hearing aid devices.

We continue to encourage users worldwide to join our Zepp OS ecosystem, [indiscernible] would support and inspire them to manage their health and fitness and enjoy for life. In addition, our inclusive and innovative Zepp OS ecosystem has attracted worldwide developers from around the globe to design apps and watch faces on our platform. In fact, surprising to me, some developers have even developed interactive game watch faces. Based on the API, which we have not yet officially opened to help nurture this driving developer community further, we are hosting the first-ever Zepp OS global online HEXO from 21 to August 31, 2022.

In summary, our second quarter revenue improved from the first quarter, which highlights our execution capabilities, product strength and [indiscernible] Zepp business management approach even though the macro environment remains challenging with ongoing geographic conflicts and COVID lockdowns. In the face of all those challenges, we continue to strive to improve our R&D, marketing capabilities and business operating effectiveness.

With our recent product launches, I am optimistic that we can deliver even stronger results in the second half. Despite the significant headwinds, I remain as proud as ever of our team as we accomplish some major milestones. This includes launching our first medical-grade product in a new product category, our invisible-in-the-canal hearing aid as well as introducing our first AI-empowered health management subscription service, our AI music sleep aid service.

These innovations have not only expanded our product category, but also helped us transform our business model from a pure device sales company to a health care management subscription provider. We view this accomplishment as a strategic upgrade into a new blue ocean [ph] market.

As mentioned earlier, our organizational restructuring strengthens the sharing of our hardware platforms resources across different business units. The use of the Zepp OS operating system and AI technology, this restructuring not only reduce redundant R&D investment and human resource costs, but also improve our overall operational effectiveness and the competitiveness of our tech.

This laid the foundation for us to quickly launch our new invisible in-the-canal hearing aid product line and the AI subscription service. In the meantime, both this new structure and the layering help our senior management team stand closer to our users and facilitate a faster and better decision making [indiscernible].

We now have a better view of the market as well as the capability to fulfill its needs by using our leading technology. Using our current integrated information system enables our R&D teams in the U.S. and China to launch more health related products in distinct categories and distribute our products worldwide through diverse global channels. So assessing our over 40 million online MAU to benefit from more opportunities to enjoy our subscription services.

As our Amazfit branded smart wearables shipment is growing rapidly worldwide, we keep acquiring new users who pay significant attention to their health. We are forming a user community with increasing user stickiness [ph]. Our years of continuous investment in applying AI technology to monitoring and solving health problems are yielding more fruits.

Combining smartwatch technology and health data, we have gained unique advantages in hearing aids and sleep aid music subscription services as well as reduce user acquisition costs. From smart bands to smart watches, we are now expanding into more health care product categories and online services. This helps the beginning of a new stage for Zepp Health and ignited the process of forming the flywheel effect.

With that, I will now turn the call over to Leon to go over the highlights of our second quarter financial results.

Leon Cheng Deng

Thank you, Wang. Hello, everyone. I would like to start by highlighting some of the key metrics driving Zepp's development for this quarter. Before providing further details on our financial performance, the global impact of the COVID-19 pandemic, which continued in the second quarter of 2022, especially the fresh lockdowns in China that affected the retail store sales and bought challenges to our supply chain globally.

Shortages of electronic components and chips for different industries persisted and accordingly affected the company's supply and production cycle. Separately, escalating geopolitical strike along -- among countries, notably the conflict between Russia and Ukraine is creating turbulence, dampening consumer confidence and causing inflation leading to a slowdown in consumer discretionary spending. These adverse conditions weighed on our revenues generated and our overall gross margin. Together, these factors have affected our Q2 results and continue to impact our ongoing second half 2022 performance.

Despite these ongoing headwinds, our Q2 revenue was RMB1.1 billion and in line with guidance, which consists of 42.9% self-branded product sales and 57.1% Xiaomi product sales versus 32.7% of self-branded product sales and 67.3% of Xiaomi products sales in the same period last year. However, our sales were affected by the timing of the new product launches compared with the same period last year.

Mi-band 6 2021 launch generated sales throughout the second quarter of last year, whereas this year's launch of the Mi-band 7 only bought sales revenues in June. Likewise, as the launches of the new Amazfit Trex 2, the Amazfit Bip 3 and Bip 3 Pro take place towards the end of the second quarter, hence, their boost to self-branded product revenue will only be visible in the second half of the year. On a sequential basis, second quarter 2022 revenue was better than first quarter 2022 and our operating profit also improved, reconfirming our solid execution capabilities.

Now let's turn to the second quarter gross margin, which can be affected by the product mix, product launch timing and product life cycles, including model upgrades. Our Q2 gross margin was 17.9%, 2.2% lower than the first quarter of 2022 and 4.1% lower than the last year's same period. Lower gross margin in the second quarter of 2022 resulted from higher outbound freight costs globally, the adverse impact of currency depreciation and the promotions for our previous generation products to prepare for the new product launches.

Turning now to costs, which has been a key focal point for the company both in terms of absolute amount as well as a percentage of sales. While we have to balance cost controls carefully with expenditures to fuel growth, we’ve already seen a decreasing trend in total operating expenses since Q3 2020.

As a portion of operating expenses is fixed and it takes time and creativity to reduce them gradually, we expect to achieve further cost reduction in absolute terms for the remainder of the year. Going forward, we will continue to rightsize our operating expenses from their current level in order to deliver profitability in the coming quarters.

First, as mentioned by Wang, we also have streamlined our organization structure in the past quarters, aiming to bring down our fixed cost breakeven point and prepare for a recovery in the coming periods. Moreover, we started to apply a strict return on investment-based and modularized approach in our day-to-day operations to drive faster decision making while becoming more service oriented and customer-centric.

Second quarter 2022 non-GAAP operating expenses were RMB296.4 million, spending on non-GAAP R&D in Q2 2022 was RMB123.3 million, a decrease of 7.4% year-over-year as we reduced the research and development costs by pursuing a smarter and leaner approach.

Q2 non-GAAP selling and marketing expenses were RMB107 million increased by 4.7% compared with Q1 2022 and 9.3% year-over-year. The increase was due to the e-commerce online advertisement promotions for our self-branded product.

Q2 non-GAAP G&A expenses was RMB6.60 million, 27.2% higher compared with first quarter of 2022 and 9.3% higher than the same period last year. It was largely attributable to the revaluation of operating working capital resulting from exchange rate fluctuation.

If we exclude the impact of the currency fluctuation, G&A expenses were relatively flat quarter-over-quarter. As our revenue improved sequentially and expenses remained largely flat, adjusted operating loss for the second quarter of 2022 improved to RMB98 million compared to the loss of RMB142.4 million in the first quarter 2022.

Our adjusted net loss in the second quarter was RMB94.4 million compared with RMB75.7 million in the first quarter. Q1 net income included RMB66.3 million investment income generated by our [indiscernible] investments, whereas our Q2 investment gain included income from fair value changes investment and pick up profit from equity method investment at RMB52,000. We will continue applying a disciplined approach and strive to return to profitability in Q3 2022.

Now turning to the balance sheet. Cash and cash equivalents and restricted cash as of June 30, 2022, were RMB997.1 million, reflecting our strict working capital control practices. Our inventory balance for the second quarter of 2022 was slightly better than the first quarter of 2022. We have introduced a more precise inventory management strategy to better serve the current business going forward.

In November 2021, the Board approved the allocation of up to US$20 million towards a share repurchase program. In Q2 2022, we continued the repurchase program, reflecting our confidence in our growth strategy and financial performance. We have bought back US$8.8 million worth of shares until June 30, 2022, and intended to carry out with this buyback program.

Lastly, I would like to discuss our outlook. In light of the ongoing challenges, our guidance for the third quarter of 2022 currently projects net revenue to be between RMB1.2 billion and RMB1.5 billion compared with RMB1.6 billion in the third quarter of 2021.

Please note, this outlook reflects the continued uncertainty of the potential effects of the COVID-19 pandemic on the sales as well as the lower discretionary consumer spending, especially in our international market.

Given this outlook, we will continue to apply strict cost control measures and disciplined working capital management through 2022. Please note that this guidance is based on existing market conditions and reflects the management's current and preliminary estimates of the market and operating conditions as well as customer demand, which are all subject to change.

This concludes our prepared remarks. We will now open the call to questions. Operator, please go ahead. Nick? Hello?

Question-and-Answer Session

Operator

Yes, please go ahead. [Indiscernible] is the first speaker. Now let's move to Lee [indiscernible] of PF Securities for the first question.

Unidentified Analyst

Okay, okay. Thank you. Hi, management. Congratulations for the first -- or second quarter, very good results. And I have two questions. Firstly, it's about your Mi-band 7. We noticed it has launched at the end of June. So could you share some color about the shipment in last 2 months and how can we expect the Mi-band 7 shipment in this year? Thank you.

Leon Cheng Deng

Yes. So we -- as we mentioned previously, Mi-band 7 was only launched in June, and I think we’ve a very good result in the first weeks when we launched the Mi-band 7. From a company perspective, the sales of June doesn't fully reflect the potential of Mi-band 7 sales because we're still constrained to some extent by the chip shortages, which is more a supply issue rather than a demand issue, right? Therefore, we expect that Mi-band 7 sales in Q3 and Q4 is going to be stronger than Mi-band 6 sales at a similar period versus last year.

However, I need to caution here because we’ve noticed also a downtrend on the overall band global market size from Q2 -- the Q2 number we haven't received yet, but we’ve received from different sources from IDC and other market intelligence companies, they are all pointing to a 30% to 40% decline of global band sales in the first quarter of this year. So I think that also continues into the second quarter of this year and probably it's going to persist into the second half of this year. So I think that's a little bit of the color for Mi-band 7.

Unidentified Analyst

Okay, okay. Thank you. And I have another question about new market. We think the VR, AR market is very likely to boost in the near-term. So I wonder how you think about this market and will Zepp launch any VR, AR [ph] products in the future?

Leon Cheng Deng

No. I think it's quite -- it's too early to talk about our future road map. But I think VR, AR is definitely a market whereby if you follow the news and the media a little bit, most of the companies see the watch or the band on the wrist as a proto to play into the VR and AR market. So from that perspective, the wearable product categories has a better lead into this market from a hardware perspective compared with many others, right? So -- and we are actually one of the biggest wearable companies in the world. So for sure, VR and AR is definitely on our road map. But with regard to the exact product timing, sorry, I couldn't say too much in today's call.

Unidentified Analyst

Okay, okay. I understand. Thank you.

Operator

[Operator Instructions] Our next question will be from Lisa Lee of Alpha [ph] Research. Please go ahead.

Unidentified Analyst

Thank you. Thank you management for taking my question. I have three questions. The first one is for your self-branded products. Can you please discuss your recent progress and strategy in the international market? And the second one, the new businesses that you discussed, such as the medical grade hearing aid and this sleep aid service seems pretty exciting. Can you please share with us more about the market potential for these new products and services as well as how we plan to monetize. And lastly, I would be grateful if you can provide some guidance for the second half of the year in terms of both the top line and margin trends. Thank you.

Leon Cheng Deng

Thank you very much. I think I will try to take your question one by one, right? I will start with the self-branded products and how we are going to drive it internationally, right? I think it's -- as we mentioned in the script early on, we have launched a few new products, which are the blockbusters of our existing self-branded product lines. For example, the more value segment, the Bip 3 and Bip 3 Pro products together with the outdoor segment, which is a Trex 2 outdoor wrapped watch, which is actually a competitor of Garmin watch as well as in September, we are going to launch our GT4, which is actually a yearly renewal of our flagship line of the smart watch.

So those three are more tailored towards international markets. And we have very good because of the apps which we have built on Zepp OS, these are also the software and the mini programs are also tailored with the individual consumer needs in different markets, and it addresses different consumers, right? So with this, we think the new product introductions, we are actually well-positioned to capture the rebound of the consumer demand because as you see, and you all know that first half of the year, most of the time is not a big sales season. But heading into Q3 and Q4, where you prepare for the Black Friday as well as the Christmas shopping season, these are the time whereby you can more make a success based on your new product introduction, right?

So I would say, number one is definitely the new product introductions on our smartwatches and band. And number two, also heading into your second question on the new businesses. I think Wang just mentioned, there are two milestone achievements, which we made in this quarter. One is the in-the-canal hearing aid devices and the other one is the sleep AI algorithm, right, as an Internet type of services.

The hearing aid devices, let me just spend a few minutes on that. It's really an innovative product because a lot of the consumer paying on that is that once a lot of people they have hearing problems, but they don't want the other people to see it. But the traditional hearing aid devices is very bulky. At the moment you wear it, everybody on the street will notice that you have some sort of a hearing problem, right?

Our product is actually trying to build out the TWS technology, which we’ve gained in making TWS devices in our company and then build on that is actually a specific form factor, very small, which you can put in-the-canal and then people can wear it without people around them without noticing that they are wearing a hearing aid devices. And in August, the FDA just issued a new regulation to allow for the over-the-counter sales for the hearing aid devices in the United States.

If you know the market a little bit, the hearing aid was a very kind of closed market, which was dominated by five manufacturers of hearing aid devices in the past. And now this FDA new ruling actually opens the door for innovative variable companies like us to also get into this domain and try to disrupt this domain, right? So from a market potential perspective, we really see this as a self-pay market, which is probably going to start more from the affluent consumers in United States and in Europe. And later on, maybe we will bring it back to China.

And then I can also point you to a company which is also listed, it's called Eargo, right? And this company has been very successful in launching similar products and selling it in United States. So I think we’ve high hopes on the hearing aid devices sales. And then we think this is actually building on our capabilities to help the company to actually go into a blue ocean kind of market.

And then the other one is the sleep AI algorithm, which you probably also know that a lot of consumers have sleeping problems. I do have that, right? And most of the apps or devices they can do right now is not to tailor for -- towards this consumer's specific need, but what we can do is because we have the wearables and we have the algorithm, through this service, you can have a feedback loop to train and get to your personalized algorithm to help you to sleep better and focus better and rest better, right?

We also think this is going to be an interesting exploration into Internet type of services, which we always wanted to do because we have a lot of vitals being monitored through different form factors of the devices, right? So we also have very high hopes on this business would take off in developed markets and then later to China. So that, I think, should answer your second question.

And with regard to the last question, our second half top line guidance, we don't guide for more than a quarter, but what I can say is that based on the current information we have, we are expecting a flat or better than last year sales for the second half of this year. I think that should give you some flavor on what we are looking at.

Unidentified Analyst

It's very helpful. Thank you, Leon.

Leon Cheng Deng

Operator, is there any other questions on the line?

Operator

No. At this time, there are no further questions. We are going to return to the company side for closing remarks.

Grace Zhang

Thank you once again for joining us today. If you have further questions, please feel free to contact Zepp's Investor Relations department through the contact information provided on our website. Thank you. You may now disconnect your lines. Thank you.

Operator

Thank you for attending today's presentation. The conference has now concluded. You may disconnect.