Earnings Call Transcript - TUYA Q2 2022

Operator, Operator

Good morning and good evening, everyone. Thank you for being here, and welcome to Tuya Inc.'s earnings conference call for the second quarter of 2022. I will now hand the call over to our first speaker, Mr. Reg Chai, Capital Market Associate Director of Tuya. Please proceed, sir.

Reg Chai, Capital Market Associate Director

Okay. Thank you. Hello, everyone. Welcome to our second quarter 2022 earnings call. Joining us today are founder and CEO of Tuya, Mr. Jerry Wang; and our CFO, Ms. Jessie Liu. The second quarter 2022 financial results and webcast of this conference call are available at ir.tuya.com. A replay of this call will also be available on our website in a few hours. Before we continue, I refer you to our safe harbor statement in our earnings press release, which applies to this call as we will make forward-looking statements. With that, I will now turn the call to our founder and CEO, Mr. Jerry Wang. Jerry will deliver his remarks in Chinese, which will be followed by corresponding English translation.

Jerry Wang, CEO

Hello, everyone, and thank you for joining us on our second quarter 2022 earnings call. This is also our first earnings call after our dual-primary listing in Hong Kong. In the second quarter, our total revenue was $62.5 million, in line with the midpoint of our previous guidance range. Sequentially, we grew our total revenue by 13.1%. However, on a year-over-year basis, we recorded a 26.1% revenue decline as we lapped a period of robust growth across the IoT industry in 2021. In particular, our IoT PaaS business revenue increased to $47.6 million, up 13.9% sequentially but down significantly year-over-year. During the second quarter, global inflation continued to rise while the Russian-Ukrainian conflict dramatically impacted the world economy. Although the latest CPI from the U.S. came in at 8.5% in July, lower than June and better than expected, the number itself was still high. High inflation affects the economy, the industrial value chain, and consumers' wallets, changing people's lifestyles and consumption habits. These changes have a long-term impact on the consumer discretionary sector. A recovery in consumer electronics will take an extended period. Meanwhile, we note that the downstream players in the IoT device industrial chain, including IoT device brands, OEMs, and the distribution channels faced massive inventory pressure from supply mismatches, which are expected to take longer to fix. As a result, our IoT PaaS business DBNER as of the end of the second quarter declined to 84%. However, our other core business, the 2B focused SaaS and other segments remained strong for the sixth consecutive quarter since we completed our public listing, with revenue reaching $7.2 million, up 114.3% year-over-year. Our SaaS and other segment has sustained a year-over-year growth rate of over 110% for 10 consecutive quarters, despite the recent turbulence in the global economy. Our gross margin in the second quarter was 42.8%. Our IoT PaaS gross margin was 42.5%, representing a slight improvement over the same period last year and remained at a healthy level despite the headwinds. Since the beginning of the second quarter, we have implemented several operational and business optimizations, as well as product and technology iterations, I will share some highlights here. We also expanded our global brand customer base. For example, we added a Fortune 5 German business group's DIY retail channel private label shipments cover a wide range of segments such as electrical, lighting, outdoor, and small appliances. Another customer is a leading U.S. consumer platform and listed company that offers more than a dozen consumer brands. We also partnered with a top-tier Korean HVAC manufacturer with distribution in Europe, America, Asia, and the Middle East. In Mexico, we worked with the leading Mexican air conditioner brand that has integrated its suppliers and the product system to develop smart home appliances. The number of our IoT PaaS premium customers, mainly the existing customers, was 267 in the second quarter, down from 285 in the same period last year. The decrease was due to the issues I mentioned earlier as well as seasonality. This resulted in certain customers reducing their orders, thus falling below the premium customer revenue contribution threshold, which is $100,000 in the last 12 months. However, we also have new customers qualified, including a top brand from North America that we announced in the fourth quarter last year, whose primary business is outdoor travel. The new customer has completed product development and testing processes for various products, started trial production and shipments in the first quarter, and completed hundreds of thousands of units in the second quarter. Next, I will share some updates on our SaaS and Other segment. During the first half of 2022, our commercial lighting and property SaaS achieved a year-over-year growth of around 100% in the number of new brand owners acquired, new customer projects served, and a new device interfaced. The addition of these partners has effectively complemented our business further. For example, the factory of Aptiv, a leading global supplier of mobile electronics and automotive system completed an intelligent transformation through our commercial lighting SaaS. The transformation saves Aptiv at least 900 kilowatt hours of electricity per day with an energy-saving efficiency of over 70%. In addition, it enabled the factory to refine its lighting management in accordance with the different needs and working hours of each workshop. As such, the factory was able to improve the productivity of its production lines while saving energy. The commercial lighting segment itself has significant energy-saving potential. Going forward, carbon accounting, theoretical energy consumption analysis, events hub, and other similar functions will be in our products and the business key development direction. Now, let's turn to the progress of our hotel and apartment subsector. In the second quarter, we developed a baseline version of our domestic hotel SaaS that integrates voice and central control. On the foundation of the baseline version, we expanded our business to the new digital commercial circuit vertical and optimized our products with more cost-effective features such as room monitoring, e-gaming hotel, and advanced construction. For the overseas hotel SaaS, we started to scale our SaaS coverage, adding over 1,000 new rooms. The hotel and rental segment is a market with clear industrial leaders that is otherwise highly fragmented. Looking ahead, we will focus on industrial-leading service providers and hotel groups, improve our product offerings, expand model use cases, and continue penetrating the industry leaders. The real estate downturn in China during the second quarter affected our smart office and smart community SaaS solutions. However, by leveraging our solid software products and hardware device ecosystem, the intellectualization projects being implemented by various customers that signed contracts with us before maintained smooth operations. Moreover, we achieved solid progress in the smart industrial vertical. One of our new customers is a large enterprise specializing in the production of high- and low-voltage electric control has been a long-term material supplier and a high-quality partner of large-scale industrial enterprises. This customer utilized our industry equipment management system to monitor and collect equipment operation data such as temperature, current, and the voltage of power distribution equipment to assess electrical stability and safety and receive timely malfunction warnings. We also helped this customer develop the power distribution energy efficiency management platform that can analyze the power distribution equipment's current, voltage, power factors, active energy, and other operating parameters. Based on the analysis, the jointly developed platform established a distribution energy-efficient model to conduct statistical analysis of the electricity consumption for various purposes to improve the electrical parameters, in fact, saving 60% to 15% of electricity. Recently, when serving customers in factories and industrial pubs, this customer also developed the need for managing new energy sources such as photovoltaic in addition to utility power management. With our access and application expansion capabilities, we are currently helping them build a full suite energy management platform. As for value-added services, our 2C VAS maintained solid performance in the quarter. At the same time, demand for 2B VAS is also on the rise. For example, our OEM app and value-added services such as the app function enhancement and related services as well as voice capability generation and services grew more than 100% or even higher year-over-year. In addition, services such as IoT certification and the cloud development framework product have also delivered solid performance. Such results indicate that in the current macro environment, customers and brands are still investing and are confident in the smart business. Moving on to our smart product cloud product. As of the second quarter, we have acquired exemplary private cloud customers such as a prominent Chinese integrated industrial investment group and multinational electrical, electronics and automotive brand headquartered in Southeast Asia with one of the world's most extensive manufacturing and R&D facilities. The IoT project with China Gas that we previously announced is also progressing steadily as planned. Since its launch, we have achieved several milestones such as completing the building of the Things Model for gas solution, rolling out a demo version, and introducing the development standards and instructions. As we expand our customer base, we see tremendous business opportunities from these industrial customers in their pursuit of smart solutions, and we will strive to convert them to our customers. As one of our core long-term strategies, Cube smart private cloud unwind a series of product technology upgrades in the second quarter. We completed the optimization of the IoT protocol for Cube. The protocol will help us better serve our industry customers as it features lower power consumption and higher coverage. It has been widely used in over 10 industries, including public utilities, logistics, warehousing, properties, and manufacturing. We also packaged our business into the SDK of the Cube app, which significantly accelerated the customer's new app development process. We are currently replicating the capabilities of the 9 major categories under the Tuya public cloud system to the Cube solution to further enrich customers' device ecosystem choices and solution diversity. We completed the independent operation and maintenance system, which fully covers the IoT infrastructure, meet operations, and business operations under the Cube solution, enabling the technical staff to better understand Cube's operations to quickly locate and solve problems. As a cloud-neutral product, we have the advantage of addressing and optimizing the complex architectural adaptability for cross-cloud deployment and the standardization process. In addition, the security of setting up a cloud platform on different isolators is also a challenge. In this regard, we replicated our experience with the Tuya cloud systems and further enhance the app and the reinforcement capabilities to give our customer a world-class security experience. Lastly, it is worth noting that on July 12, ioXt along with authoritative experts released the 2022 global IoT security white paper, in which Tuya was nominated as the best security practice in the IoT industry. This nomination illustrates the industry recognition of our ongoing efforts in security compliance and further highlights security compliance as one of the core competitive advantages of our platform. Our business progress and strategy developments in the second quarter. Overall, the severe challenges throughout the quarter are persisting, and we do not expect the economic downturn, high global inflation, supply chain inventory, and other issues to improve soon. However, our mission is unchanged to actively leverage Tuya's technology and product strength to explore new opportunities. Finally, on our internal management, the efficiency-centric initiatives we previously announced are already having a positive impact on our financial results, which our CFO, Jessie, will discuss in more detail.

Jessie Liu, CFO

Okay. That concludes the remarks by Jerry. Before I begin, please note that all amounts are in U.S. dollars and all comparisons are on a year-over-year basis, unless otherwise stated. As Jerry just mentioned, we continue to face a series of unprecedented challenges, specifically global inflation, COVID resurgence in Mainland China which caused significant business disruption and inconvenience and the macroeconomic headwinds further exhibited downstream inventory backlog issues. Despite the challenges, we continue to focus on executing our efficiency improvement strategies towards our goal of prioritizing profitability and leverage our competitiveness to explore new long-term opportunities in the IoT industry. Now, I will provide a closer look into our financial results. For the second quarter of 2022, our total revenue was $62.5 million, within our previous guidance range and down 26.1% year-over-year. The decline was driven by a 38.1% year-over-year decrease in our IoT PaaS revenue, which was down to $47.6 million for the quarter. Based on our own estimates gleaned from downstream and the consumer discretionary industry sources, broad-based demand declined in a consistent trend with our revenue decline. Major markets, notably the U.S. and Europe slowed significantly, whereas China grew slightly versus last year. The smart consumer electronics sector is subject to fast-changing short-term demand, which is thus more susceptible to a slower economy compared to other sectors, such as industrial, agriculture, automobile, and new energy, in which companies, especially those with large scale or in the electric vehicle sector are more resistant to short-term downside risk. We are actively exploring opportunities to enter a wider range of the stable industries by leveraging our competitiveness and existing technology and ecosystem advantages. Total gross margin and IoT PaaS gross margin for the quarter were stable at 42.8% and 42.5%, respectively, as we effectively implemented a series of business management and efficiency improvement initiatives. Now, let's focus on our operating activities and related expenses. Please note that we are presenting our operating expenses on a non-GAAP basis by excluding share-based compensation expense from our GAAP numbers to provide better clarity on the trends of our actual operating base expenses so that you can review performance in the same way as our management team. During the quarter, non-GAAP total operating expenses decreased by 21.1% to $49.1 million from $62.2 million in the same quarter of 2021. Specifically, non-GAAP R&D, sales and marketing, and G&A expenses decreased to $33.8 million, $13.2 million, and $5.3 million, respectively, and other operating income net was $3.2 million. The significant improvement in the non-GAAP operating expenses was mainly due to the large decrease in basic employee-related costs, such as payroll and benefits, partially offset by one-off additional costs arising from headcount optimization and restoration as well as indemnification related to rental termination. Our average salaried employee headcount during the quarter decreased by approximately 23% year-over-year. Dynamic adjustments will be made based on the current scale and overall organization objective to achieve further improvement, if any. We optimized operations during the quarter, especially with 2 major initiatives to improve our technology research and development efficiency. Let me give you some examples. First, we established an R&D Project Review Committee to carefully reevaluate each of our R&D projects and develop an itemized evaluation system to conduct value management on the aspect of internal efficiency improvement, key and the core capability construction, and opportunities and the revenue generation. Approvals from the Committee led by our CTO and Head of Business Units, along with their refined budget models are required for projects to be executed. Second, we completed the classification of R&D team resources into 4 types in order to allocate resources by type to our R&D objectives to manage R&D more efficiently. We also optimized other aspects of operation. For example, in terms of inventory, we retired more than 1,000 redundant material codes, improving the speed of system processes and laying a good data foundation for further in-depth operating analysis. We also launched a system function to collect service fees to recover the internal time costs incurred in executing less cost-effective activities so as to promote order bundling and improve customer service efficiencies. Regarding employees, we launched an action plan named 100-day sprint, to encourage our employees to make accelerated progress. We also launched a Project 360 evaluation project to help most potential employees achieve outstanding improvements in the workplace. Now, turning to the bottom line. Our non-GAAP loss from operations narrowed by 15.9% to $22.3 million in the quarter from $26.5 million in the same period of 2021, and our non-GAAP net loss narrowed by 19.1% to $18.7 million in the quarter from $23.1 million in the same period of 2021. Our non-GAAP operating margin and non-GAAP net margin in the quarter were negative 35.6% and negative 29.9% compared to negative 31.3% and negative 27.3% in the same period of 2021, respectively. If we further exclude one-time additional expenses related to operating efficiency improvement initiatives and expenses that were irrelevant to daily business operating activities, our non-GAAP operating margin and non-GAAP net margin for the quarter would improve to negative 31.2% and negative 22.7%, respectively, after a sequential decrease during the last 3 quarters. That indicates that our measures to address market headwinds are showing early success. Moving on to the cash, you can refer to our earnings release of operating cash flows during this quarter. Our operating cash flow, excluding the cash received from the ADS sharing program has improved significantly to an outflow of $1.5 million in this quarter compared to the outflow of $7.2 million, $46.1 million, $53.2 million, and $57.4 million for each quarter since last Q2 to this Q1. As of June 30, 2022, cash, cash equivalents, and short-term investments were $951.5 million. We believe this balance is sufficient to meet our liquidity and working capital needs for the foreseeable future. The sufficient capital reserves are one of our greatest advantages, giving us resilience to navigate an adverse macro environment. Finally, turning to our share repurchase program. During the second quarter, we repurchased approximately 11.2 million ADS on the open market at a cost of approximately $30.0 million. Today is the end date of our share repurchase plan authorized on August 30, 2021. We have completely bought back 23.1 million of ADS with total cost of $109 million, which represents our commitment to shareholders and the market and shows our high confidence in Tuya's long-term growth prospects. Before I close, I would like to emphasize that the global consumer discretionary industry and consumer spending are expected to be challenging in the second half, due to softening economy conditions, high global inflation, the downstream inventory glut, and greater competition brought on by technology iteration in the IoT industry or other factors that are outside of our control. You can refer to the business outlook section in our earnings release for more details. Despite these challenges, we are confident in our long-term growth prospects and are committed to iterating our products and services, further enhancing our software and embedded hardware capabilities, expanding our customer base, diversifying our revenue streams, and further optimizing operating efficiency. With that, operator, we are now ready to take questions. Thank you.

Operator, Operator

We have our first question from Liu Yang from Morgan Stanley.

Liu Yang, Analyst

Let me rephrase my questions. It's focused on the demand situation. My first question is what the management outlook is regarding the demand inflection point, based on conversations with key customers and their business plan inventory levels. Additionally, considering the current weak demand, is there a possibility for Tuya to experience improved demand due to gaining market share?

Jessie Liu, CFO

Okay. So to address your question, first, we have not seen signs of a turning point of overseas demand for IoT consumer electronics devices yet. And we feel the turning point will only come when the inflation has significantly improved, and the inventory backlog is cleared at the retailer and the brand side. So let’s take an overall look at the global economy and the feedback from our customers. In the United States, for example, according to the latest, our brand customers’ feedback, consumer electronics retail quantity is currently down about 30% year-over-year at the retail side. The decline, combined with the retail channel and brand inventory backlog pushes the brands to a more conservative approach. So they place fewer orders to OEMs. So it wasn’t surprising to see OEM purchase orders from brands shrink by as much as 50%. In Europe, the European Central Bank raised interest rates by 50 basis points in late July to curb high inflation. This is Europe’s first rate hike since 2011, just as Europe struggles with record inflation triggered by COVID and the war and the rising food and energy prices. According to Eurostat, Europe’s annual inflation rate jumped to 8.9% in July, more than 4x the ECB’s inflation target of 2%. So we have seen Europe is experiencing a significant weakening demand for discretionary products, which include IoT consumer electronics devices. So basically, our European customers are giving similar feedback as U.S. customers. In China, one of the more representative figures of Chinese consumer spending is the number of smartphone shipments. Based on IDC report, shipment in the Chinese smartphone market declined by around 15% year-over-year in the second quarter. Also, based on numbers from the National Bureau of Stats, total retail sales of consumer goods nationwide fell 4.6% year-over-year in the second quarter. So overall, the global economic environment is becoming more complex and challenging, energy and commodity prices are rising and the imbalance between supply and demand is increasing, adding more downward pressure on the global economy. We think the weakening of demand for IoT consumer electronics devices will continue until inflation shows significant improvement. We will continue to work to improve our efficiency and continue to set breakeven as one of our core priorities. Regarding our business in China, we have highlighted several business opportunities earlier. Companies nationwide are facing challenges due to the resurgence of COVID during the second quarter. However, we still added many like-minded partners. For example, we helped the leading portable power energy storage brand, Hello Tech Energy, develop an outdoor portable power supply. We partnered with a world-renowned smart energy system solution provider, CHINT Group, to develop the prepaid electricity meter and management system. This partnership will enrich our energy-saving related product capabilities from both software and hardware aspects. We believe these capabilities will further complement our core IoT business. To fight against this quite negative environment of inflation and downward consumer demand, our strategy is more to expand young consumer electronics. In terms of IoT PaaS, we are making progress in developing the business of, for example, energy-related equipment, IoT or commercial and industrial environments. In Q2, close to 2% of our current IoT PaaS shipment went through the industrial segment. So it’s outside of consumer electronics, including industrial sensors, professional lighting or commercial lighting, industrial energy reservation products, commercial and industrial security products, and central HVAC equipment for large commercial buildings. At the same time, we are expanding our customer base beyond the consumer electronics devices industry through our multiple SaaS offerings. So we believe that expanding the young consumer electronics is a good strategy for the company long-term. So I hope this answers your questions, and we can go to the next one.

Operator, Operator

Next question we have from CICC.

Unidentified Analyst, Analyst

Let me translate it quickly. So in July, Tuya and Amazon launched the Matter solution and expected to complete some operating capital with other products. From a Matter perspective, do you see the salaries and how do you see the potential impact on the industry?

Jerry Wang, CEO

Okay. Thank you for the question. We can look at Matter from both a commercial and technology development perspective. As an early adopter, Matter and also a key Board member of the Connectivity Standards Alliance, Tuya has officially launched two enabled solutions this year. Matter is the connectivity protocol that connects local smart home common functionality. Simply put, using the Matter protocol, devices can be directly shared with the Apple HomeKit or connected to different brands of smart speakers such as Alexa and Google Assistant without having to be interfaced in the development process to achieve basic local interaction. This will be very convenient for developers of IoT products. We believe such technology progress will further promote IoT penetration rate for — especially for smart home devices. From a business and market perspective, there have been no significant technology or perception changes in the market over the past 2 years regarding connectivity protocols. Matter belongs to local general control, which cannot replace the cloud control or exclusive special function with multiple device interaction. This experience differs greatly compared to the mature and mainstream Wi-Fi products nowadays. So it is estimated that after the release of the first solution, it will take a period of time for adjustment and adoption to evaluate its actual performance. Some of those IoT products with very simple limited functions, they chose direct connection as the path to ship IoT. Both products will have increasingly rich IoT capabilities and personalized demand, but cloud service will still be a rigid requirement. Overall, we will — Tuya will incorporate Matter into our technology system based on one-stop capabilities, including Wi-Fi threat and especially gateway and central controller, as well as our product level solutions across all categories. While adjusting the need for standard local connectivity features, our cloud-based IoT capabilities, software algorithms, and app capabilities will help make devices within Matter protocol smart. In addition, our Matter solution will enable customers to achieve information transfer and OTA upgrades with smart devices directly through the Tuya IoT PaaS without having to rebuild DCL servers. Overall, with the Matter, we have participated in various tests of project measures and brought first-time installation to our customers. We believe our customers will make the best choice for their products and the business which we can totally support.

Operator, Operator

Next question, we have John Wang from Goldman Banks.

John Wang, Analyst

We have been able to now. What's your plans on headcount in the second half of this year and the cost control measures? And also maybe refresh road map and target for the margin this year?

Jessie Liu, CFO

Thank you, John. In today's report, we addressed the effect of Q2 expenses on our non-GAAP operating margin and non-GAAP net margin. Our efficiency and optimization efforts in Q2 had a positive impact on our income statement and cash flow. Therefore, we plan to continue this approach in the second half to manage our operations and maintain expense control while seeking ways to more efficiently support our operations, sales, product, and R&D systems. Our organizational structure and internal adjustments are based on the strategy we established at the beginning of 2022, which focuses on upgrading our product and research associated with the Cube smart private cloud offer, expanding our business in China, and forming the Tuya Plus Triangle team to enhance our focus and attract more key accounts. We have distinct goals and strategies for each development stage. Additionally, we are transitioning from a platform centered on consumer electronic products to leveraging our experience and technical edge in IoT PaaS for the industrial sector, targeting key customer strategies. During the initial phase of team restructuring and scaling, we aligned our personnel based on suitability principles. We comprehensively evaluated various factors like business demands, development stages, and demand characteristics to assign teams and members who provide targeted support and expansion. For instance, with the private cloud, many clients require the integration of technical details with intricate market needs. Thus, we have deployed our experienced sales manager, product manager, and project manager to systematically offer services from a presale solution and delivery perspective, overcoming traditional personnel conflicts. We are adopting a similar approach for R&D. More detailed efficiency metrics have been previously discussed, so I won’t reiterate them. Regarding the management of our other business unit, the functions and teams of DNA are relatively straightforward to adjust, leading to improvements in human efficiency and therefore reducing costs. However, due to our listing in Hong Kong this quarter, professional fees like compliance auditing will see a slight increase moving forward. Overall, we aim to achieve a suitable team size through efficient operations and fine-tuning adjustments while supporting our new strategies, developing platform products, enhancing core capabilities, and managing R&D tasks. At our current scale, we will continuously assess market demand and business expectations to ensure our output efficiency and financial results align with our objectives. Thus, we will regularly evaluate our employee headcount. Currently, we see significant opportunities to enhance our operational efficiencies through various initiatives. Our commitment to making breakeven a top priority for the company remains unchanged, and we will actively pursue different strategies to achieve this goal as soon as possible.

Operator, Operator

Thank you. I will now hand you back to the management team for the closing remarks. Please go ahead.

Jerry Wang, CEO

Okay. So, thank you again for joining our call today. If you have any further questions, please feel free to contact us through our IR website. We look forward to speaking with everyone on our next earnings call. Have a good day.

Operator, Operator

Ladies and gentlemen, this concludes today's call. Thank you for joining, and you may now disconnect your lines.