Earnings Call Transcript - TUYA Q2 2023

Reg Chai, Investor Relations Director

Good morning, good evening ladies and gentlemen. Thank you for standing by and welcome to Tuya Inc’s Second Quarter 2023 Earnings Conference Call. I’ll now turn the call over 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, Founder & CEO

Hello, everyone. Thank you for joining Tuya's Q2 2023 earnings conference call. The second quarter of 2023 marked a significant milestone for us. For the first time in our company's history, we have achieved a quarterly breakeven and recorded modest profit on a non-GAAP basis of approximately $1.5 million, translating to a non-GAAP margin of around 2.7%. Moreover, we achieved a positive operational cash flow for the quarter, bringing in about $7.5 million. This moving to positive non-GAAP profitability and the expansion of positive operating cash flow marked a turning point in our overall day-to-day operations. This signifies our growing capacity to generate value and the intentional responsibility for any enterprise and business operations. Undoubtedly, this accomplishment attests to the dedication of our team and the strategic operational adjustments we have implemented over the last two years. Each member of our organization has played a crucial role in this milestone. Going forward, we remain firmly committed to focusing on further refining our operations, both structurally and functionally, seeking avenues to enhance efficiency and reduce costs. Our aim is to ensure consistent financial performance and progress towards achieving breakeven at the non-GAAP operating level. In the second quarter of 2023, our total revenue reached approximately $57 million, representing a sequential growth of around 20%. This marks the third consecutive quarter of sequential growth. Comparing year-over-year, there was an 8.9% decline in our total revenue. The factor in this was the currency fluctuation, particularly the weakening of the RMB against the U.S. dollar, which accounted for around 5.6 percentage points of the year-over-year decline. Excluding the impact of the currency fluctuations, our total revenue was close to flat year-over-year. It's worth noting that the resurgence in consumer demand has not yet reached its full potential and the cautious operating strategies adopted by downstream businesses during the destocking cycle persist, thereby impacting this quarter's results. Our overall gross margin is about 46.7%. Within this figure, the gross margin for IoT PaaS climbed back to 44.2%. Meanwhile, thanks to the successful implementation of the IoT device solution strategy, the gross margin of our smart device distribution segment rose to 23%. Our software and value-added services maintained a steady gross margin of 74.5%. Of particular note, our cloud storage services have been consistently generating solid cash flows and stable revenues, marking its transition into a period of scalable growth. Regarding our corporate operational management, our non-GAAP operating expenses for this quarter showed a sequential decrease, a testament to our stringent cost budgeting across all departments. When we speak of efficiency, our revenue supported by headcount and gross profit supported by headcount reached historical highs in this Q2, following several quarters of continuing improvement. Now let's dive into some business updates from the second quarter. In terms of our business strategies, our focus remains on three key areas: executing our customer-focused strategy, improving our IoT developed platform, and continual product enhancement. Development of the IoT platform continues to be favored by top-tier customers. In early June, we held a signing ceremony in collaboration with our customer, Haier Group's new energy brand, Green New Energy Technology. Together, we aim to jointly develop smart devices for home energy management, including PV, storage, charging devices, and heat pumps and to establish a smart home energy management platform. We initiated services for a prominent listed company with a market cap close to RMB 100 billion and the leading player in the electrical and home appliance industry. Tuya will provide them with the residential energy storage EMS management system. Combined with the smart communication stick solution, we have secured a partnership with a leading Swedish retailer whose distribution channel extensively covers the Nordic region and whose business focuses on DIY and home products. All smart home brands under their umbrella were utilized in our platform. Additionally, we have newly acquired a renowned global brand specializing in engineering joint products and irrigation equipment, which is also a subsidiary of a European-listed leading company in engineering jointing technology. They predominantly cover markets in North America, Europe, and Australia, and have already made payment to commence preliminary preparation related to their IoT app industrial. Tuya's smart private cloud product also continued to help us acquire top customers. We've recently forged an agreement with the subsidiary of a leading real estate conglomerate in Thailand, marking our third private cloud collaboration in the country. Tuya's growing presence and influence in Thailand are underscored by our collaborations with influential local companies, including conglomerates, telecommunications operators, and top real estate groups. The insights and experience gathered from our ventures in the Thai market will serve as the strategic roadmap for our expansion into other countries. As we continue to enhance the IoT developer experience, we're now also exploring opportunities and value beyond consumer electronics with developers and enterprises. For example, the energy saving sector with its practical and sustainable nature garnered significant attention from global corporate customers. In light of this, we showcased the Tuya residential PV energy storage solution at AWE. Additionally, these modular proficiencies have been seamlessly integrated into our SaaS offerings. A case in point is Tuya's SMB Bluetooth mesh lighting control solution, empowering small and medium-sized businesses to easily achieve a green energy-efficient indoor environment. Our smart device distribution business is an integral component of our software and hardware enrichment strategy, which has mainly originated from new customers we acquired since our strategic realignment in the middle of last year. The gross profit of the segment in Q2 was approximately $1.49 million, marking a sequential growth of around 13.8% and a year-over-year increase of around 58.2%. The overall gross margin was 23%. Our flagship product solutions such as Zigbee gateways and sensor control screens as part of the IoT solution model contributed to the healthy comprehensive smart device gross profit. Regarding our product lines, in Q2, the comprehensive revenue from our voice sensor control product line registered a year-over-year growth surpassing 50%, with the smart device solution model seeing an impressive year-over-year surge of approximately 280%. From an industry standpoint, sensor control products act as the entrance for our interaction, processing the capability to replace traditional panel switches in a variety of settings, indicating a dynamic and swift growth trajectory. Tuya boosts competitiveness in this sector. Our sensor control product solutions encompass a diverse area of operating systems and panel firmware. This also extends to software-as-a-service features like multimedia, visual intercom, gateway, and gestures. In terms of hardware, we offer full-size adaptability support for all communication protocols and integration with popular controller ICs, meeting the product requirements of mainstream brands worldwide. The dual model of IoT PaaS and smart device solutions underpinned by our software and hardware enhancement strategy has provided our customers with a broad spectrum of choices. For instance, key customers can leverage the IoT PaaS model incorporating OS, cloud, and App SDK in accordance with their unique business needs and organizational characteristics, enabling them to foster a more autonomous business development environment. At the same time, some cross-sector multinational corporations, SaaS service providers, and integrators can choose the smart device solution for a streamlined and habitual market entry, which in turn further drives the sustained generation of software revenue. Our SaaS and other segments reported year-over-year revenue growth of 30.2% as Q2 revenue reached $9.4 million. Breaking this down to key products, as previously mentioned, our cloud storage value-added services consistently demonstrated strong revenue characteristics. Amid the steady growth in device scale, these services have continuously delivered high-quality revenues at the millions of dollars level, more than doubling year-over-year. As for SaaS, sectors such as hotels, rental, and real estate achieved moderate year-over-year growth despite the soft economic cycle. Conversely, commercial lighting, falling within the broader light industry, experienced a year-over-year decline attributable to macroeconomic challenges. I also want to highlight another milestone we achieved in May 2023. Tuya officially became the world's only company to offer support for both vendor identification, the VID, and non-VID scope to product attestation authority, the PAA, within the matter of a full-stack solution. This allows us to sign product attestation intermediates for VID to meet the requirements of any eligible alliance member. As a result, Tuya is capable of not only reducing the cost of matter device certification for developers, but also facilitating them in those and controllable authentication process, allowing developers to advertise their products faster to market. Moreover, Tuya can also provide comprehensive lifecycle management for PAA certification, enabling developers to focus on device development while enjoying a similar experience. Overall, during Q2 and the first half of 2023, the consumer electronics segment continued to face pressures from high inflation and the associated inventory implications. However, there are encouraging signs globally. For example, inflation rates in Europe and the United States have descended to their lowest level in over two years. Anticipated sales for several IoT smart device categories are trending towards positive year-over-year growth. Given this external change and our internal metrics, we believe that we have navigated through the toughest times and we expect to return to year-over-year revenue growth in the second half of the year. Our leaner and more streamlined operational structure also gives us the confidence to pursue ongoing improvements in our financial performance. As we look ahead, we are looking forward to a future of sustained and steady growth.

Yao Liu, CFO

Thank you. As I review our results, please note that all amounts are in U.S. dollars and all comparisons are on a year-over-year basis, unless otherwise stated. In the second quarter of 2023, our total revenue reached $57 million and our gross profit was $26.6 million. Both metrics have shown sequential improvements over the past three consecutive quarters. However, both metrics recorded a decline on a year-over-year basis. When we excluded the impact of the depreciation of the RMB against the USD, which now has an exchange rate surpassing 7.2, our revenue essentially remained stable compared to the same period last year, while our gross margin showed a 6% increase from the same period last year. Considering the currency rates, we anticipate facing ongoing challenges related to currency exchange in the third quarter. The global consumer electronics sector is grappling with the pervasive impact of heightened inflation. However, our forward-thinking and strategic interventions have yielded encouraging results. By adopting a customer-focused strategy, our average revenue per customer increased sequentially. Additionally, we've reported a significant uptick in revenue and gross profit per employee basis and have noted a more equitable distribution in geography revenue contributions, fortifying our position against market headwinds. Our blended gross margin for the second quarter expanded to 46.7% from 42.8%, achieving a historically high level since our inception. I'd like to emphasize the gross margin is pivotal for the long-term sustainable growth of the company, reflecting the value of our services and products bring to customers and securing our profitability. This margin is a testament to our value proposition, the efficiency of our operations and our balanced approach between profitability and growth. In the second quarter, our IoT PaaS gross margin increased to 44.2% from 42.5% in the same period last year. This uplift contributed 1.2 percentage points to the year-over-year expansion of our blended gross margin for the quarter and represented a significant rebound of 3.7 percentage points from the first quarter. We are confident in the value proposition of our IoT PaaS products distinguished by our unique software capabilities, leading IoT functions, as well as effective pricing strategies under management. However, given the macroeconomic downturn and inventory backlog leading to slow-moving issues across many enterprises, our holding in IoT chips was not exempt from this pressure. To adjust this, we have refined our inventory management strategy, emphasizing prudent control over chip inventory levels and strategic purchasing decisions. Furthermore, we've been guiding our customers in their IoT solution selection and when necessary, utilizing specific pricing strategies to facilitate inventory reduction, therefore alleviating the financial impact of inventory allowances. In the second quarter, we have effectively minimized the impact of these allowances. While it's essential to recognize that inventory management and potential write-downs are dynamic areas influenced by market conditions, we remain confident in our ability to maintain them within reasonable levels. Overall, as our core business, we believe that IoT PaaS will continue to be a stable and robust contributor to our profitability. The gross margin for our smart device distribution segment in the quarter reached 23%. This segment has evolved from initially facilitating customers in acquiring smart devices quickly, easily, and cost-effectively to providing logistics value and support for clients with IoT solutions, aiding them in expanding product categories and penetrating new markets. In the second quarter, the smart device distribution segment contributed 1.3 percentage points to the year-over-year growth of our blended gross margin. The gross margin of our SaaS and other segments was at 74.5% in the second quarter, characterized by its diverse composition, including SaaS, B2B, and B2C value-added services, apps, and various customer developments and smart private cloud projects. Notably, as our cloud storage revenue continues to grow, its profit contribution has become even more significant, accounting for approximately 1.8 percentage points of the year-over-year growth of our blended gross margin in the quarter. The consistent financial performance from this high-value software value-added services coupled with the expansion of our device ecosystem further affirmed our strategic direction and confidence for the future. Moving on to our operating activities and related expenses. We are presenting our operating expenses on a non-GAAP basis by excluding share-based compensation expenses and the credit-related impairment loss from our GAAP numbers. This credit-related impairment loss stems from our strategic investments in certain IoT-related private companies. Some of these companies have encountered operational difficulties after facing two years of headwinds, leading us to provision for impairments. However, this has no material impact on our operations and business. Therefore, we've excluded from our GAAP numbers. We believe this provides better clarity on the trend of our operating expenses aligning with how our management team reviews our performance. In the second quarter of 2023, our non-GAAP total operating expenses decreased by 32.7% to $33 million from $49.1 million in the same period last year. Our employee-related costs, excluding share-based compensation, declined by 33.2% year-over-year in Q2, and the cost related to office and property leasing concurrently decreased by 51.6%. Combined, this cost represented about 75% of our total non-GAAP operating expenses in Q2. As of now, our team's size has been further streamlined to around 1,500 employees. We continue to explore opportunities for further optimization in both our business and organizational structure. Marketing and promotion expenses decreased by 70.1% year-over-year, highlighting our commitment to budget control. Travel-related expenses were nearly flat year-over-year and decreased sequentially. Cloud infrastructure costs now remain at a stable level, flat year-over-year. Our team remains committed to striking a balance between driving innovation, enhancing our cloud platform, and maintaining a large stable global operation system, all while focusing on our cost efficiency. Professional fees under G&A expenses dropped by 23.4% from that of Q1 following our annual reporting activities in the U.S. and Hong Kong. Year-over-year, professional fees were down 30.7% compared to the same quarter last year. We are pleased to report that these overheads are now consistently managed and were contained. The company remains dedicated to ensuring quality corporate compliance and professional services at a cost-effective rate. During Q2, we generated approximately $12.1 million in deposit interest income because of our conservative capital strategy. The income was recorded as our financial income for the quarter. As a result of our consistent efforts over several quarters, our non-GAAP net loss has been steadily narrowing in the past quarters. In Q2, we achieved profitability by reporting a non-GAAP net profit of $1.5 million, translating to a non-GAAP net profit margin of 2.7%. This transition from a loss to a profit is a significant milestone for us. With encouraging indications from our business evident from stable gross margins and our disciplined approach to expense management, we remain optimistic about sustaining and progressing our financial trajectory. Moving on to cash. As of June 30, 2023, our cash balance, cash and cash equivalents, as well as short-term investments reached $42.3 million. This represents a slight increase from the end of Q1, primarily due to an expansion of operating cash flow of $7.5 million. While cash flow is nominally subject to fluctuations in working capital changes and payment terms, our operating cash flow now stays at a much better level compared to a year ago. Furthermore, our financial position remains strong. Our accounts receivable turnover is less than a month with the majority of our business collaborations requiring prepayments from customers. Our liability-to-asset ratio has consistently remained at or below 10% since 2021, and we have always been free from any interest-bearing liabilities or long-term capital commitments. Finally, as articulated in Jerry's strategic outlook, we remain confident in the long-term perspective of our company.

Yang Liu, Analyst, Morgan Stanley

Let me translate my question. First, I congratulate you for achieving non-GAAP breakeven this quarter. My question relates to demand. In recent months, we have observed that export data from China is quite weak. Based on Tuya's communication with downstream entities, such as OEMs in China, how is their customers' demand outlook impacted by the weak export numbers? The second question concerns customer inventory. We are pleased to see that management expects year-on-year revenue growth in the second quarter to turn positive. Is this due to the customer inventory digestion nearing completion, and are they preparing to restock their inventories?

Yao Liu, CFO

About demand, to start with the conclusion. Over the past few months, we have actually observed an ongoing improvement in inflation in Europe and the U.S. The total sellout of IoT products for all our brand customers during the first half of this year showed a modest year-over-year growth. Despite noticing a recent weakness in China's export numbers, we hold a cautiously optimistic view towards the future demand for end consumer IoT electronic products. From a macroeconomic perspective, there's been a notably easing inflation. As of July 2023, the inflation rate in the European Union has dropped to 5%, while the U.S. saw a slight rebound to 3.2% in July following a decrease to 3% in June. Since peaking in the mid to late last year, the decline has been pronounced especially in the first half of this year. However, both from the CPI figures and the core CPI indicators suggest that the risks associated with inflation are not completely eliminated, and the prices of some consumer goods remain high, requiring continuous observation by companies in this sector. In China, after a first half year resurgence in travel-related spending, retail sales of consumer goods in the middle of the year dropped to a lower single-digit year-over-year growth rate, but stabilized in July. Regionally, our perception is that the overall trend is similar across the regions, but with differences in detail. For example, in the United States, although the overall consumer electronics market was sluggish in Q2, there was still decent demand for home appliances followed by relatively stable year-over-year growth for safety products and improvements in the situation for electrical products. In Europe, primary countries maintained a good rebound in consumer spending with strong demand for energy efficiency-related products. We've seen a strong resurgence in categories like gateway controls, safety sensors, and some home appliances, electrical products. In China, based on official data and the rebound in travel, tourism and food spending during the first half of the year, consumer electronics like cellphones exhibited weak performance. However, due to demand for safety and energy efficiency, certain categories stood out even amidst the overall weak electronic demand. Other emerging global markets for smart products, such as Southeast Asia, the Middle East, and Latin America have rebounded quite well. However, the lighting segment continues to face pressure from the performance of leading global lighting companies that have reported their results. Overall, we believe that the long-term development trend for the IoT consumer electronics sector should be steady and consistent. Both enterprises and consumers will continue to explore and focus on realizing the value of IoT against the backdrop of being the world's leading IoT cloud platform with a high market value, the overall growth pattern should align with the overall brands and the sellout growth trend in the industry. In regards to the inventory question, by the middle of this year we observed that our downstream inventory has markedly improved, and we expect it will return to a healthy level by the end of this year. At the end of last year, we devised a method to estimate downstream inventory levels by comparing the total IoT device activations with our sales. This downstream includes OEM brands, retail channels, and all other entities between us and the consumer. We previously anticipated that downstream inventory would continue to be digested throughout 2023 and by the end of this year would return to healthy levels seen in 2019 and 2020. Current downstream inventory progress aligns with our expectations. Our recent service of top customers worldwide also indicate varying paces due to individual business plans or strategies. However, the general feedback suggests that inventory management has returned to a controllable state. Two years ago, the consumer electronics supply chain built excessive inventory during 2 to 3 quarters due to chip shortages and price hikes. This was followed by an almost two-year inventory destocking cycle. We believe that moving forward, businesses in the consumer electronics value chain will operate more rationally and learn less from past inventory management cycles. Considering the positive inflation trends and nearing the end of a two-year inventory destocking cycle, we are confident that after a pause of six quarters, our revenue will show year-over-year growth in the second half of the year.

Timothy Zhao, Analyst, Goldman Sachs

Congratulations on the strong results. I have two questions. First, could you provide insight into the expected gross margin trend for the second half of this year, given your guidance that revenue will improve year-on-year? Secondly, regarding generative AI, I noticed that you launched certain products and shared service strategies a few months ago. Can management provide further insights on how to meet the demand for generative AI and how that will affect your business model?

Yao Liu, CFO

Thanks for Timothy's question. First, let me address the gross margin question. Beyond promising signals in revenue, we're particularly inspired by our gross margin. Since Q1 of 2019, our gross margin has consistently improved from an initial 24% to almost 47% this quarter. Despite challenges like the pandemic, inflation, and inventory issues, several reasons contribute to the steady improvement of gross margin. Firstly, the proportion of high-margin products in our IoT PaaS business has been increasing. Secondly, the overall high-margin SaaS sectors' revenue contribution to the total revenue has been continuously growing, reaching about 16% in Q2 2023. Lastly, the transformation of the business model within our smart device distribution business has made a significant improvement in gross margin, moving from about 10% to now 23%. Looking forward, we expect to maintain a steady gross margin. We are also focused on the company's growth and exploring new directions. With initial trials of new business, we usually present more aggressive gross margins to attract new customers, but balance that by expecting a steady gross margin in the near future. In regard to the second question about AI, during the AI boom in Q1 this year, we shared our insights and direction. We are optimistic about the upgrades and efficiency that AI and AIGC can bring to IoT developers and end users. Our perspective remains consistent, and we are currently working on various AIGC-related projects. Firstly, a common approach in the IoT industry is the utilization of AI in customer services. We are leveraging AI to empower Tuya's customer support, which will enable more intelligent and flexible conversations with users, thereby providing higher quality and personalized services. Additionally, by training on Tuya's documentation, we can pinpoint end user issues with more precision, enabling automated responses and interactions. This enhances the user experience and significantly boosts efficiency for end users, enterprise developers, and Tuya's internal R&D team. Another direction is to empower developers, for instance, Tuya's SaaS development framework now allows for auto-generating service codes based on described requirements such as device inquiries or scenario inquiries. This ensures that when developers are creating their IoT device management performance or similar needs, they can significantly improve efficiency while maintaining code quality and consistency. The third focus area is AI assistant apps, which can be integrated into mobile apps or central control panels with interactive screens. This AI assistant will allow end users to seamlessly set up and manage IoT scenarios. For example, when a user states a request such as analyzing energy consumption from a specific timeframe, they can instantly view the corresponding analysis results along with personalized recommendations for energy savings or other usage scenarios. Additionally, we assist enterprise clients in generating device management strategies using AI. Specifically, we train several popular language models based on industry verticals, creating professional models that understand device operation and energy-saving requirements. The goal is to make the entire process easier, with users clearly communicating their needs, allowing for predictive device usage under different strategies, thus presenting various optimization options. The overall aim is to enhance user energy efficiency and comfort. It's essential to note that AIGC's most notable feature is the transformation of human-machine interaction methods. Whether the output meets expectations, its commercial viability, and how cost-effective AIGC is in various scenarios remain complex questions. It's still at an early stage of our AI journey.

Mingran Li, Analyst, CICC

Let me rephrase my question. My first question is about which types of projects in PaaS and what downstream scenarios you think will be better positioned to support our growth for the full year despite relatively weak demand. My second question concerns this quarter, which is significant because it's the first time you reached breakeven profitability on non-GAAP net income sooner than expected. Could you share more insights on the trends towards reaching breakeven in the future?

Yao Liu, CFO

Thank you for the CICC's question. Let me first address the growth patterns of different categories. The differences in our various business categories are quite noticeable. Our performance aligns well with the trends outlined earlier for each region. However, between Tuya and the final consumer, the business operations and the decisions of downstream companies also play a significant role. This quarter, our performance was significantly hampered by the lighting sector, but most non-lighting sectors have already achieved modest year-over-year growth. For example, the safety sensor sector has remained almost level year-on-year. This can be attributed to the fact that during volatile periods, fundamental demand for safety and protection remains stable. The home alliance sector has shown year-over-year growth since the first quarter of last year with an impressive exceedance of 20% growth in Q2. It's a very positive sign. Furthermore, we remain bullish on the renewable energy segment itself as well as the value generated by integrating renewable devices with other IoT home devices. While we're just starting, we believe we are among the globally competitive enterprises in integrating home alliance IoT with new energy products. Our residential PV energy storage IoT solution displayed at AWE this year manages traditional household electricity consumption while visualizing real-time energy flow from solar power generation into energy storage batteries, distribution, and consumption to electric vehicle charging. It can optimize energy usage strategies and assist homeowners in managing household energy efficiently, especially in markets like Europe and Australia. In terms of SaaS segments and smart scenarios, we've discussed cloud storage and intelligent business areas previously. There are distinct differences in business models and products. For instance, software services addressing end-user needs have a more pronounced advantage. SaaS being a direct B2B offering is greatly influenced by corporate budget decisions and business development efforts. However, we remain resilient in this area. The pandemic disrupted the global promotion of our SaaS offerings years ago, but as restrictions eased towards the end of last year, we restarted our efforts, focusing mainly on the China market and Southeast Asia regions, making steady progress. In Thailand, we secured a project with listed groups, and furthermore, we replicated our benchmark projects in Spanish student apartments, securing another project in the U.K. Regarding profitability, we will continue to prioritize achieving a non-GAAP operating breakeven as a key goal. While maintaining the quality of business operations, we will explore new avenues for growth. Our primary operational focus includes maintaining an efficient organizational scale and seeking areas for adjustments and optimization. We will consistently identify methods to reduce costs and improve efficiency within our operations, including refining our business models moving forward. Furthermore, we aim to achieve our non-GAAP operating breakeven within the next few quarters, sustaining non-GAAP net profit in the future. Thank you all again for joining our call. If you have further questions, please feel free to contact us or request through our IR website. We look forward to speaking with everyone in our next earnings call. Have a good day.

Operator, Operator

This concludes today's call. Thank you for joining. You may now disconnect.