Earnings Call Transcript - ZEPP Q4 2023

Operator, Operator

Hello, ladies and gentlemen. Thank you for standing by for Zepp Health Corporation's Fourth Quarter and Full Year 2023 Earnings Conference Call. At this time, all participants are in listen-only mode. Today's conference call is being recorded. I will now turn the call over to your host, Ms. Grace Zhang, Director of Investor Relations for the company. Please go ahead, Grace.

Grace Zhang, Director of Investor Relations

Hello everyone, and welcome to Zepp Health Corporation's fourth quarter and full year 2023 earnings conference call. The company's financial and operating results were issued in a press release via the newswire services earlier today and are posted online. You can also view the earnings press release and slides referred to on this call by visiting the IR section of the company's website at zepp.com. Participating in today's call are Mr. Wang Huang, 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 made under the safe harbor provisions of the US 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 are included in the company's annual report on Form 20-F for the fiscal year ended December 31, 2022, and other filings as filed with the US Securities and Exchange Commission. The company does not assume any obligation to update any forward-looking statements except as required under applicable law. Please do note that GAAP 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 contains 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. Please go ahead.

Wang Huang, CEO

Hello, everyone. Welcome and thank you for joining our call. In 2023, amidst global macroeconomic uncertainties, our ROI-oriented strategy and ongoing business model transformation began to bear fruit. This strategy shift has enabled us to strengthen our commitment to becoming a global provider of cutting-edge, smart, wearable healthcare solutions. Before we dive into our earnings, I would like to spend some time talking about our strategy as we reflect on 2023. Over the past two years, we have been on a transformative journey to become less dependent on Xiaomi branded products and instead develop a self-reliant company driven by its self-branded product sales. This shift is starting to show promising results, as evidenced by our two consecutive non-GAAP profitable quarters. Looking at 2024, building on the actions we have taken in the past, we are excited to be making a strategic leap and harnessing the synergy between our product and sales channels. This leap forward is grounded in three core pillars. First, we are putting greater emphasis on R&D and product-driven innovations where we will fully embrace AI and offer more innovative products that closely align with the needs of our key markets. Second, we are continuing to ensure profitable growth, maximizing the value we derive from each and every product sold. Guided by this approach, we are choosing profitability over scale in some regions, such as India, which transitioned in 2023 from a loss-making market to a profitable one. In certain other areas, we are investing aggressively to gain market share, aiming to generate long-term returns. Last but not least, we will invest in branding and marketing communications in order to enhance our brand presence by welcoming our Amazfit athletes and increasing sponsorships of big sports events. I believe you will see the Amazfit brand more visible across the world in the coming quarters. With these three pillars, I am confident we can propel our growth and generate a higher return for our employees and shareholders in the long run. In the fourth quarter of 2023, our focus on strategic transformation towards a more self-reliant revenue stream has gained traction, aimed at reducing dependency on a single customer, lowering revenue concentration, and shifting our emphasis increasingly on self-branded products. These efforts to become self-reliant have made significant progress. As a result, despite a year-over-year decline in our revenue during the fourth quarter, our self-branded products maintained sequential growth momentum with a quarter-over-quarter growth of 14.8% and contributed to 91% of our top line, up from 77% in the previous year. Notably, our gross margin reached a record high in the fourth quarter, a testament to our effective prioritization of profitability over scale. This significant achievement was largely driven by our higher margin self-branded products. The launch of the Amazfit Active and Amazfit Active Edge series in Q4, as well as the Amazfit Balance special edition, enhanced our product portfolio and significantly elevated our market presence. At the same time, we will continue to improve our retail channels and enhance our product mix to sustain the higher gross margin trend, leveraging self-branded revenue to bolster the company's overall performance and steering us towards sustained profitability. To further solidify our market-leading position in smart wearables, we continue diversifying our product lineup to meet evolving market demand. In October, we launched two new lifestyle smartwatches, the Amazfit Active and the Amazfit Active Edge in Europe and the Asia-Pacific. These smartwatches tailored for today's urban lifestyles combine elegance with powerful functionality, incorporating the AI-powered Zepp Coach and seamlessly integrating into our users’ hectic lives. At Zepp, innovation is at the core of everything we do. To reflect this vision, I would like to highlight some of our success in smart wearable technology at CES 2024. The CES launch of the Amazfit Helio Ring, our first smart ring, underlines our dedication to providing pioneering, accessible healthcare solutions. The Amazfit Helio Ring is designed to offer unparalleled recovery support to athletes. These developments demonstrate our commitment to empowering individuals to take control of their health and well-being through our smart wearables. Building on the momentum of our product expansion, we remain dedicated to leveraging Zepp OS. We recently introduced Zepp OS 3.5 with Zepp Flow at MWC Barcelona 2024 in February, a substantial update powered by large language model AI, marking a significant leap in wearable intelligent devices and bringing unprecedented levels of interaction. Zepp Flow offers seamless natural language communication, allowing users to interact with their devices naturally, covering tasks like setting an alarm or analyzing sleep quality through a conversation. Additionally, we provide our users with consistent software updates. For example, the Amazfit Balance now features new training templates, new skiing map functions, and enables smart NFC car payment in Europe, enhancing both the sporting experience and general daily convenience. Our blood pressure measurement software has been extended to a broader range of products including the Amazfit Falcon, Active Cheetah Pro, Amazfit T-Rex Ultra, Amazfit T-Rex 2, and GTR 4, aiming to deliver personalized and advanced wellness support to a greater number of users. Our products' seamless integration of hardware and software not only assists users in improving their well-being but also elevates their lifestyle. I'm happy to share a compelling example that comes from one of our Japanese users who found himself caught in a snowstorm during a hiking trip in Mont Blanc. Fortunately, our T-Rex 2 guided him safely back. He shared his experience on Yamap, Japan's leading outdoor app, and even sent us a thank you email. Stories like these fill us with pride as we see our products contribute to the enthusiasm and satisfaction of our users. 2023 leaves behind a tapestry woven with both challenges and triumphs. As we are transforming into a self-reliant company and shifting our strategy from pursuing pure revenue growth to profitability, we have seen a decline in revenue despite our Amazfit branded products contributing to 74% of our total revenue compared to 59% in 2022. Furthermore, our efforts translated into a commendable 36% reduction in non-GAAP net loss, marking a pivotal shift for us as we achieved profitability in both Q3 and Q4, leveraging our gross margin and cost management strategies. Another operational milestone in Q4 2023 was the successful completion of mass production of our Amazfit Bip watch line at our Vietnam factory. This achievement underscores the execution of our multi-sourcing global supply chain strategy and paves the way for further global expansion. Additionally, we have witnessed a surge in product visibility, particularly on social media platforms and through key opinion leaders' endorsements, including a growing market presence and heightened consumer engagement. Looking to the future, we see a healthy and sustainable growth trajectory for Zepp. Our relentless drive for innovation and strategic expansion of our product offerings positions us to effectively adjust to the evolving demands of our global user community. Despite headwinds posed by macroeconomic challenges, our focus remains steadfast on bolstering profitability and seeking dynamic opportunities to propel our resilient growth and secure greater bottom line stability. This approach not only strengthens our competitive edge but also ensures our long-term success in the ever-evolving smart wearable industry. I will now turn the call over to Leon to go over the highlights of our fourth quarter financial results.

Leon Cheng Deng, CFO

Thank you, Wang. Greetings, everyone. And thank you again for joining our earnings call today. I would like to start by discussing some key metrics from our financial results for the fourth quarter of 2023. As we have mentioned in the past, the broader consumer electronics industry has yet to recover and remains subdued across our geographies. This is partially due to sluggish demand for high-value consumer electronics products such as TVs and mobile phones, coupled with challenging economic conditions in parts of the EMEA and APAC regions. However, we saw some modestly improved performance in the smartwatches for outdoor/sports category, though the market remains highly competitive. Aimed at these challenges, we steadfastly adhered to our strategic plan. This holiday season, we took an unconventional approach by launching an extended pre-Christmas promotion on selected products. Traditionally, we focused on offering discounts centered around Black Friday and Cyber Monday. However, this year we decided to align with consumer expectations for ongoing discounts throughout the holiday season. This strategy resonated well with our consumers. We have met our own sales expectations while delivering strong gross margins for the quarter. All of this is a testament to our strong brand, our great product lineup, and the value that our products can offer. However, given that the successful promotion occurred later in the fourth quarter, it is likely that it might have advanced some sales from Q1 of 2024. Since Q1 is typically our slowest quarter of the year, we're adopting a more cautious outlook for the revenue projections in the upcoming quarter. I would like to emphasize that we are laser-focused on the areas within our control. We're holding our market share steady without sacrificing gross margin. As we stand at the start of a multi-year product cycle, we're beginning to harvest the benefits of our research and development investments. This allows us to branch into new categories and introduce innovative products such as the Helio Ring we unveiled at CES, with more announcements planned for the coming quarters. We are also broadening our distribution channels to align with where our customers prefer to shop. Additionally, we're reinventing our brand marketing and activation to tap into sports and address new audiences. As Wang highlighted earlier, you will see our brand featured more prominently at sports events and we will welcome more athletes to join our Amazfit family. Such strategic positioning of the company aims to accelerate our growth while managing expenses carefully to ensure margin expansions in the years to come. Now, turning to Q4 sales, our overall sales for the quarter was US$85 million, in line with the lower end of our guidance as we navigated the technical challenges in our categories and a highly promotional environment. This reduction in sales was influenced partially by our strategic decision to prioritize profitability over scale, with foreign exchange fluctuations also having a negative impact. In markets like China and India, our business model mirrors this emphasis on profitability over scale. The shift has resulted in these markets turning net profit positive in 2023. Furthermore, despite year-over-year revenue declines in our self-branded products, we achieved positive quarter-over-quarter revenue growth, convincing us that our strategic approach will empower our business's long-term sustainability and resilience. Moving on to gross margin, which can be influenced by various factors such as product mix, product launch timing, and product lifecycles, including model upgrades. As Wang indicated earlier, our Q4 2023 gross margin reached an impressive 34.7%, surpassing Q3 and marking the highest gross margin in the company's history. This achievement can be attributed to a favorable product mix, a higher proportion of new product launches such as Amazfit Active and Amazfit Active Edge series, and reduced clearance activities. Importantly, we anticipate this positive trend in gross margin to extend into Q1 and throughout 2024. Now, let's turn our attention to costs. As we have discussed, cost management remains a critical area of focus for our company, both in terms of their absolute amount and as a percentage of sales. Hence, we continue to exercise disciplined control over our expenses during the quarter. Since Q3 2020, we have consistently reduced our operating costs while strategically investing in innovative products and technologies, as well as geographical expansion. As a result, non-GAAP operating expenses for Q4 stood at US$27 million, RMB191 million, comparable with Q3 2023 and consistent with the guidance we provided. Adjusted research and development expenses in the fourth quarter of 2023 were $11 million, a decrease of 30.8% year-over-year. This comprised 12.8% of revenue versus 10% for the same period in 2022. The decrease was primarily attributed to our refined research and development strategies, as we constantly assess resources efficiently to maximize return on investment and productivity. Also, we integrated an AI-based R&D platform to improve our efficiency. At the same time, we're committed to investing in new technologies and AI functions to maintain our competitive edges against our peers. Adjusted selling and marketing expenses in the fourth quarter of 2023 were US$12 million, a year-over-year decrease of 31%. These expenses accounted for 14.3% of revenues compared to 11.6% in the same period in 2022. The reduction in amount was mainly due to our ongoing efforts to improve profitability and refine our sales channel mix. In addition to the in-depth enhancement of our retail channels, such efforts also included a strategic allocation of staff throughout our sales regions. Additionally, we launched Amazfit Wellness Wonderland at a pop-up store in Berlin to spotlight wellness during the holiday season. We showcased our brand concept through a collaboration with Siciliano Contemporary at the launch of the Amazfit Balance special edition watch, drawing significant media attention. This concept was also highlighted in Zepp Health's 10 years of innovation campaign. We are committed to making smart investments in marketing and branding initiatives that will fuel our longer growth. Adjusted G&A expenses amounted to US$4.0 million in the fourth quarter of 2023, a year-over-year decline of 37.8%. These expenses represented 4.8% of revenues compared with 4.3% in 2022. This decrease in absolute amount was largely attributed to our efforts in optimizing personnel and enforcing strict cost control over administrative expenses. Looking ahead, our commitment to prudent cost management will continue in the coming quarters, with anticipated costs remaining at or below our current levels. We'll maintain our strategic investments in R&D activities and marketing expenses to ensure our long-term competitiveness, striking a balance between monitoring discretionary spending and making strategic investments critical for our long-term growth. In Q4 2023, we reported an adjusted operating profit of US$2.4 million, RMB17 million, which includes a non-cash US$3.5 million valuation allowance of deferred tax assets versus the operating loss of US$8 million in the same period last year, driven by the expansion in our self-branded products' gross margin and our streamlined operating expenses. Now, turning to the balance sheet, as of December 31, 2023, our cash and cash equivalents along with restricted cash balance totaled approximately US$140 million, RMB1 billion. This positions us with ample runway to capitalize on potential marketing opportunities and invest in our business growth. We have also focused on managing our working capital efficiently. We kept inventory levels steady at US$85 million, RMB600 million, the lowest level in the company's history. We'll continue to manage inventory levels tightly as we weather the macroeconomy. In Q4, coupled with operating profits and efficient working capital management, we achieved positive operating cash flow. This marks our sixth consecutive quarter of positive operating cash flow and we expect to continue this position in the coming quarters. Since Q2 2023, we have initiated the retirement of portions of our short and long-term debt portfolio, successfully retiring US$4.8 million, RMB34 million of debt in Q2 and US$16 million, RMB170 million in Q3. In Q4, we continue to reduce our debt levels by another US$12 million, RMB84 million. As our operating cash continues to strengthen, we intend to do more in the coming quarters. Furthermore, by the end of December 31, 2023, we had repurchased shares worth $12.9 million. We remain committed to continuing our buyback program in the fourth quarter and in the quarters following that, underscoring our confidence in the company's future and our commitment to delivering long-term value to our shareholders. Looking ahead, as I mentioned before, Q1 is traditionally a soft quarter for us. Therefore, our Q1 guidance range is projected to be US$42 million to US$49 million, RMB300 to RMB350 million, with self-branded products accounting for about 90% of the revenue. In conclusion, the fourth quarter presented challenges that we overcame by prioritizing profitability over scale. This strategy, combined with our disciplined approach to cost management, has been instrumental in achieving encouraging performance and delivering a second consecutive quarter of non-GAAP profitability for us. As we look ahead, we remain confident that these strategic initiatives will continue to deliver long-term value to our investors and shareholders, as well as our employees. Thank you all for your time. I would now like to open the call for any questions.

Operator, Operator

Thank you. We will now begin the question-and-answer session. Our first question today will come from Nicolette Jones of Brooks Investments. Please go ahead.

Unidentified Analyst, Analyst

Hi. I have two questions. Please could management provide more details on the outlook for 2024 and the first quarter? And for my second question, I'd like to find out more about the company's regional strategy?

Wang Huang, CEO

Nicolette, if you could repeat the second question one more time for me, please.

Unidentified Analyst, Analyst

Oh, yes. Hi. I'd like more details on the regional strategy.

Wang Huang, CEO

Okay. On the regional strategy, thank you. Let me address your first question regarding the outlook for the first quarter and 2024. The first quarter is typically a relatively soft quarter for the consumer electronics industry. Therefore, our guidance for the first quarter is between $42 million to $49 million, or RMB equivalent of RMB300 to RMB350 million for the top line. Normally, our guidance stops at providing revenue estimates only. But in this call, I want to provide some insight into full year 2024. Looking at the full year 2024, if we start from a broad perspective, both IDC and Catalyst are projecting overall market value growth for the smartwatch sector, which is the sector we operate in, at single-digit, high single-digit growth for year 2024. Therefore, our revenue growth target for 2024, based on this information, is likely to be on par with or higher than the overall market growth for our self-branded products. This provides guidance for our 2024 sales. Regarding gross margin, as mentioned, our overall gross margin percentage during the second half of 2023 hovered between 30% to 35%. We expect this gross margin to expand in the upcoming quarters throughout 2024 as well. Lastly, regarding operating costs, our quarterly operating cost run rate remains around RMB200 million, which we've maintained for more than four quarters throughout 2023. We are confident in our ability to manage costs in the year to come. Now, regarding your second question about our regional strategy. Much of our sales revenue comes from overseas markets, with more than half of our revenue from the EMEA region. The remainder is split between the USA and Asia Pacific. Looking at 2024, there are a few big events on the horizon, including the Olympics in Paris and the European Cup soccer tournament in June and July in Europe. These events will represent a significant opportunity for our sales. Additionally, the USA represents another bright spot for growth, as we have made substantial progress in offline channels in the US. Our products are featured in Best Buy, Target, and Walmart, with plans to expand into more stores. We believe that in 2024, we should achieve reasonable growth in the USA. In the Asia-Pacific region, we see great potential in markets like Thailand, Japan, and Taiwan, where we anticipate significant revenue growth.

Unidentified Analyst, Analyst

Thank you.

Operator, Operator

Our next question today will come from Sid Rajeev of Fundamental Resource Corp. Please go ahead.

Sid Rajeev, Analyst

Hi. Congratulations on your strong results. I have a couple of questions. On your balance sheet, you have close to $250 million in investments. The market cap is just $75 million. So it seems like the market is not recognizing the value of the investments you have on your books. What's your plan with these investments on a long-term basis? Any plans to divest at least a portion of it in the near term?

Leon Cheng Deng, CFO

Yes, I think you are referring to the China A-Stock listed company, in which we invested and currently hold a minority share. This company plays a key role in our vertical integration plan for wearables, as it manufactures sensors and produces chips for not only us but also other smartwatch manufacturers. In the future, having this A-listed company in China presents benefits, as it can supply goods to us and many other ecosystem companies in the wearable domain. This strategy is somewhat similar to Apple's chip strategy, but the key difference is that we aim to open our offerings to others. Moreover, if you consider the market value of the A-listed company and multiply it by our shareholding, the value is already larger than our current market cap, suggesting that there's untapped value to be realized.

Sid Rajeev, Analyst

Got it. Thanks.

Leon Cheng Deng, CFO

But we have no intent to sell that stake at this moment in time.

Sid Rajeev, Analyst

Okay. Your cash position is very strong. One would expect you to be paying down your debt sooner than what you've been doing. How much debt would you pay down this year?

Leon Cheng Deng, CFO

Overall, in 2023, as I mentioned, we paid down more than RMB200 million in debt. If you look at our balance sheet now, we hardly have any short-term debt, just some long-term obligations. Most of the long-term debt is related to acquiring our stake in the listed company. For 2024, we plan to retire a similar amount or potentially more than what we accomplished in 2023. If we achieve this, by the end of 2024, we could have little to no debt.

Sid Rajeev, Analyst

Okay, perfect. Thank you so much, Leon.

Leon Cheng Deng, CFO

Thank you, Sid.

Operator, Operator

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

Grace Zhang, Director of Investor Relations

Thank you once again for joining us today. If you have further questions, please feel free to contact Zepp Health's investor relations department through the contact information provided on our IR website. This concludes this conference call. You may now disconnect your line. Thank you.

Operator, Operator

The conference has now concluded. Thank you for attending, and you may once again disconnect.