Earnings Call Transcript - ZEPP Q4 2022

Operator, Operator

Hello, ladies and gentlemen. Thank you for standing by for Zepp Health Corporation's Fourth Quarter and Full-Year 2022 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 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 the 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 made 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 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 contains a reconciliation of the unaudited non-GAAP measures to the unaudited most directly comparable GAAP measures. I’ll now turn the call over to our CEO, Mr. Wang Huang. Please go ahead.

Wang Huang, CEO

Hello, everyone. Thank you for joining our call. In 2022, we faced substantial macro challenges such as the ongoing COVID-19 pandemic, the Ukraine-Russia war, global infection, and weakening consumer confidence. These factors affected our operations. While in Q4, consumer discretionary spending decreased due to macroeconomic uncertainties, particularly in Europe and the U.S. Against this backdrop, our fourth quarter revenue came in at RMB1.1 billion, down 35.5% year-over-year, primarily due to decreased sales of Mi Band products. Our company foresaw the decline of the basic band market quarters ago and shifted our focus to self-branded watches. I'm pleased to share with you that our self-branded products accounted for 77.4% of our sales during the fourth quarter, compared to 57.7% in the same period last year. We now offer various product lines for our self-branded products, including outdoor sports and fitness, and basic watch lines. As you remember, leading the company through its IPO 5 years ago, our self-branded products only accounted for roughly 20% of the company's revenue. Over the past 5 years, we have successfully transformed our business from a model which revenue was largely contributed by a single customer to becoming a top global player in the smart wearables and healthcare services industries. Despite macro challenges, our self-branded products showed strong performance during Q4 with a 28.5% quarter-over-quarter revenue increase and continued gross margin expansion. The success is due to improved sales of our high-margin products and enhanced brand value together with our optimized solid performance in sales channels demonstrating our improved market position. We believe that the smart wearable market has significant growth potential. We are confident in the growth trajectory of our Amazfit and Zepp products. And we are committed to further expanding our self-branded product line. As we move forward, we will continue to focus on product innovation and optimizing our cost structure to drive profitability and reinforce our business resilience. We believe the smart wearable market has not yet achieved its full potential. For example, as we integrate GPT technology into our Zepp OS, we are able to offer a highly advanced and personalized experience for our users. This allows us to stand out in an increasingly competitive smart wearables industry by providing personalized sleep insights, coaching, goal tracking, nutrition advice, and health monitoring features, all seamlessly integrated within our wearable devices. Our dedication to improving the user experience and enhancing overall well-being sets us apart from our competitors and positions us as a leader in the industry by continuing to leverage the power of GPT technology and other cutting-edge offerings. We are strategically expanding our reach and building long-term value. Our company has a long history of investing in cutting-edge technology to enhance our products and services. Several years ago, we invested in liquefied architecture chip technology and now we are able to use our own in-house designed, low power, high performance RISC-V chip for smartwatches. This investment has allowed us to improve our smartwatches' performance and battery life. We are proud to leverage this technology in conjunction with our AI technology. Similar to GPT, to offer tailor-made user experiences with the power of our RISC-V chips and AI technology; we can significantly enhance user's health and fitness performance. We also utilize this technology to optimize user service, feedback analysis, marketing data analysis, AI coding, and testing, allowing us to increase operational efficiency and improve service quality. In addition to enabling users to design their own AI empowered watch faces, we have also developed many apps that are automatically designed by AI, similar to GPT technology. This allows us to offer users a highly personalized experience and sets us apart from our competitors in the smart wearable industry. So, we will integrate these technology advancements into our Zepp Smart Coach function to elevate the user experience to new heights. Now, let's move to our global operations and products. Our new self-branded products had an impressive market performance, resulting in increased brand recognition among consumers worldwide in Q4. Amazfit won NPD's Consumer Electronics Industry Performance Award in the fitness tracker category for top e-commerce U.S. market share gain, validating our product competitiveness in the premium market. We also expanded our presence on the global stage by opening our Warsaw office in February. We successfully launched the Amazfit Falcon globally, which received recognition from the global high-end sports professional community. And our newly launched Amazfit GTS 4 and GTR 4 have been well received by consumers worldwide. In Q4, we remained concentrated on optimizing our cost structure as we strive for profitability and further enhance business resilience in 2023. We will continue with these cost-cutting initiatives while balancing cost controls with expenditures to fuel growth. And we anticipate that these actions will meaningfully benefit our business operations in the long run. We are extremely confident in our ability to seize market opportunities, enhance our product value, and continue to deliver additional shareholder value while providing users with more defined and comprehensive healthcare products and services. We believe that by optimizing our cost structure and balancing cost controls with investment in growth, we can continue to enhance our product value and improve margins rather than focus solely on quantity. We prioritize quality growth and aim to win the competition in advanced markets like Europe and North America. Even in the face of global macroeconomic uncertainty, we remain committed to providing cutting-edge technology and products, thus staying at the forefront of wellness solutions. Thank you again for joining us today. I will now turn the call over to Leon to go over the highlights of our fourth quarter financial results.

Leon Deng, CFO

Thank you, Wang. Greetings, everyone. I would like to begin by discussing the key metrics of our fourth quarter financial results. Our fourth quarter revenue came in at the lower end of our guidance range, approximately RMB1.1 billion, reflecting a 35.5% year-over-year decrease. As we all know, this quarter was marked by macro headwinds as ongoing geopolitical tensions and lower discretionary spending persisted, particularly in Europe and the U.S. As a result, consumers remained cautious with their household budgets due to recession and inflationary pressures. Our sales in China were also impacted by lower consumer spending, specifically during the month of November and December, as the COVID-19 pandemic outbreak and policies dampened consumer confidence amid macro uncertainty. Furthermore, our supply chain was affected by the sudden lifting of COVID-19 restrictions in China, causing delays in some of our new self-branded product launches. Consequently, this had a net adverse impact on our first quarter sales as well. At the same time, we're encouraged by the bright spots we have seen in many parts of our business. As Wang mentioned, our self-branded products comprised 77.4% of total sales, compared to 57.7% for the same period last year. Moving forward, we're confident that our self-branded products will gain more traction as we continue to improve our product capabilities and increase brand awareness on a global scale. Let's now take a closer look at our gross margin, another bright spot in the quarter's performance. Our gross margin can be influenced by various factors such as product mix, product launch timing, and product life cycles, including model upgrades. Despite the challenges we faced during the quarter, we achieved a year high gross margin of 20.7%, compared to 19.3% in Q4 2021 and 19.1% in Q3 2022. This improvement was mainly driven by the successful launch of our margin-accretive new products and the optimization of our product and channel mix. As we continue to implement these proven initiatives, we're confident that we can sustain our positive gross margin trends into 2023. Turning now to costs. As we have discussed, costs have been a key focal point for our company, both in terms of their absolute amount and then as a percentage of sales. Since Q3 2020, we have seen a trend towards a decrease in total operating expenses while still making strategic investments to fuel growth. Our company's adjusted operating expenses, excluding share-based compensation for the fourth quarter of 2022, were RMB277.6 million, reflecting a year-over-year decrease of 5.9% and a quarter-over-quarter decrease of 6.1%. However, excluding severance payments of RMB10 million, our Q4 operating expenses would be RMB267 million. While we acknowledge that reducing fixed costs can be challenging, we're taking further steps to control our expenses and have already made good progress in cutting our expenses run rate. Looking ahead, we expect our total operating expenses to reach approximately RMB250 million or lower in the coming quarters, which represents a significant decrease of around 20% or more from the average of RMB300 million per quarter in 2022. We'll continue to right-size our organization and streamline our cost base in order to achieve profitability in the coming quarters. Spending on R&D in Q4 2022 was RMB114.3 million, an increase of 21.9% year-over-year, partly due to the lower government subsidy received. If we exclude that factor, our R&D expenses remained slightly down versus the fourth quarter of 2021, thanks to our efficient product development processes. Selling and marketing expenses were RMB125.1 million, 17.8% lower year-over-year, mainly due to the pruning of our retail channels in Q4. At the same time, we continue to make investments selectively in various international markets and sales channel expansion through digital marketing initiatives and also partnerships with leading global sales platforms. These investments are critical to driving our long-term organic growth. Our Q4 expenses were RMB53.4 million, which is almost in line with the third quarter of 2022 and a 17.5% decline compared with RMB64.7 million in the fourth quarter of 2021. We believe that this decrease reflects our execution excellence and reaffirms the effectiveness of our expense control strategies. Our non-GAAP operating results improved throughout the year, with Q4 being the best performing quarter in 2022 from a percentage perspective. These results demonstrate a sequential improvement in our cost control given Q4's smaller revenue scale. Our adjusted net loss in the quarter was RMB60.3 million, compared with RMB52 million in the fourth quarter of 2021. In the fourth quarter, the company wrote down RMB30.1 million valuation allowance for deferred tax assets. Excluding share-based compensation, the one-off severance packages, and the deferred tax asset impact, the adjusted net loss was RMB20.1 million in the fourth quarter. Now turning to the balance sheet. Our cash flow has remained strong, thanks to our enhanced efficiency in working capital management. In Q4, we generated positive cash flow from operations, some of which were used to retire certain short-term debts. During the fourth quarter, we continued to manage our inventory with precision, successfully reducing our inventory balance to RMB1 billion, compared to RMB1.25 billion at the end of 2021 and down from its peak of RMB1.5 billion in 2022. In November 2021, the board approved the allocation of up to US$20 million toward a share repurchase program. In Q4 2022, we continued our repurchase program, a testament to our ongoing confidence in our long-term growth prospects. We had bought back US$10.3 million worth of shares by the end of December, and we intend to carry out this buyback program. Moving on to our outlook. In light of ongoing macroeconomic challenges, our guidance for the first quarter of 2023 currently projects net revenue to be between RMB0.6 billion and RMB0.75 billion, compared with RMB0.76 billion for the first quarter of 2022. Please note that this outlook reflects continued uncertainty around the potential effects of the COVID-19 pandemic on sales and lower discretionary consumer spending, especially in our international markets and global macro weakness. However, we have seen some positive signs and the year may be somewhat back-end loaded as we gradually release our new products. This concludes our prepared remarks. We will now open the call for questions. Operator, please go ahead.

Operator, Operator

Thank you. The first question comes from an analyst. Please proceed.

Unidentified Analyst, Analyst

Thank you, management, for taking my questions. I have two questions. The first one is, your fourth quarter margin looks quite strong. What has driven this performance? Was the improvement due to self-branded products? And secondly, how should we think about the full-year 2023 in terms of revenue growth, gross margin, SG&A etcetera? Thank you.

Leon Deng, CFO

Thank you, Lisa. Let me quickly come back on your first question. Yes, the gross margin improvement in Q4 is primarily driven by the gross margin performance of the self-branded product. So, there are two things to it. First, we improved on the product mix. In the past, the Xiaomi products represented a majority of our revenue base, but in Q4 2022, our self-branded products actually represented more than 77% of the overall mix for the quarter. So, the product mix definitely plays a role, and you all know that our self-branded products carry a higher margin than the Xiaomi branded products. Second is also on the channel mix. What we did in Q4 and also in the second half of 2022 was to gradually prune our channel, our retail partners. We focused on the profitability selectively with our retail partners and pruned those that were not making money. So, in essence, the product and channel mix has been one of the reasons driving the overall gross margin up for the company for Q4, and we see this trend continuing into 2023. Regarding the full-year 2023, normally we don’t guide for the full-year performance; we only guide for the upfront one-quarter performance. However, I can say that we are cautiously optimistic about the full year because according to IDC data and reports from other third-party market research institutions, the overall wearable market for 2023 is still pointing to modest growth, likely single-digit growth for the full year. Our market share among the global players has remained relatively stable and even improved during the course of 2022. While we are cautiously optimistic about 2023, we believe the year may be somewhat back-end loaded due to seasonality; the high season for our industry always centers around Q3 and Q4. So overall, we see our revenue being cautiously optimistic, but more skewed towards the second half of this year. Regarding gross margin, I have mentioned that our gross margin performance has shown an increasing trend quarter-by-quarter in 2022, and we expect this trend to continue into 2023. We believe that the product mix and channel mix will continue to improve for our company. On the operating costs overall, as I noted earlier, we have managed to tune the cost down to a level in Q4, whereby excluding severance cost, it stands at RMB270 million per quarter, compared to the full-year run rate of RMB300 million per quarter for 2022. We expect this number to be further reduced to around RMB250 million per quarter or even lower for 2023. Overall, given these factors, we believe we are on a good track to return to profitability in 2023, hopefully in the second half of the year, if not earlier.

Unidentified Analyst, Analyst

That's very clear. Thank you. And if I may, can I add one more question? Can you also discuss your performance in different regions? For example, now we're seeing, I guess, the recovery trends in China, but not so much in Europe and North America. Can you talk about your performance in different regions, and give us more details there? Thank you.

Leon Deng, CFO

No, I think, yes, in China, you see a gradually recovering trend, although relatively slow in Q1 2023. This is going to improve as we progress further into the year, but China actually contributes a small portion to our overall self-branded product portfolio. Our biggest market is actually in Europe, where we are somewhat impacted by the cuts in discretionary income due to inflationary pressures and also, to some extent, by the Ukraine and Russia war. However, we're mitigating that situation. In February this year, we even opened a regional office in Warsaw on top of the other satellite offices we already have in Europe. We see certain bright spots in Europe, especially in Eastern Europe, where our market share has increased significantly during the year in Poland, and we are maintaining and improving our share in southern European markets as well. Europe has and will remain a cornerstone for our regional performance. Additionally, there's a bright spot in the United States, as Wang mentioned earlier. We won a third-party consumer electronics industry performance award for the fitness tracker category for the top e-commerce U.S. market share gain in 2022. We gained market share from virtually nothing to a double-digit number throughout 2022. Therefore, we believe the U.S. market will continue to serve as a growth engine for us in 2023 and beyond. In summary, while we are in an environment of inflation and cuts to consumer discretionary spending, we still see bright spots across different regions, indicating significant potential for us to explore in 2023 and beyond.

Unidentified Analyst, Analyst

Thank you.

Operator, Operator

The next question comes from an analyst. Please go ahead.

Unidentified Analyst, Analyst

Hi management. Thank you for taking my questions. And congratulations on the fourth quarter and a very good result. I have two questions. First is about your gross margin. We have noticed that many IC prices have fallen significantly since last year. How can we measure the impact on the company’s gross margin? Thank you.

Leon Deng, CFO

Yeah, Ian. Thank you. So far, at least in Q1, we haven't seen too much of a price decrease. In other words, we haven't yet realized the benefits of IC prices going down, which should translate into a better margin for us. The reason is that it takes a few quarters for the price changes to be reflected in our bill of materials because most of the purchases we make are long lead time purchases, particularly for chips, where we lock in prices several quarters before the current quarter. Therefore, we haven't yet seen too much of that benefit in our gross margin. However, as you mentioned, we are aware of the declining costs for ICs in the industry, and I believe in the coming quarters we will eventually see that benefit flowing into our gross margin, further improving our gross margin performance beyond what we have forecasted so far.

Unidentified Analyst, Analyst

Okay, understood. Thank you. The second question relates to the growing popularity of AI, particularly regarding ChatGPT, which we perceive as a very good opportunity for Zepp OS. Could you provide us with a more detailed outlook on your future product plans regarding the ChatGPT application? Thank you.

Leon Deng, CFO

Yeah. No, ChatGPT is indeed a very interesting topic, but it's not just a buzzword for us. It really has been incorporated into many parts of our operations. There are two aspects to it. First, we have applied ChatGPT in our basic processes: consumer care, gathering consumer insights, linking APIs to our research and development processes, and helping us identify errors and enhancing our coding efficiency. So, we have integrated ChatGPT into our day-to-day operations because we have always been a technology-driven company that utilizes the most advanced technology whenever there's potential. Secondly, what differentiates us from others, like Apple, who also have a ChatGPT application that functions merely as an interface, is that we've integrated ChatGPT into our Zepp OS. This integration assists us in tailoring experiences for users based on their data, providing insights into sleep patterns, AI coaching, goal tracking, etc., significantly beyond what we could achieve without it. I believe we are one of the first wearable companies to apply GPT technology to this extent in the industry, and we will continue to explore its potential.

Unidentified Analyst, Analyst

Okay. Thank you. Very clear.

Operator, Operator

As there are no further questions now, I'd like to turn the call back over to the company 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’s Investor Relations department through the contact information provided on our website. This concludes this conference call. You may now disconnect your lines. Thank you.

Operator, Operator

Again, the conference has ended. You may disconnect your line. Thank you.