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spk04: Hello, ladies and gentlemen. Thank you for standing by for ZEP Health Corporation's third quarter 2022 earnings conference call. At this time, all participants are in a 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.
spk02: Hello, everyone, and welcome to ZEP Health Corporation's third quarter 2022 earnings conference call. The company's financial and operating results were issued in a press release via the mutual 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 ir.zep.com. Participating in today's call are Mr. Huang Wang, our Chairman of the Board of Directors and Chief Executive Officer, and Mr. Liang Zheng, 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 Yang, 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 20F of the fiscal year ended December 31, 2021, and other filings filed with the U.S. Securities and Exchange Commission. The company does not assume any obligation to update any forward-looking statements except under applicable law. Please also note that ZEPP's earnings press release and this conference call include discussions of unaudited gap financial information as well as unaudited non-gap financial information. ZEPP's press release contains reconciliation of the unaudited non-gap measures to the unaudited most directly comparable gap measures. I'll now turn the call over to our CEO, Mr. Huang Wang. Please go ahead.
spk05: Hello, everyone. Thank you for joining our call. First, I would like to provide some context by adjusting the microenvironment, which continued to worsen during Q3 and impacted our operations amid heightened geopolitical uncertainties and COVID-19 containment measures in China. Against this backdrop, our third quarter revenues came in within our expectation at RMB 1.2 billion, down 24.9% year-over-year, primarily due to decreased sales of new-band products. Despite these challenges, we continue to grow during the quarter, with top line up 8.8% quarter-over-quarter, a significant reflection of the resilience of our business. I would like to highlight that despite the micro headwinds we faced during the quarter, our self-branded products have returned to their growth trajectory with a 4.2% year-over-year and 35.6% quarter-over-quarter increase in revenue. This growth was underpinned by increased recognition from global consumers as we made progress in enhancing our product value and expanding our sales channels. In the North American market, as we have expanded into more retail channels, our revenues grew by 23% year-over-year and 34% quarter-over-quarter. In Europe, We also had several bright spots in Poland, for example, where our revenue growth rate was 222% year-over-year. We were also the official partner of the 44th Warsaw Marathon, which has further raised our brand value and recognition. In France and Spain, we enjoyed 36.4% and 26.2% revenue growth, respectively, against macro challenges. In September, we debuted our brand new Amazfit GDR4 and GDS4 at the EVA event. The Amazfit GT4 series is packed with premium features for both section and function. Over 190 media outlets in the EMBA region reported our launch event at IFA, and our GT4 series was named by three media sources as the best IFA product. Our new GTR4 and GTS4 are equipped with the industry's first fuel bank circularly polarized GPS antenna technology, enabling movement tracking, and positioning up to 99% as accurate as handheld GPS locators in open-air scenarios. This generation also features our new BioCheck 4.0 with a high-precision PDG optical sensor. and both models' heart rate checking performance is enhanced to match that of heart rate cells. We believe these upgraded product features will prove attractive to users worldwide, enabling more people to reach their fitness goals and better manage their health in their daily life. Furthermore, we are excited to team up with Adidas LearnTastic a well-established digital platform that serves 182 million athletics to empower users to synchronize workout data to Adidas learning via the Zap app. This function became available on our newly released Amazfit GT4 series in October and will gradually become accessible on our other smartwatches going forward. By partnering with global brands that share our passion for helping users achieve their fitness goals, we hope to further expand our user community and achieve continual growth. In October, we introduced our fresh premium multishareable GPS watch. The Amazfit Falcon. It features the new AI-powered ZEP coach, providing users with scientific and tailored fitness guidance through our self-developed smart coaching algorithm. Plastic with a top aircraft-grade titanium unit body and 20 ATM water resistance, a first for Amazfit smart watches, as well as 150 billion sports modes, accurate dual-band GPS checking, and six satellite positioning systems. Amazfit Falcon is devoted to sports companion built to breaking limits. Beyond smart wearables, we forged ahead with the expansion of our new healthcare solutions product line-up, this step priority. which features discrete invisible in-ear technology up to 18 hours of battery life and 12 unique settings to choose from for optimized effects. Apart from auditory health, we believe sleep is crucial to mental health and overall well-being. innovative AI-generated sleep aid soundscapes that adapt to users' biological states, our newly developed ZappAura solution can help users fall asleep faster and sleep more deeply. We are confident that these new innovations represent an important milestone in our expansion into the healthcare sector and will usher in a new growth stage for us. Additionally, we have always been passionate about technology innovation and fostering a more vibrant developer community while striving to reinforce our brand identity on the global stage. Accordingly, we were proud to join past sponsors such as Microsoft and Google Cloud in sponsoring the world's largest collegiate hack zone, CalHacks 9.0, held in October. During the event, we talked to more than 5,000 plus attendees and have successfully attracted more than 1,500 top talent students to visit our booth and learn more about who we are. We also awarded crash prizes and our amazing smartwatches to winners in their watch faces and apps categories in order to recognize their ingenuity and encourage their use of technology to creating solutions that improve our world. as we anticipate continuing microeconomic headings in Q4 and potentially beyond. Increasing organizational efficiency has also been a key focus of our management team this year. And our measures have delivered concrete results in cost efficiency in R&D and G&A expenses But we will take additional measures when needed to keep the fixed cost based in the check. All in all, our fruitful third quarter results, including new product launches and encouraging performance from our self-branded products, highlight our organization's resilience in the face of multiple external challenges. We will further expand our products and services offering while improve organizational efficiency to maximum the value of our shareholders as well as help more users to live a healthy life. Thank you again for joining us today. I will now turn the call over to Leo to go over the highlights of our third quarter financial results.
spk01: Thank you all. Hello, everyone. I would like to start by highlighting some of the key metrics of our third quarter financial results. As mentioned by Wang, in the third quarter, we saw persistent challenges associated with high input and freight costs, the evolving geopolitical situation, and ongoing COVID-19 containment and control measures in China. These adverse conditions weighed on our revenue generated and our overall gross margin. Aimed at the macro volatilities and uncertainties, our Q3 revenue comes in line with our guidance at RMB 1.2 billion, down 24.9% year-over-year, which consists of 53.5% of self-branded product sales and 46.5% of Xiaomi product sales. versus 38% of the self-branded product sales and 61.4% of Xiaomi product sales in the same period last year. The decline in revenue at large is mainly driven by the lower they expected Mi Band sales in the third quarter. However, our self-branded products restored their growth with a 4.2% year-over-year increase in revenue despite the headwinds. We have seen bright spots in many parts of our business. For example, in North America markets, our revenue grow 23% year over year and 54% quarter over quarter. Quarter over quarter, we continue to improve on both our top line and the bottom line, with 8.8% revenue growth and a narrow loss during the quarter. our adjusted net income for the quarter is minus RMB 8.8 million, which included a one-off severance cost of RMB 10 million. These almost break-even results demonstrated our organization's resilience and the effectiveness of our continued measures to streamline our cost base. On a sequential basis, Third quarter 2022 revenue was better than the second quarter 2022 revenue, and our operating profit also improved, reconfirming our solid execution capabilities. Notably, our self-branded product revenue in the third quarter grew 35.6% sequentially, boosted by our newly launched products, including the new Amazfit GT4 series, the Amazfit BIP3, the Amazfit BIP3 Pro, and the Amazfit T-Rex 2. Now let's turn to our third quarter gross margin, which can be affected by the product mix, product launch timing, and product life cycles, including model upgrades. Our Q3 gross margin was 19.1%, 1.1 percentage points lower year over year, affected by higher freight costs compared with the same period last year, and clearance of our previous generation products, partially offset by higher gross margin coming from our new product introduction. However, given the 1.2 percentage point increase quarter over quarter, we can see a positive gross margin development trend now. It's also worth mentioning that given the new product launches, our gross margin for self-branded products exhibited continuous growth month over month in the third quarter. Turning now to costs, which has been a key focal point for the company, both in terms of absolute amount as well as the percentage of sales. While we have to balance cost controls carefully with expenditures to fuel growth, we have already seen a decrease in trend in total operating expenses since Q3 2020. As a portion of the operating expenses is fixed and takes time and creativity to reduce them gradually, we expect to achieve further cost reductions in absolute terms for the remainder of the year. Going forward, we'll continue to right-size our operating expenses from their current level in order to deliver profitability in the coming quarters. Our third quarter 2022 operating expenses for RMB 303.9 million, representing a 1.6% quarter-over-quarter decline. Spending on R&D in Q3 2022 was RMB 127.4 million, an increase of 17.2% year-over-year. The increase was mainly driven by the lower government subsidy received, excluding the above factors the R&D expenses remained slightly down versus the third quarter of 2021 due to strict productivity measures applied. Selling and marketing expenses were RMB 123.9 million, 36% higher year over year, mainly due to our increased investments in various international markets and sales channel expansion through digital marketing initiatives and partnerships with leading global sales platforms. These actions are critical to drive our long-term organic growth. Q3 G&A expenses reduced 14.8% compared with the third quarter of 2021 and 26.5% compared with the second quarter of 2022. This decrease illustrates the effectiveness of our expense control strategy. As we look ahead, cost structure optimization will continue to be our primary focus, especially aimed at the complex and high-volatile macro environment. With higher productivity, ROI-based operations, and more disciplined cost reduction measures, we expect to reduce our operating expenses further. As our revenue improved and expense declined sequentially, adjusted operating loss for the third quarter of 2022 improved further to RMB 65 million, compared with the adjusted loss of RMB 98 million in the second quarter and the adjusted loss of RMB 142 million in the first quarter of 2022. We also paid close attention to the foreign exchange fluctuations and recorded a positive FX contribution year-to-date, thanks to our proactive management of the FX risks. Our adjusted net loss in third quarter was RMB 8.8 million, which includes a 10 million severance payment, narrowed compared with the loss of RMB 90.4 million in the second quarter, and the loss of RMB 75.7 million in the first quarter of 2022. Now turning to the balance sheet, our cash flow also remains strong, with cash flow from operations in Q3 standing positive at RMB 115.3 million. As of September 30, 2022, cash and cash equivalents were RMB 1.01 billion compared with RMB 997 million as of June 30, 2022. During the quarter, we continued to manage our working capital and inventory more efficiently and realized lower inventory levels quarter over quarter. We're targeting to reduce our inventories by year end to be on par or lower than the levels we expected 2021. In November 2021, the Board approved the allocation of up to U.S. dollars 20 million toward a share repurchase program. In Q3 2022, we continue the repurchase program reflecting our confidence in our growth strategy and financial performance. We have bought back U.S. dollars 9.2 million worth of shares until September 30, 2022, and intend to carry on with this buyback program. Moving on to our outlook. In light of the ongoing challenges, our guidance for the fourth quarter of 2022 currently projects net revenue to be between RMB 1.1 billion and RMB 1.35 billion, compared with RMB 1.66 billion for the fourth quarter of 2021. Please note that this outlook reflects the continued uncertainty of the potential effects of the China COVID-19 pandemic policy on sales and the lower discretionary consumer spending, especially in our overseas markets, aimed global macroeconomic weakness. Please also note that this guidance is based on existing market conditions and reflects the management's current and preliminary estimates of the market and operating conditions, as well as the customer demand, which are all subject to change. This concludes our prepared remarks. We'll now open the call to questions. Operator Felix, go ahead.
spk04: Thank you. We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. For the benefit of all participants on today's call, if you wish to ask your question to the company's management in Chinese, please immediately repeat your question in English. At this time, we will pause momentarily to assemble our roster. The first question today comes from Clive Chung with Credit Suisse. Please go ahead.
spk00: Thank you, management, for taking my question. This is Clive from Credit Suisse. I have three questions. I'll ask them all at once. So number one, I saw the sales and marketing expenses disproportionately grew this quarter. I noticed in the prepared remarks Leon already mentioned it's gone into channel expansion in specific markets. Could you share a little bit more color on where geographically this has gone into and what kind of digital channels are we targeting at the moment? That's number one. Number two, with regards to our staff force right now and with a reduced capacity, how does that impact our R&D efforts and product delivery intensity? And lastly, number three, I think there was a mention on supply chain constraints. And my question is what components in particular Are we facing the most delays and impacting our fourth quarter shipments or for next year as well? Thank you.
spk01: Thank you, Clive. Let me answer the easiest question first on the supply chain constraints. I think in Q3, all the supply constraints we have seen at the beginning of the year for the first half of the year has been elevated. So basically the supply constraints issue no longer applies to us starting from the second half of Q3. And we don't see any of that would impact us in Q4 anymore. And similarly, also the freight cost, we also see a trend that the freight cost is going down, especially on the sea freight. So that additional freight cost situation versus last year, which we have experienced for the first three quarters of this year, should also kind of resolve to a certain extent in Q4. So I think that hopefully answers your third question. And then let me turn to the first question, which is on the marketing and sales expenses. Yes, we have invested quite a bit in the international marketing and sales expansion, i.e. investing on the digital platforms, for example, on Amazon and some local online platforms, the big ones regionally, right? For example, Coolblue in the Netherlands, MediaMart.com in a lot of the European countries. And we will continue to invest on those online platforms as we see the shopping pattern from most of the international clients we have are more turning to the big online channels. And also given our DNA, we believe that investing on digital campaigns and digital marketing and investing on online platforms will probably going to yield a bigger return for ourselves. And additionally, we also increased our investments on offline channels, for example, In United States, we have seen quite a growth year over year. A large part of that is driven by our offline channel investments. For example, we're actually getting listed in big offline channels like Best Buy, Target, et cetera, et cetera, in United States. And we're also deepening our presence in offline channel growth in Europe as well. Nevertheless, we also have expanded in the Asian countries expansion, for example, in India and in the rest of the ASEAN countries. To give you an approximation, I think we kind of invested around 10% of the sales and marketing expenses relative to our self-branded sales value in this quarter. And I think we will continue with that run rate in the upcoming quarters as well. And then turning to your second question on the reduced capacity with regard to the RMD resources, I think we have also mentioned in our prepared remarks we have actually looking at how to optimize our R&D efforts. For example, in the past, since we don't have ZAP, before we had the ZAP OS, each and every product, we need to kind of engineer a separate software platform for it in order to sell our smartwatches. And now with ZAP OS, we can apply a more platforming approach with less people in order to deliver a high quality product. And we're also trying to streamline our operations to try to generate more efficiencies on applying a so-called Lego approach in working out our R&D projects and our new smartwatches. So I think that's why at a reduced R&D spending level, we believe we're going to churn out the same quality of R&D efforts or even more uh with a reduced sales force a workforce i think that's um that's that's that's in a nutshell what we're trying to do i hope those thank you very much give you a flavor on what it is yeah very clear thank you leah as a reminder if you would like to ask a question please press star then one to enter the queue
spk04: The next question comes from Lisa Lee with Alpha Research. Please go ahead.
spk03: Hi, management. Thank you for taking my question. I just have one question. You mentioned further cost reductions going forward. Can you please elaborate on your measures, and how should we think about, how should we quantify further cost reductions in the fourth quarter and next year? Thank you.
spk01: Thank you, Lisa. We have identified a few areas to streamline our costs. Number one is what I just mentioned in the area of R&D. We're trying to apply a so-called platforming approach and a legal block to make sure that we can kind of realize the similar goal with a reduced workforce, right? Number two is on the sales and marketing expenses part. We are trying to look at the return on investments on our marketing investments. For example, if we're going to sponsor a sports activity, a marathon, for example, we want to look at the return on investment very closely. to make sure that we're not investing on certain things just for the sake of investing on it. And also we're actually looking at the channel performance in different offline channels to try to see what type of products we should sell in which channel and then try to get the best return out of that. And the third one is on the G&A expenses part. We are practically looking at where we can save and what we can leverage more from either third-party services or looking at whether or not we could streamline the service and actually prioritize certain requests or opportunities rather than the others. So I think to answer your question, we are currently standing at operating expenses overall of $300 million per quarter. And then in Q3, this includes a $10 million severance cost. So basically if you strip that one out, we're probably at a $290 million kind of operating expenses level for Q3. And in Q4, we're more looking at streamline the cost base towards the $250 million level. And hopefully that will be a first step. And then going into next year, we're going to proactively check the cost base and see if we need to reduce the cost base even further if the macro environment is not improving.
spk03: That's very helpful. Thank you. I actually have another question. Can you also give us some guidance on your gross margin going forward?
spk01: Yeah, so you have seen our gross margin is actually picking up, although it hasn't come back to the 2021 level yet. I think there's two folds of rationale here. we try to we understand that inventory level is a big problem for us because we exit the year with high ambitions but in q1 we got hit by the russian and ukraine war by the lower consumer spending issues in most of our international markets so therefore actually we have put a lot of resources and effort in cleaning up all the old generation products, if you want to put it in that way. So what you see here in the mix of our Q2 and Q3 gross margin, it actually carries a big chunk of the lower gross margin coming out of clearing our previous generation products. But I think we're looking at the end of this exercise so that our self-branded products gross margin should improve or increase from their current level going forward as we head into the high season in Q4. And that's number one. Number two, you also notice that our mix has skewed from in the past, it was Xiaomi products play in the majority weight of our sales revenue mix. And our self-branded, I think Xiaomi used to account for 70%, and I think in 2021 was 60% of our overall revenue. But then this year, as we head into Q1, Q2, Q3, I think here today, we're at more self-branded product stands for around 55-ish of the overall mix, and Xiaomi is actually becoming the minority part of our product mix. So I think we intended to actually continue this trend going forward. And then the self-branded products going into Q4 and next year, as you notice that in Q3, our self-branded products start the growth trajectory again. And I think we expect that trend to continue for the upcoming quarters as well. And in the meantime, we'll try to see if we can get more revenue from the Xiaomi side. And then by playing that mix and then playing it more towards self-branded products accounts for the majority of the revenue mix of the company together in improving the margins of the self-branded products. I think you're going to look at the overall gross margin for the company is going to gradually improve from its current level as we reported in Q3. So I hope that will give you some color on what it is going to be in the upcoming quarters.
spk03: Yes, that's great color. Thank you, Leon.
spk04: As there are no further questions, now I'd like to turn the call back over to the company for closing remarks.
spk02: Thank you once again for joining us today. If you have further questions, please feel free to contact SEP's Investor Relations Department through the contact information provided on our website. This concludes this conference call. You may now disconnect your line.
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