Zepp Health Corporation

Q1 2023 Earnings Conference Call


spk00: Excuse me, this is a conference operator. Thank you for your patience. The call will begin in a few minutes. Thank you. Please continue to hold. Thank you. Thank you. Thank you. Hello, ladies and gentlemen. Thank you for standing by for ZEPP Health Corporation's first quarter 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.
spk04: Hello, everyone, and welcome to ZEP House Corporation's first quarter 2023 earnings conference call. The company's financial and operating results were issued in a press release of 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 ir.z.com. Participating in today's call are Mr. Wang Huang, our Chairman of the Board of Directors and Chief Executive Officer, and Mr. Liang Chen Zheng, our CFO. 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 provisions 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 are included in the company's annual report on Form 20-S for the fiscal year ended December 31, 2022, 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 as required under applicable law. Please also note that ZEPPS earnings press release and the conference call include discussions of unaudited gap financial information as well as unaudited non-gap financial information. ZEPPS press release contains reconciliation of the unaudited non-gap measures to the unaudited most directly comparable gap measures. I will now turn the call over to our CEO, Mr. Wang Huang. Please go ahead.
spk02: Hello, everyone. Thank you for joining our call. In the first quarter, you recorded revenue of RMB $645.2 million with RMB $391 million from our self-branded products and RMB $254 million from the Xiaomi ODM business. Our total revenue declined as causes consumers limited discretionary spending due to volatile geopolitical and macroeconomic conditions in Europe and the US. As we mentioned in the earlier quarters, We anticipate that the Xiaomi ODM business will diminish further and that our self-branded product line will become the main growth driver in the future. In the quarter, we made progress globally by strengthening our go-to-market capabilities and increasing brand awareness. along with the value of our product. Growth, higher shipment, and market share gained this 20% increase in the Southeast Asia and East Asia region. Despite experiencing a decline in the consumer electronic device market during the first quarter of 2023, we maintain our optimism that macro headwinds will subside, and we expect to see a market recovery during the second half of the year. Furthermore, another cause for optimism is that cannabis recently forecasted an increase in the smartwatch market in 2023. We strongly believe in Amazfit's long-term potential in the smartwatch market, presenting a significant opportunity to boost sales by enhancing our product competitiveness. By leveraging our vertical integrated mix-size-based chip and ZEPP OS in all product lines, we can reduce product costs and improve product growth profit margins. Our high-end products offer similar performance to premium competitors, but at a fraction of the most of the cost and with longer battery life. This all helps us generate higher revenue and profit margins along with our integrated supply chain and efficient R&D. We will secure our position in the 100 to 200-year dollar market segment while expanding into premium segments and enhancing our sales channels and supply chain management for increased profitability. With these enhancements now implemented, I am thrilled to share that our new products have achieved a remarkable 34.6% margin in the current quarter. We remain confident that the overall margin will improve in the future as we work towards achieving a more optimal inventory level. the rapid implementation of OpenAI's LLM technology sets us apart from our competitors in the industry. By utilizing sports watches powered by generated AI, we will position ourselves as a trailblazer in the market. emphasizing our advanced grade technology rather than traditional sports watches. For example, as we mentioned last quarter, we have been the industry pioneer in integrating GPT technology into our products and services, such as ZEP Coach and ZEP Aura. On March 29, we launched the beta version of an AI powered Zap Coach chat function for a mainstream Falcon user. Powered by its constantly learning and evolving AI chat capability, Zap Coach chat can provide users with abandoned, personalized, and updated exercise recommendations. In recent quarters, we have implemented refreshed marketing and product strategies that include creating communities for sports and outdoor resources by leveraging generated AI technology, we have not only supported the growth and development of athletes, both in series and outdoor in series, but also built a thriving user community in the sports and outdoor sectors. This has resulted in the organic spread of positive word of mouth and distribution, which has further boosted our brand and reputation in the mid- to high-end market. As a result, we have also gained brand premium in the mid- to low-end market, driving higher profit margins in the future. Alongside our endeavors to equip our products with cutting-edge technologies, we have also been striving to expand our product portfolio, aiming to offer more diverse products to address different cohorts' fairness, health, and lifestyle needs. In Q1, we launched the Amazfit T-Rex Ultra, our ultimate outdoor GPS smartwatch on March 20. It received positive feedback from outdoor sports insurers for its project design. premium materials, and 160-plus sports modes. We have other exciting product plans for the year ahead, aiming to bring advanced features to more users. For example, on May 4, we released a significant firmware update for the Amazfit TX2 smartwatch. It includes hot-ray recovery information, terrain, metrics, attitudes, water temperature, slope, and automatic slope analysis. These enhancements improve the user experience making our smartwatches reliable fitness companion for indoor and outdoor activities. For the past few months in 2023, we have seen some signs of economic recovery in certain markets. That said, The fragile economic environment in many other markets remains an uncertain factor, dampening consumer confidence and potentially our sales performance in the coming quarter. Nevertheless, we remain confident in our strategy described above. And we believe this is the right path leading to the company's sustainable growth as we aspire to become a leading global healthcare solution provider. And it will enable us to deliver incremental value to our users and shareholders. Thank you again for joining us today. I will now turn the call over to Leo to go over the highlights of our first quarter financial results.
spk01: Thank you, Wang. Greetings, everyone. Let me walk you through some key metrics of our first quarter 2023 financial results. In the first quarter, we recorded revenue of RMB $645.2 million, within our guidance range, and down 14.8% year-over-year. The decrease was mainly due to the global macroeconomic uncertainties that dampened discretionary consumption in the first quarter. According to Canalys, the value of the global wearable markets, including basic band, basic watch, and smartwatch, decreased by 8% in the first quarter. And more specifically, the basic band subcategory lost more than 30%. Also, as I mentioned a few times before, Q1 is typically the lowest seasonal quarter of our financial year. Before diving into our financial performance, I would like to provide a brief overview of the macro environment. In the first quarter, we experienced a shift in China's COVID zero policy. the reopening disrupted our new product launch schedule due to the factory closures. As a result, we had to postpone the release of some of our new product lines to subsequent quarters, which has a negative impact on our Q1 sales. At the same time, consumer spending was rather tippet, especially as the pendulum has swung away from goods and toward travel and services as the consumer enjoys some of the activities that they were deprived of during the pandemic. The consumer electronics space in particular continues to experience softness to this matter, which together with the geopolitical risks in Europe, pressure on our top line in North America and Europe. Despite the challenging start of the consumer electronics market during the first quarter of 2023, we remain optimistic about the smart wearable markets recovery in the second half of the year. Despite these headwinds mentioned above, as Wang just mentioned, in some of our global markets, our self-branded products achieved encouraging year-over-year sales growth during the quarter. Thanks to our enhanced brand value and product features, we remain confident in our ability to drive our self-branded products to grow further in the coming quarters. Moving on to our growth margin, which can be influenced by various factors such as product mix, product launch timing, and product life cycles, including model upgrades. As we took an ROI-oriented approach to optimizing our product and sales channel portfolio, the gross margin for our self-branded products remained relatively healthy. Meanwhile, gross margin for Xiaomi products declined significantly in the quarter as a result of its multi-year pricing strategy. Above factors combined drove our overall gross margin to 15.9% in the first quarter, down lowered by 4.2% year-over-year and 4.8% versus previous quarter. We believe with the launch of our new higher-margin products and continued pooling of our low ROI products and cellos, the gross margin of our self-branded products will expand further for the remainder of the year. Now let's look at our costs. as we have always mentioned in our past earnings costs. Costs remain a main forecast for the company, both in terms of their absolute amount and as a percentage of sales. Since Q3 2020, we have been pleased to see a trend toward a decrease in total operating expenses while still making strategic investments in new products, technologies, and footprint expansions. to fuel our long-term growth. In Q1, we made good progress in cutting our expenses run rate further by successfully reducing our quarterly operating expenses to RMB 253.8 million, reflecting a year-over-year decrease of 17.5% and a quarter-over-quarter decrease of 13.3%. non-GAAP operating expenses decreased to RMB 229.8 million, which is the lowest level in the past two years. As a percentage of revenue, our first quarter adjusted operating expenses rate decreased by 3.3 percentage points year over year. Going forward, we'll continue to manage our expenses in a disciplined manner and enhance our operating efficiencies. targeting to cut our expenses run rates to approximately non-GAAP RMB 200 million or lower in the coming quarters, which represents a significant decrease of around 33% or more from the average of RMB 300 million per quarter in 2022, as we aim for a turnaround in profitability in the coming quarters. Spending R&D in Q1 23 was R&D 117.9 million, decreasing by 19.5% year over year. Benefiting from our enhanced R&D efficiency, it is also worth mentioning that R&D expenses now account for nearly half of our total operating expenses. As we remain committed to investing in our future by investing in new technologies to enhance offerings for our users. Selling and marketing expenses were RMB 86 million, declined by 16.6% year over year, as we carefully review our sales channel strategy while still investing opportunities with higher ROIs to fuel growth. 2.1 G&A expenses were RMB 49.9 million, lowered by 14.2% versus RMB 58.2 million in Q1 2022 and down by 6.5% compared with RMB 53.4 million in Q4 2022 due to organization delaying and strong cost control measures. We believe that our progress in cost optimization is a strong testament to our execution capability and will benefit our long-term growth. That's to decrease the operating expenses. Our adjusted operating loss narrowed by 10.9% year over year. However, our reduced cost did not fully offset the impact of a smaller revenue scale and lower gross margin for Xiaomi products during the quarter. Our adjusted net loss in the first quarter was RMB 112.7 million versus a loss of RMB 75.7 million in the first quarter of 2022. While our Q1 2022 loss include 60.6.3 million investment income generated by our SIFI investment, we will continue to enhance our cost control policies by implementing more comprehensive measures specifically targeting areas such as travel expenses, personnel-related costs, and other expenditures incurred by the company. Simultaneously, we're dedicated to refining our product pricing strategy to optimize both our gross margin and sales revenue, ultimately leading to an improvement in our bottom-line performance. Despite a bottom-line loss, our cash flow remains strong thanks to our working capital management efficiency. We have sustained positive operating cash flow for three consecutive quarters since Q3 2022. Now, turning to the balance sheet, cash and cash equivalent restricted cash and term deposits as of March 31, 2023, were RMB $1 billion. an improvement from RMB 973 million as of December 31st, 2022. As we continue to execute our precise inventory management strategy, we further reduce our inventory balance to RMB 800 million by the end of the quarter from RMB 1 billion at the end of the year 2022. And it is the lowest level in the past six quarters. In November 2021, the board approved the allocation of up to U.S. dollars 20 million toward a share repurchase program. In Q1 2023, we continued our repurchase program as we remain confident in our business prospects in the longer term. We have bought back U.S. dollars 11.1 million worth of shares by the end of March 31st, 2023, and we intend to carry on with this buyback program. Now let's discuss our outlook. In light of the ongoing geopolitical and macroeconomic challenges, our guidance for the second quarter of 2023 currently projects net revenue to be between RMB $650 million and RMB $850 million, compared to RMB $1.1 billion for the second quarter of 2022. We expect roughly 65% to 75% of the revenue will be contributed by our self-branded products in the second quarter. Please note that this outlook reflects continued uncertainty around lower discretionary consumer spending, especially in our international markets and global macroeconomic weakness. That said, we have seen some positive signs, and much of the year lies ahead of us. Furthermore, as we mentioned last quarter, the year may be somewhat back and loaded as we gradually release our new products. And with that, I would open it up for questions. Operators, please go ahead.
spk00: Thank you. We'll now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you're 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 2. For the benefit of all participants on today's call, if you wish to ask your question to the Companies Management in Chinese, please immediately repeat your question in English. At this time, we will pause momentarily to assemble our roster. The first question comes from Nicolette Jones with Brooks Investments. Please go ahead.
spk05: Thank you for taking my questions. So I have three questions. Firstly, can you please provide some color on the revenue trend of self-branded products in the second quarter and beyond? And then secondly, I'd like to ask if you can discuss factors that impacted your margins in the first quarter and margin outlook in the remainder of the year. And lastly, I'd like to understand a bit more about the revenue breakdown by region. Thank you.
spk01: Yeah, it's a lot of questions. So let me start with the first question. I think it's on the self-branded product margin. Sorry, I think it's around self-branded product revenue outlook for Q2 and the quarters ahead of us, correct?
spk05: Yes, thank you.
spk01: Okay. Now, I think As we just guided, we're looking at roughly RMB 650 million and RMB 850 million for Q2 as our revenue range. And then out of that number, there's going to be around 65% to 75% of the revenue, which is going to be contributed by our self-branded products. So if you take the mid number over there, in essence, we're looking at the second quarter revenue, which is going to be around, let's take a number, 750 million RMB. And out of that, 70% would be our self-branded products. If that number is correct, I think that is actually going to be indicating that our self-branded products revenue is going to start to grow versus the same period of last year. And looking ahead, we have mentioned a few times that we're actually transforming more into self-branded driven revenue kind of company rather than in the past majority of our revenue is actually consists of the ODM Xiaomi product and you will see this trend starting to take a shape more in I think we have already started to you have already seen this trend but I think after a few quarters, especially Q2, Q3, Q4 this year, you will start to see a solid trend of majority of our sales revenue is going to be generated by self-branded products. Well, we still have a small portion of the Xiaomi and ODM products revenue and in return, that sales mix change is going to help us to deliver a higher gross margin. So I think that naturally goes into your second quarter, which is on the margin outlook. I think one of the things I would like to call out in the first quarter this year is that we have already seen, I think we have already seen consecutively a few quarters in the past that our self-branded product gross margin is starting to recover and we see this trend progressing into Q1 this year. And we have already mentioned in our prepared remarks that in Q1, our new product sales gross margin is around 35%, which is a lot higher than what we have sold in the past. Our overall gross margin for the self-branded products in quarter one was still flat year over year, largely because we still have some of the old inventories from the previous generation products, which we carried over from previous years, which we tried to sell off. And I think we're coming, and that's why you also see our inventory uh balance uh decreased dramatically in the past six quarters and we are now at 800 million worth of inventory which is if you put it into perspective that's just equivalent to the sales outlook of a quarter out sales for us right and i think coupled with the clearance of the old inventory which come more or less to the end right now plus the newly launched product of self-branded products which is going to take its shape in quarter two and ultimately into the high season of Q3 and Q4. We see the gross margin of our self-branded products as well as the overall gross margin is going to shoot up or continue to improve in Q2 and ultimately in Q3 and Q4. I think that should answer your second question. And your third question, if I remember clearly, it's about the revenue breakdown by region. I think we have mentioned several times that our biggest sales region for our self-branded products is in Europe. And that actually stands for around 60% of the overall self-branded revenue for us. And in many of the big European countries, for example, Spain and Italy, we hold a very dominant market share position in those countries. And we will continue to expand in Europe, especially in the east part of Europe, as well as in the countries like traditionally a very strong brand awareness for uh our premium competitors for example apple and the samsung brands uh you're you're more looking at countries like germany and uk etc etc right and apart from europe i think we also see united states as one of the countries and regions which can give us quite a growth opportunity because we have been operating in U.S., in the North American market, for roughly close to two years, less than two years, and we have already developed our market share from zero towards 11%. That's actually ranked ourselves among the top five players in the U.S. So I think U.S. will continue to push up after Europe. And the third biggest sales region for us is the ASEAN countries. You're looking at Japan, Korea, and Malaysia, Singapore, and India. These, we actually group them as one of the Asia-Pacific countries, and then they also play as an important part of our self-funded revenue. Last but not the least is China. I think we also want to play smartly in China by selling selectively our premium products in China and try to look at the profitability rather than the scale because the competition in China is quite fierce, especially in the smart watch domain. But I think In certain premium price segments, we have a unique position to compete over there. So that altogether hopefully would give you a view on where we're going to push for this year's revenue for self-branded products.
spk05: Yes, thank you. That's very helpful. Thank you.
spk00: Again, if you have a question, please press star then one. The next question comes from Lisa Lee with Alpha Research. Please go ahead.
spk03: Thank you for taking my question. I have two questions. The first one is on the very strong margin that you just mentioned for your new products. You said it was around 35% in the first quarter. I'm just wondering what are the drivers behind this performance, and are there any further upside to this number? And the second question is on the run rates of your operating expenses. You, I think, talked about a target of $200 million on the adjusted basis in the coming quarters. But I noticed in the first quarter, your total operating expenses have reached around $225 million, I think, on the adjusted basis. So are you being a little bit conservative on this target? And what is your run rate currently? Thank you.
spk01: Yeah, so let me try to answer the easy ones. Let's start with the run rate of the expenses, then I'll get back to the margins, because that's probably is going to be a little bit longer story here. Yes, you're right, Lisa. So if you look at our 2022 and 2021 quarterly expenses run rate, we're around 300 million RMB per quarter, which is adding up the R&D, G&A, plus the sales and marketing expenses all together. So this is actually one of the key KPIs, the management play a lot of focus into our day-to-day operation. So we have done a few things. We actually look at our... So there's number one. It's definitely the personnel, right? So we look at our workforce and we try to streamline our workforce and then we try to get it in line with our revenue scale. So that's definitely the one which we did in the past quarters. I think that's more or less coming to an end. And the second one is what we did is to look at our expenses based on a so-called ROI, return on investment approach. And we always look at the discretionary expenses in a way that whenever we could save, we asked people to be a little bit more cautious in for example, traveling, for example, spending on our marketing campaign by looking twice or three times whether or not it makes sense and what's the return on that. And the last thing which we did is on R&D part, we are more applying a so-called platforming approach whereby we look at our vertically integrated chips, OS, and everything together and try to lower the overall cost of delivery on our products. So that all translates into a lower R&D expenses, a lower sales and marketing expenses, and a lower G&A expenses. And you're right. I think last quarter we have guided that our target for this year probably is going to be achieving a run rate of 250 million per quarter and then we have already achieved that number and we have over delivered in essence this quarter on RMB 200, around 229 million for the quarter. And as we mentioned in our prepared remarks, we're looking at operating expenses, run rate of 200 million for the year. And yes, I still think by applying a more target approach, like what I just described, we still have room to push for a little bit lower than that number. At this moment, we're more looking at a run rate of 200 million RMB per quarter for that. And going back to your first question on the margin and then the margin development for our products for this year, I think there are a few drivers. Number one is that we are actually looking at, as you know, we have three different product lines which are targeting different type of consumers. Number one is our so-called spots and outdoor range, which is supported by our watch like a T-Rex and Falcon theories. These are the so-called Apple Ultra and Garmin watch competitors, which we want to use these type of, and we offer these watch at a relatively lower price with similar functionalities versus our competitors. And these watches actually have gained great traction in the marketplace right now. And we want to actually deepen on building on those reputations we generated through this watch and also the functionalities we have achieved out of this watch. And we want to actually use this type of reputation to sell and increase our ASPs of our overall product portfolio at large. And number two is actually what I mentioned just now on applying a vertical integrated supply chain as well as the chips, the OS, and the R&D effort altogether, so-called platforming approach in our R&D. In the past, if you have 10 platforms, then in essence you need to spend the money 10 times. But if you can actually single everything into one platform, then you are going to reduce your cost dramatically and at the same time deliver a user experience and functionalities much better than a scattered software and hardware landscape in the past. So I think with that second lever of vertically integration, we should be able to gain market share in those price segments between $100 and $200 range, which is also the part which our competitors like Huawei, like Xiaomi, and other brands, there's a fierce competition over there, but I think through a vertical integration and a pure player, we should have a better competitive edge over there. So number one is to increase the ASP on our premium watches. Number two is to use our vertical integrated system platforms and everything to increase our competitiveness on the lower tier price points. so that we can actually gain market share at the bottom from the Xiaomi, Huawei, and Samsung guys, and at the top from Apple and Garmin guys. And altogether, that should be the path on how we're going to increase our gross margin for our products in the future.
spk03: Thank you.
spk01: I hope that gives you a view. That's very helpful.
spk03: Yes, it did. Thank you.
spk00: As there are no further questions now, I'd like to turn the call back over to Grace John for any closing remarks.
spk04: Thank you once again for joining us today. If you have further questions, please feel free to contact ZAP's Investor Relations Department through the contact information provided on our website. This concludes this conference call. We may now disconnect your line. Thank you.
spk00: Again, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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