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Operator
Hello, ladies and gentlemen. Thank you for standing by for ZEPP Health Corporation's third 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.
Grace Zhang
Hello, everyone, and welcome to ZEPP Health Corporation's third quarter 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 earnest press release and slides referred to on this call by visiting the IR section of the company's website at ir.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 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 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 20F 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 ZEPP's earnings press release and this conference call include discussions of unaudited GAAP financial information, as well as unaudited non-GAAP financial information. ZAP'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 Wang-Shuang. Please go ahead.
Wang Huang
Hello, everyone. Welcome to ZAP Health Third Quarter 2023 Admin Conference Call. In the third quarter, we achieved a business turnaround returning to profitability after enduring six consecutive quarters of losses. Despite an year-over-year decline in revenue, our high-margin self-branded product contribution to our top line now accounted for approximately 80% compared to the average of around 40% for the previous five years. This accomplishment reaffirms the effectiveness of our operational strategy and the early success of our business model transformation. Before delving into the details, I would like to provide a recap of our business model transformation, which has taken nearly two years to bring us to our current position. transformation has involved departing from a business model that heavily rely on a single customer for the majority of our revenues is that we aim to establish ourselves as a self-reliant global smart variable and healthcare solutions provider. Throughout this transformative phase, we have recognized the importance of enhancing the quality of our revenue streams. This transition signifies a deliberate shift from pursuing sheer growth to a steadfast commitment to achieve profitability. Our strategic focus is centered on improving our growth margin and ultimately guiding us towards sustained profitability and future growth. Notably, our Q3 performance indicates an early success on this journey. While Xiaomi branded products face persistent industry-wide headwinds, our self-branded products sustain sequential growth momentum is 12.3% quarter-over-quarter revenue growth. This was driven by our expanded AI power product portfolio and average brand influence worldwide, resulting in a rise in product adoption across several markets, notably In Southeast Asia and central region, our self-branded product revenue increased by 28.4% and 79% respectively year over year. It's also worth mentioning that we turned net profit positive for the Chinese and Indian markets during the third quarter as we remain focused on high-quality growth with effective region-specific sales expansion and cost-reducing strategies. Amid our business model transformation, we prioritize profitability over sheer revenue growth. This strategy is a strategic shift from results in a significant surge in our gross margin, reaching a historic high of 33.9% in Q3. This achievement is fueled by R&D breakthroughs, such as our industry-leading GPS check technology and the continuous update of ZipOS, supporting our premium product lines and elevating our ASP, thereby enhancing our product competitiveness. The expansion in growth margin is also a result of persistent efforts to improve overall operational efficiency. Looking ahead, We remain dedicated to refining our retail channels and product mix to sustain this positive trend in high growth margin, fostering profitable growth for future. While employing a profitability-oriented approach to our business operations this quarter. We also remain focused on leveraging our R&D capabilities to enrich and iterate our product and service offerings to attract a broader community of users. In September, we launched the Amacy Balance previously known as the Amazfit GT Series, a powerful smartwatch that enables users to track the ultimate balance between life, work, and wellness with seamlessly integrated advanced features for health, fitness, and lifestyle. Specifically, Amazfit Balanced features integration with Zap Coach a chat AI power fitness coaching service, ZEP Aura for AI power to rest and wellness services, and ZEP Pay for convenient NFC contactless payments. Notably, it's Amazfit's inaugural smartwatch to house a certified medical device blood pressure monitoring app in China. Moving forward, We are expanding the back pressure measurement software from the balanced product line to include a variety of watches, such as Amazfit Active, Cheetah, and T-Rex. This integration augments the overall value of our smart watches in comparison to other Chinese competitors who only utilize barometric measurements on specific models for blood pressure. We believe our approach is more convenient and applicable across our entire watch series. In October, we also unveiled the Amazfit Active and Amazfit Active Edge, both tailored for modern day city consumers. featuring an elegant appearance and powerful functionality with our AI power zap coach. Amazfit Active is an ideal companion for people trying to live a healthy and active lifestyle. Meanwhile, the tough yet stylish Amazfit Active Edge infuses our lifestyle series with new vitality, allowing users to express their identity and personality through its unique design. We still have many amazing new products on the way for the upcoming months, so stay tuned. We are currently hosting a message city campaign to champion a balanced and active lifestyle, which we consider the core value of Amazfit Watches. Successful sections have taken place in Dostoyevsk, Germany, and Madrid, Spain, with more city campaigns lined up. We invite users to join these sections, share feedback on our products, and collectively build a community that are the for the users of Amazfit smartwatches. We would be delighted to have you participate in these sections as well. At that, innovative minds are the driven force needed to advance the integration of technology especially on the ZEPP OS. To that end, we recently sponsored CalHex, the world's largest collegiate tech zone. For the second consecutive year, this event's wealth of tech talent presents an opportunity for us to discover bright new minds and ideas, thereby empowering us to fulfill our mission. We will continue to involve DevOps and increasingly rolling out our new updates to users to grow the user base. Alongside our ongoing product catalog expansion, we consistently enhance our product experience by rolling our software updates. the threat adoption, and the evolution of ZipOS. We are offering more regular updates to our users than before. For example, we released three major updates for Amazfit 2.2 in the third quarter. First, our official system upgrade to ZipOS 2.2 One, brought users a fresh interface and new interactive experiences. Then we also delivered a targeted sport mode upgrade and upgraded algorithm, enabling users to check their physical status in real time. The same is true for our Amazfit Falcon users and much more. These efforts to enhance our product value drove increased vibrance and engagement across our user community during the quarter. Notably, German marathon champion, Patrick Pfeiffer, has teamed up with us for his four-match season to showcase the performance and features of Amazfit Cheetah Pro, whether elevating our brand influence and enlarging our user base. Furthermore, we continued to leverage AI to drive our success, applying AI technology to both our products and services, as well as our daily operations. Evidenced by our latest product launches, we are integrating our AI powered features, such as Zap Coach and Zapora into more of our products and services to help users train and manage their health effectively. Additionally, we continue to adopt GPT technology to facilitate our software development and enhance our IT efficiency, which has yield encouraging results. we will continue to enhance our AI capabilities to prepare our development to the next level. Looking ahead, we remain committed to providing our flourishing global user community with our enriched product lines empowered by our evolving AI ecosystem as the macro environment remains challenging. We are striving to maintain and increase our profitability while also actively exploring opportunities to drive our top-line growth to enhance our product value and attract a broader range of users. As we help more people manage their lives and well-being with our intelligent healthcare solution tools, we remain confident of achieving healthy, sustainable growth. Thank you again for joining us today. I will now turn the call over to Leon to go over the highlights of our third quarter financial results.
Amazfit Balanced
Thank you, Wang. Greetings, everyone, and thank you for joining our earnings call today. I would like to start by discussing some of the key metrics from our financial results for the third quarter of 2023. As noted before, we believe that we have been in a post-pandemic downswing in the cycle for our categories that may not yet to be at its end. Our performances varies on a regional basis. Revenue in the Americas continue to be strong or partially offset by the softer performance in EMEA and APAC. reflecting the particularly difficult macroeconomic environment affecting both regions, which impacted our retailers' selling growth. Throughout the year, we saw the reduction in channel inventory levels, which put us in a healthy channel inventory position across our channels and geographies as we entered the holiday season. As I lived through multiple times in my 20 years in tech, We fully expect that consumer behavior will normalize in time, and our focus on innovation, execution, and exciting product roadmap will result in us returning to revenue growth in time. In Q3 2023, we recorded revenue of RMB 0.6 billion, in line with our guidance range, down by 50% year over year. This decline was mainly driven by lower Xiaomi branded product sales. During the quarter, our revenue generated from Xiaomi branded products decreased by 77%, where our self-branded products experienced a 26% decrease. Partially due to the timing of the new product introductions, as we will launch Amazfit Active and Amazfit Active Edge products in Q4 this year, and also in part due to our strategic approach to improve both channel and product mix. However, we have lost a 7.6% quarter-on-quarter growth for our self-rendered products, which attribute to our enhanced brand value and new product features. Despite the revenue decline, as Wong mentioned, we achieved a return to profitability and realized a third quarter 2023 net income of RMB 3 million compared with a net loss of RMB 17 million for the third quarter last year and a net loss of RMB 17 million for the second quarter of 2023. Moving on to our gross margin, which can be influenced by various factors such as product mix, product launch timing, and product life cycles. including model upgrades. Our gross margin for third quarter stands at a record high of 33.9%, almost doubled compared with the same period last year. This achievement is largely attributed to the strategic transformation driving us to focus more on made-fit branded products, especially the higher ASP series and the reduced clearance activities. Although the gross margin on Xiaomi branded products experienced a decline, the gross margin on our self-branded products, which now contributes to more than 90% of our total gross profit, more than compensated for this weakness, resulting in improvements in the third quarter gross margin compared with the second quarter. We're confident that with this positive momentum, alongside new product introductions planned for the upcoming month, as well as a moderated level of the clearance activity, we should be able to sustain the further expansion of our company's gross margin. Turning now to costs, as we have discussed, cost has been a key focal point for our company, both in terms of their absolute amount and as a percentage of sales. Hence, we continue to control expenses in a disciplined manner during the quarter. Since Q3 2020, we have been pleased to see a downtrend in total operating expenses while still making strategic investments in new products, technologies, and footprint expansion to fuel our long-term growth. In Q3, our non-GAAP operating expenses stood at RMB 180 million, the lowest level since Q3 2019, and better than the guidance we previously provided. Our R&D expenses in the third quarter of 2023, or RMB 75 million, decreased by 41% year-over-year. This comprised 12.4% of revenues versus 10.6% for the same period in 2022. The decrease is largely attributed to our refined research and development approaches as we consistently evaluated resources efficiently to ensure maximized return on investment and productivity. We're committed to investing in new technologies and AI to maintain our competitive edge against our peers. Our selling and marketing expenses for the third quarter of 2023 will RMB 70.6 million, a 43% decrease year-over-year, only primarily to our retail channel mix improvements. At the same time, we continue to invest strategically in our brand and execute ROI-driven marketing strategies. Our G&A expenses for the third quarter of 2023 were RMB 48 million, down by 8.9% year-over-year, compared with RMB 52 million in Q3 2022, benefiting from our effective cost control measures. Looking forward, we are steadfastly committed to our prudent stance in the coming quarters and expect to maintain operating expenses at around these current levels or even lower. Simultaneously, we'll continue to invest in research and R&D activities and marketing initiatives to foster long-term growth and competitiveness while diligently monitoring discretionary spending. Our operating results pivoted to a profit of RMB 11 million compared to the operating loss of RMB $73 million in the same period last year and the operating loss of RMB $72 million in Q2 2023 as a result of the expansion of our self-branded products gross margin and streamlined operating expenses. As we entered the traditionally high holiday season, we expect to realize operating profits in Q4. Now, turning to the balance sheet, cash and cash equivalents and restricted cash as of September 30, 2023, totaled approximately RMB $1 billion. Provide us with sufficient runway to seize 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 RMB 780,000 million, consistent with Q2 2023, and remains at a multi-year low level. We'll continue to manage inventory levels tightly as we weather the macro economy. In Q3, coupled with operating profits and efficient working capital management, we achieved positive operating cash flow. This is our fifth consecutive quarter of positive operating cash flow, and we expect to continue with this positive operating cash flow trajectory into coming quarters. Since Q2 2023, we started to retire part of our short-slash-long-term debt portfolio and retired $35 million of debt. In Q3, we continue to reduce our debt levels by another RMB 117 million. As our operating cash flow continue to strengthen, we intend to do more in the coming quarters. Furthermore, by the end of September 30, we had repurchased shares worth US dollars 12.3 million. We remain committed to continuing our buyback program in the fourth quarter, underscoring our confidence in the company's future and our commitment to delivering long-term value to our shareholders. Looking into the future, our revenue guidance for Q4 is projected to be in the range of RMB 600 to RMB 850 million. We anticipate that the trend of quarter-over-quarter growth in self-branded product sales will continue, contributing to an improving overall performance. Our focus on profitability, as well as strengthening our self-branded product performance, remains unwavering. In conclusion, the third quarter presented us with both challenges and opportunities. While external factors played a significant role, our strategic approach to prioritizing profitability over scale, our focus on self-branded products, and our disciplined cost management approach have all been instrumental to our encouraging performance and business turnaround in the third quarter. We're confident that these strategies will continue to deliver value to our investors and shareholders over the long term. Thank you all for your attention, and I will now open the call for any questions you may have. Operator, please go ahead.
Operator
Thank you. We'll now begin the question and answer session. For the benefit of all participants on today's call, if you wish to ask your questions to the company's management in Chinese, Please immediately repeat your question in English. 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. To withdraw your question, please press star, then 2. At this time, we will pause momentarily to assemble our roster. Our first question comes from Nicolette Jones of Brooks Investment. Please go ahead.
Nicolaus
Hello. Thank you for taking my question. I actually have two questions. Firstly, is this margin level sustainable? And secondly, in terms of profitability, can you sustain profitability in the fourth quarter?
Amazfit Balanced
Yeah. Thank you, Nicolaus. I mean, let me take these two questions. I think, as we mentioned before, the gross margin portfolio of our company is actually improved quite a bit throughout the year. You saw that our gross margin actually jumped in Q2 versus Q1 and also versus last year to a high of 22%, and thereafter, in Q3, our gross margin further improved to 34%, roughly. This is actually due to a mix of product mix improvement and retail channel mix improvement in our gross margin management. As we head into Q4, which is traditionally the high seasons for our product categories, and then also, as I mentioned, we launched quite some new products. starting from second half of this year, and these new products also carry a much higher gross margin than what the old products used to carry before. Therefore, I think given the high season in Q4, given the product mix improvement we're doing, and given the relative moderate clearance activities which we're going to do, but obviously we're going to do some in Black Friday and the Christmas season to catch the cells. We still expect that Q4 gross margin will continue at the Q3 level and maybe a little bit even further, expand further in Q4. I think that should give you a feeling for the gross margin portfolio for Q4, how that looks like. With regard to the profitability in Q4, we normally don't guide on that, but I think as you hear, I mentioned that given the high season of Q4 and the improved gross margin performance of the company, and we also intended to streamline our cost at its current level or even lower, We believe that this all gives us a good chance in delivering a Q4 operating income, which would allow us to continue the performance improvement trend throughout the year.
Nicolaus
Thank you.
Operator
Again, if you'd like to ask a question, please press star, then 1. 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
Thank you once again for joining us today. If you have further questions, please feel free to contact Jeff'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.
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