Zepp Health Corporation

Hello, ladies and gentlemen. Thank you for standing by for ZEPP Health Corporation's fourth quarter and full year 2023 earnings conference call. At this time, all participants are in listen-only mode. Today's conference call is being recorded. I will now turn the call over to your host, Ms. Grace Shum, Director of Investor Relations for the company. Please go ahead, Grace.

Hello, everyone, and welcome to Zapp Health Corporation's fourth quarter and full year 2023 earnings conference call. The company's financial and operating results were issued in a press release via the newsletter 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 .com. Participating in today's call are Mr. Wang Wenhuang, our Chairman of the Board of Directors and Chief Executive Officer, and Mr. Leon Teng, 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 Young, 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 Security Litigation Reform Act of 1995. Forward-looking statements involving hurry risks and uncertainties. As such, the company's actual results may be materially different from the new success 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 do note that debt earnings press release and this conference call include discussions of unaudited debt financial information as well as unaudited non-debt financial information. That press release contains a reconciliation of the unaudited non-debt measures to the unaudited most directly comparable debt measures. I will now turn the call over to our CEO, Ren. Please go ahead.

Hello, everyone. Welcome, and thank you for joining our call. In 2023, amidst global microeconomy uncertainties, our ROI-oriented strategy and ongoing business model transformation began to bear fruit. This strategy shift has enabled us to strengthen our commitment to becoming a global provider of cutting edge smart variable healthcare solution. Before we dive into our earnings, I would like to spend some time talking about our strategy as we reflect on 2023. Over the past two years, we have been on a transformative journey to become less dependent on Xiaomi branded products and instead develop a self-reliant company driven by its self-branded product sales. This shift is starting to show promising results as evidenced by our two consecutive non-GAAP profit quotas. Looking at 2024, building on the actions we have taken in the past, we are excited to be making a strategic leap and harmonizing the synergy between our product and sales channels. This leap forward is grounded in three core pillars. First, we are putting greater emphasis on R&D and product-driven innovations, where we will fully embrace AI and offer more innovative products that closely align with needs of our key markets. Second, we are continuing to ensure profitable growth. maximizing the value we derive from each and every product sold. Guided by this approach, we are choosing profitability over scale in some regions, such as India, which transitioned in 2023 from a loss-making market to a profitable one. In certain other areas, we are investing aggressively to gain market share, aiming to generate long-term returns. Last but not least, we will invest in branding and marketing communications in order to enhance our brand presence by welcoming our amazing athletes and increasing sponsorship of big sports events. I believe you will see the Amazfit brand more visible across the world in the coming quarters. With these three pillars, I am confident we can propel our frame view and generate a higher return from our employees and shareholders in the long run. In the fourth quarter, of 2023, our focus on strategic transformation towards a more self-reliant revenue stream has gained traction. Aimed at reducing dependency on a single customer, lowering revenue concentration, and shifting our emphasis increasingly on self-branded products, these efforts to become self-reliant have made significant progress. As a result, despite a year-over-year decline in our revenue during the fourth quarter, our self-branded products maintained a sequential growth momentum with a quarter-over-quarter growth of 14.8%, and contributed to 91% of our top line, up from 77% in the previous year. Notably, our gross margin reached a record high in the fourth quarter, a testament to our effective prioritization of profitability over scale. This significant achievement was largely driven by our higher-margin, self-branded products. The launch of the Amazfit Active and Amazfit Active Edge series in 2004, as well as the Amazfit Balance Special Edition, enhanced our product portfolio and significantly elevated our market presence. At the same time, we will continue to improve our retail channels and enhance our product mix to sustain the higher growth margin trend. leveraging self-branded revenue to bolster the company's overall performance and steering us towards sustained profitability. To further solidify our market-leading position in smart variables, we continue diversifying our product lineup to meet evolving market demands. In October, we launched two new lifestyle smartwatches, the Amazfit Active and the Amazfit Active Edge in Europe and APEC. These smartwatches paired for today's urbanize. Branding elegance with powerful functionality incorporates the AI-powered ZAP coach, and effortlessly integrate into our users' hectic lives. At ZAP, innovation is at the core of everything we do. To reflect this vision, I would like to highlight some of our success in smart variable technology at CES 2024. The CS launch of the Amazfit Helio Ring, our first smart ring, underlines our dedication to providing pioneering accessible healthcare solutions. The Amazfit Helio Ring is designed to offer unparalleled recovery support to athletes. These developments in our commitment to empowering individuals to take control of their health and well-being through our smart variables. Building on the momentum of our product expansion, we remain dedicated to leveraging ZappOS We recently introduced ZapOS 3.5 with Zapflow at MWC Barcelona 2024 in February, a substantial update powered by large language model AI, marking a significant leap in wearable intelligence devices and bringing unprecedented levels of interaction that flow offers seamless natural language liquidation to provide users with exactly what they want from setting an alarm deactivating the always-on display feature to providing feedback on last night's sleep quality and analyzing the readiness score from the previous day's activities and offering recommendations for improvement in the following days. All can be done by interacting with the watch using human natural language and without the need to memorize any predefined commands. Additionally, we provide our users with consistent software updates. For example, the Amazfit Balance now features new training templates, new ski map functions, and enables smart NFC car payment in Europe, enhancing both the sporting experience and general daily convenience. Our bulk pressure measurement software has been expanded to a broader range of products, including the Amazfit Falcon, Active Cheetah Pro, Amazfit T-Rex Octra, Amazfit T-Rex 2, and GTR 4, aiming to deliver personalized and advance wellness support to a greater number of users. Our product's seamless integration of hardware and software not only assists users to improving their well-being, but also elevates their lifestyle. I'm happy to share a comparing example that comes from one of our Japanese users who found himself lost in a snowstorm during a hiking trip in Mont Blanc. Fortunately, our Chilex2 guided him safely back. He shared his experience on Yarmouth Japan's leading outdoor app, and even sent us a thank you email. Stories like these fill us with pride as we see our products contribute to the enthusiasm and certification of our users. 2023 leaves behind a tapestry woven with both challenges and triumphs. As we are transforming into a self-reliant company and shifting our strategy from pursuing pure revenue growth to profitability, we have seen a decline in revenue despite that. our Amazfit branded products contributed to 74% of our total revenue, compared to 59% in 2022. Furthermore, our efforts translated into a commendable 36% reduction in NUMGAP's net loss, marking a pivotal shift for as we achieved profitability in both Q3 and Q4, leveraging our cross margin and cost management strategies. Another operational milestone in Q4 2023 was the successfully completed mass production of our amazing BEEP watch line at our Vietnam factory. This achievement not only underscores the execution of our multi-sourcing global supply chain strategy, but also paves the way for further global expansion. Additionally, we have witnessed a surge in product visibility particularly on social media platforms and through key opinion leaders endorsements, including a growing market presence and heightened consumer engagement. Looking to the future, we see a healthy and sustainable growth trajectory for ZAP. our relentless drive for innovation and strategic expansion of our product offerings positions us to effectively adjust the evolving demands of our global user community. Despite headwinds posed by macroeconomic challenges, our focus remains steadfast on bolstering profitability and seeking dynamic opportunities to propel our resilience growth and secure greater bottom line scalability. This approach not only strengthens our competitive edge, but also ensures our long-term success in the ever-evolving smart variable industry. I will now turn the call over to Leon to go over the highlights of our fourth quarter financial results.

Thank you, Wei Yan. Greetings, everyone, and thank you again for joining our earnings call today. I would like to start by discussing some key metrics from our financial results for the fourth quarter of 2023. As we have mentioned in the past, the border consumer electronics industry has yet to recover and remains subdued across our geographies. This is partially due to a sluggish demand for high-value consumer electronics products, such as TV and mobile phones, coupled with challenging economic conditions in parts of the EMEA and APAC regions. However, we saw some modestly improved performance in the smart watches for outdoor slash sports category, though the market remains highly competitive. Aimed at these challenges, we steadfastly adhered to our strategic plan. This holiday season, we took an unconventional approach by launching an extended pre-Christmas promotion in selected products. Traditionally, we focused on offering discounts centered around Black Friday and Cyber Monday. However, this year, we decided to align with consumer expectations for ongoing discounts throughout the holiday season. This strategy resonated well with our consumers. We have met our own sales expectations while delivering strong gross margins for the quarter. All of this is a testament to our strong brand, our great product lineup, and the value that our products can offer. However, given that this successful promotion occurred later in the fourth quarter, it is likely that it might have advanced some sales from Q1 of 2024. Since Q1 is typically our slowest quarter of the year, we're adopting a more cautious outlook for the revenue projections in the upcoming quarter. I would like to emphasize that we are later focused on the areas within our control. We're holding our market share steady without sacrificing gross margin. As we stand at the start of a multi-year product cycle, we're beginning to harvest the benefits of our research and development investments. This allows us to branch into new categories and introduce innovative products, such as the Helio Ring we unveiled at CES, with more announcements planned for the coming quarters. We're also broadening our distribution channels to align with where our customers prefer to shop. Additionally, we're reinventing our brand marketing and activation to tap into sports, and address new audiences. As Wayne highlighted earlier, you will see our brand featured more prominently at sports events and will welcome more athletes to join our Amazfit family. That strategic positioning of the company aims to accelerate our growth while managing expenses carefully to ensure margin expansions in the years to come. Now turning to Q4 sales, our overall sales for the quarter was US dollars 85 million slash RMB 6 billion, aligned with the lower end of our guidance as we navigated the technical challenges in our categories and the highly promotional environments. This reduction in sales was influenced partially by our strategic decision to prioritize profitability over scale with foreign exchange fluctuations also having a negative impact. In markets like China and India, our business model mirrors this emphasis on profitability over scale. The shift has resulted in these markets turning net profit positive in 2023. Furthermore, despite year-over-year revenue declines in our self-branded products, we achieved positive quarter-over-quarter revenue growth convincing us that our strategic approach will empower our business long-term sustainability and resilience. Moving on to gross margin, which can be influenced by various factors such as product mix, product launch timing, and product life cycles, including model upgrades. As Weiya indicated earlier, our Q4 2023 gross margin reached an impressive 34.7%, surpassing Q3 and marking the highest gross margin in the company's history. This achievement can be attributed to a favorable product mix, a higher proportion of new product launches, such as Amazfit Active and Amazfit Active Edge series, and reduced clearance activities. Importantly, we anticipate this positive trend in gross margin to extend into Q1 and throughout 2024. Now, let's turn our attention to cost. As we have discussed, cost management remains as a critical area of focus for our company, mostly in terms of their absolute amount and as a percentage of sales. Hence, we continue to exercise discipline control over our expenses during the quarter. Since Q3 2020, we have consistently reduced over-operating costs, all while strategically investing in innovative products and technologies, as well as geographical expansion. As a result, non-GAAP operating expenses for Q4 stood at US dollars 27 million, RMB 191 million, comparable with Q3 2023 and consistent with the guidance which we provided. Adjusted research and development expenses in the fourth quarter of 2023 was dollars 11 million, a decrease of 30.8% year-over-year. This comprised 12.8% of revenue versus 10% for the same period in 2022. The decrease was primarily attributed to our refined research and development strategies as we constantly accessed resources efficiently to maximize return on investment and productivity. Also, we integrated an AI-based R&D platform to improve our efficiency. At the same time, we're committed to investing in new technologies and AI functions to maintain our competitive edges against our peers. Adjusted selling and marketing expenses in the fourth quarter of 2023 was US dollars $12 million, a year-over-year decrease of 31%. These expenses accounted for 14.3% of revenues compared to 11.6% in the same period in 2022. The reduction in amount was mainly due to our ongoing efforts to improve profitability and refine our sales channel mix. In addition to the in-depth enhancement of our retail channels, Such efforts also included a strategic allocation of stuff throughout our sales region. Additionally, we launched Amazfit Wellness Wonderland and a pop-up store in Berlin to spotlight wellness during the holiday season. We showcased our brand concept through a collaboration with Cicely Nano Contemporary Play at the launch of the Amazfit Balance Special Edition Watch. drawing significant media attention. This concept was also highlighted in the Dev Health 10 Years of Innovation campaign. We are committed to making smart investments in marketing and branding initiatives that will fuel our longer growth. Adjusted G&A expenses amounted to US dollar 4.0 million in the fourth quarter of 2023. a year-over-year decline of 37.8%. These expenses represented 4.8% of revenues compared with 4.3% in 2022. This decrease in absolute amount was are largely attributed to our efforts in optimizing personnel and enforcing strict cost control over administrative expenses. Looking ahead, our commitment to prudent cost management will continue in the coming quarters, with anticipated costs remaining below our current levels. will maintain our strategic investments in R&D activities and marketing expenses to ensure our long-term competitiveness, striking a balance between strictly monitoring discretionary spending and making strategic investment critical for our long-term growth. In Q4 2023, we reported an adjusted operating profit of US dollars 2.4 million RMB 17 million, which includes a non-cash US dollars 3.5 million valuation allowance of deferred tax assets versus the operating loss of US dollars 8 million in the same period last year as a result of the expansion in our self-rendered products gross margin and our streamlined operating expenses. Now turning to the balance sheet, As of December 31st, 2023, our cash and cash equivalents, along with restricted cash balance, totaled approximately US dollars 140 million slash RMB 1 billion. This positions us with ample runway to capitalize on potential marketing opportunities and invest in our business growth. We have also focused on managing our working capital efficiently. We kept inventory levels steady at US dollars 85 million, RMB 600 million, the lowest level in the company's history. We'll continue to manage inventory levels tightly as we weather the macro economy. In Q4, coupled with operating profits and efficient working capital management, we achieved positive operating cash flow. This marks our sixth consecutive quarters of positive operating cash flow, and we expect to continue this position in the coming quarters. Since Q2 2023, we have initiated the retirement of portions of our short and long-term debt portfolio, successfully retiring US dollars $4.8 million RMB 34 million of debt in Q2, and USD 16 million, RMB 170 million in Q3. In Q4, we continue to reduce our debt levels by another US dollars 12 million, RMB 84 million. As our operating cash continue to strengthen, we intend to do more in the coming quarters. Furthermore, by the end of December 31st, we had repurchased shares worth $12.9 million. We remain committed to continue our buyback program in the fourth quarter and in the quarters following that, underscoring our confidence in the company's future and our commitment to delivering long-term value to our shareholders. Looking ahead, as I mentioned before, Q1 is traditionally a soft quarter for us. Therefore, our Q1 guidance range is projected to be US dollars 42 million to US dollars 49 million, RMB 300 to 350 million, with self-branded products accounting for about 90% of the revenue. In conclusion, the fourth quarter presented challenges that we overcame by prioritizing profitability over scale. This strategy combines our disciplined approach to cost management as being instrumental in achieving encouraging performance and delivering a second consecutive quarter of non-GAAP profitability for us. As we look ahead, we remain confident that these strategic initiatives will continue to deliver long-term value to our investors and shareholders, as well as our employees. Thank you all for your time. I would now like to open the court for any questions. Operators, please go ahead.

Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speaker phone, please pick up your handset before pressing the keys. 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 Once again, it is star and then one to ask a question. Our first question today will come from Nicholas Jones of Brooks Investments. Please go ahead.

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

Nicola, I mean, if you could repeat the second question one more time for me, please.

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

Okay, on the regional strategy. Thank you. So let me take this question. I think your first question on the outlook for first quarter and also on 2024, I think on the first quarter, I just mentioned that typically it is a relatively soft quarter for the consumer electronics industry. Therefore, our guidance for the first quarter was between the range of $42 million to $49 million, or RMB equivalent to $300 to $350 million for the top line. Normally, our guidance stops at giving the guidance only for the revenue, but in this call, I think I want to provide some color for year 2024, as you asked. I think looking at the full year 2024, if we start from the big picture, both IDC and Catalyst actually are projecting overall market value growth for the smart watch sector, which is the sector which we're operating in, of a single digit, high single digit growth for year 2024. Therefore, I think our revenue growth target for 2024 at this juncture, to the best of our knowledge, is actually going to be on par with or higher than the overall market growth for our self-branded products on the top line. So I think that's the guidance on the 2024 for the full year for the sales. And coming to gross margin, as you heard what we just mentioned, that our overall gross margin percentage as a percentage of cells actually hovered in the second half of 2023 of somewhere between 30 to 35%. and we expect this gross margin to expand in the upcoming quarters and throughout 2024. Therefore, I think it's reasonable that you could anticipate that our gross margin performance is going to be at least on par with second half of 2023 or even higher than that, right? And then the last missing Puzzle of this is actually the operating cost, which is, I think we have mentioned that the run rate of our quarterly operating cost is around RMB 200 million-ish. And we have actually maintained this run rate for more than four quarters throughout 2023. And we have been demonstrating that we're able to keep up with this cost level and adjusted this level if we need in the year to come. So I think that should give you a feeling on where the year 2024 would bring us on the bottom line in this case. I think that should give you a sense of the first quarter guidance and the full year 2024. Then I'm actually coming to your second question, which is our regional strategy. I think for a lot of analysts, including yourself following us, you must know that Majority of our sales revenue is actually coming from the overseas market with more than half of the revenue coming from the EMEA region. And then for the remainder, we have half of that coming out of the USA and the other half coming out of the Asia Pacific region, right? So, and I think looking at 2024, there are a few big events in front of us, being the Olympics in Paris, in Europe, and also the European Cup, which is a soccer game, also in July and June, July timeframe in Europe. So Europe will be a big sports year for us. And for sure, we'll also bank on those big sports events in order to boost our sales for the company. And not to mention that USA actually stands as another bright spot for growth for us because we have made quite some advancement in the offline channels In U.S., for example, we are featured in Best Buy, Target, and many offline channels, and also including Walmart in U.S. at this moment. And we're actually expanding into more stores and also more offline channels in the USA as we speak, which we believe in 2024 we should see a reasonable growth coming out of USA for us as well. I think that is in a nutshell where we play in the regional structure. And not to mention that in Asia Pacific region, we have markets whereby we also see a great potential, for example, Thailand, Japan, Taiwan, et cetera, et cetera, where we think we can also make a big leap of our revenue in the year to come.

Thank you.

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

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

Yes, I think you were referring to the China A Stock listed company, which we invested and we took a uh a minority share in that company i think that company if you look at it it it is actually placed into the vertical integration of our big plan for the wearables because that company to be specific actually is making the sensors and producing the chips for not only us, but also other wearable manufacturers for the smart watch product. And in the future, I think having this company as an A-listed company in China has its benefits because it can not only supply goods to us, but also it can supply goods to many other ecosystem companies which want to play in the wearable domain. And I think this is a little bit similar to the Apple chip strategy, but the only difference is that Apple doesn't open it to the others. and we as a player and a strong player in the smartwatch domain, we would like to actually open up more to the ecosystem within China on the wearables domain. And I think And also having this listed company in China would benefit this company and our company on the specific semiconductor push, which we're going to get from the Chinese market. And it's a highly competitive market. So, um, and, and, and, and, and to some extent, uh, I think our, uh, the, if you look at the market value of the eight listed company, multiply our shareholding, uh, the, uh, value is already bigger than, uh, the, our market cap per se, right. Which is, unfortunately there's something in. uh the equation which does not play uh or the value has to be fully unleashed in order to uh realize uh the the full value of this company got it thanks but we have no intent to to to to sell that stake at this moment of time okay um your cash position is very strong um you know someone would expect

You'll be paying down your debt sooner than what you've been doing. How much of debt would you pay down this year?

I think overall in 2023, as I mentioned, actually we'll pay down more than two, if I remember clearly, I think more than 200 million RMB in debt. And at this moment in time, if you look at our balance sheet, we have hardly any short-term debt and we only have some long-term debt, but majority of that long-term debt is actually for the purchase of the stake in the China listed company. And then we have also pledged the shares in order to make that purchase. So in essence, that doesn't play into the health of the overall cash balance I have on ZEPP Health. And if you look at 2024, we also have similar intent as the probability I just mentioned, and I give a picture on how 2024 would be looking like. I think together with the positive operating cash inflow, we're thinking about retiring similar amount or more than what we did in 2023 in 2024. on the debt portfolio. And that will make us, if we do that by the end of 2024, that will give us no debt or close to no debt situation by the end.

Okay, perfect. Thank you so much, Leon.

Thank you, Sid.

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

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

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