Zepp Health Corporation (NYSE:ZEPP) Q4 2022 Earnings Call Transcript

Zepp Health Corporation (NYSE:ZEPP) Q4 2022 Earnings Call Transcript March 21, 2023

Operator: Hello, ladies and gentlemen. Thank you for standing by for Zepp Health Corporation’s Fourth Quarter and Full-Year 2022 Earnings Conference Call. At this time, all participants are in listen-only mode. Today’s conference call is being recorded. I will now turn the call over to your host, Ms. Grace Zhang, Director of Investor Relations for the company. Please go ahead, Grace.

Grace Zhang: Hello, everyone and welcome to Zepp Health Corporation’s fourth quarter and full-year 2022 earnings conference call. The company’s financial and operating results were issued in our press release via the News Wire Services earlier today and are posted online. You can also view the earnings press release and the slides we refer to on this call by visiting the IR section of the company’s website at . Participating in today’s call are Mr. Huang Wang, our Chairman of the Board of Directors and Chief Executive Officer; and Mr. Leon Cheng Deng, our Chief Financial Officer. The company’s management will begin with prepared remarks and the call will conclude with a Q&A session. Mr. Mike Yeung, our Chief Operating Officer will join us for the Q&A session.

Before we continue, please note that today’s discussion will contain forward-looking statements made under the Safe Harbor Provision of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, the company’s actual results may be materially different from the views expressed today. Further information regarding this and other risks and uncertainties is included in the company’s Annual Report on Form 20-F for the fiscal year ended December 31, 2021, and other filings as filed with the U.S. Securities and Exchange Commission. The company does not assume any obligation to update any forward-looking statements, except required under applicable law. Please also note that Zepp’s earnings press release and this conference call include discussions of unaudited GAAP financial information, as well as unaudited non-GAAP financial information.

Zepp’s press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited most directly comparable GAAP measures. I’ll now turn the call over to our CEO, Mr. Wang Huang. Please go ahead.

Wang Huang: Hello, everyone. Thank you for joining our call. In 2022, we faced substantial macro challenges such as the ongoing COVID-19 pandemic. The Ukraine, Russia war, global infection and weakening consumer confidence. These factors affected our operations. While in Q4, consumer discretionary spending decreased due to macroeconomic uncertainties, particularly in Europe and the U.S. Against this backdrop, our fourth quarter revenue came in at RMB1.1 billion, down 35.5% year-over-year, primarily due to decreased sales of Mi Band products. Our company foresaw the decline of their basic bank market. Quarters ago, and shifted our focus to self-branded watches. I’m pleased to share with you that our self-branded products accounted for 77.4% of our sales during the fourth quarter, compared to 57.7% in the same period last year.

We now offer various product lines for our self-branded products, including outdoor sports and fitness, business, and basic . As you remember, leading the company through its IPO 5 years ago, our self-branded products only accounted at roughly 20% for the company’s revenue. Over the past 5 years, we have successfully transformed our business from: one, which revenue was largely contributed by a single customer to becoming a top global player in the smart wearables and health care services industries. Despite macro challenges, our self-branded products showed strong performance during Q4 with 28.5% quarter-over-quarter revenue increase and continued gross margin expansion. The success is due to improved sales of our high margin products and enhanced brand value together with our optimized solid performance in sales channels demonstrating our improved market position.

We believe that the market has significant growth potential. We are confident in the growth trajectory of our Amazfit and Zepp products. And we are committed to further expanding our self-branded product line. As we move forward, we will continue to focus on product innovation and optimizing our cost structure to drive profitability and reinforce our business with resilience. We believe this most valuable market has not achieved its full potential yet. For example, as we integrate GPT technology into our Zepp OS, we are able to offer a highly advanced and personalized experience for our users. This allows us to stand-out in an increasingly competitive smart wearables industry by providing personalized sleep insights. Coaching, goal tracking, nutrition advice, and health monitoring features.

All with seamlessly integrated within our wearable devices. Our dedication to improving the user experience and enhancing oral well-being from our competitors and positions us as a leader in the industry by continuing to leverage the power of GPT technology and other cutting edge offerings. We are strategically expanding our reach and building long-term value. Our company has the long history of investing in cutting edge technology to enhance our products and services. Several years ago, we invested in liquefied architecture chip technology and now we are able to use our own in-house design, low power, high performance RISC-V chip for smartwatches. This investment has allowed us to improve our smartwatches performance and battery life. We are proud to leverage this technology in conjunction with our AI technology.

Similar to GPT, to offer tailor made user experience with the power of our electrified chips and AI technology we can significantly enhance user’s health and fitness performance. We also utilize this technology to optimize user service, feedback analysis, marketing data analysis, AI coding and testing, allowing us to increase operational efficiency and improve service quality. In addition to enabling users to design their own AI empowered watch faces, we have also developed meaning apps that automatically is done by AI similar to GTP technology. This allows us to offer users a highly personalized experience and sets us apart from our competitors in the smart wearable industry. So, we will integrate these technology advancements into our Zepp smart coach function to elevate the user experience to new highs.

Now, let’s move to our global operations and products. Our new self-branded products has an impressive market performance, resulting in increased brand recognition among consumer worldwide in Q4. Amazfit consumer electronics in the in the fitness tracker category for top e-commerce U.S. market share gain, validating our product competitiveness in the premium market. We also expanded our presence on the global stage by opening our office in February. We successfully launched the Amazfit Falcon globally, which received recognition from the global high-end sports professional community. And our newly launched Amazfit GTS 4, and GTR 4 have been well received by consumers worldwide. In Q4, we remain concentrated on optimizing our cost structure as we strive for profitability and further enhance business resilience in 2023.

Photo by National Cancer Institute on Unsplash

We will continue with these cost cutting initiatives, while balancing cost controls with expenditures to fuel growth. And we anticipate that these actions will meaningfully benefit our business operations in the long run. We are extremely confident in our ability to see market opportunities, enhance our product value, and continue to deliver additional shareholder value, while providing users with more and comprehensive healthcare products and services. We believe that by optimizing our cost structure and balancing cost controls with investment in growth. We can continue to enhance our product value and improve margins rather than focus solely on quantity. We prioritize quality growth and aim to win the competition in advanced markets like Europe and North America, even in the face of global micro economy and certainly, we remain committed to providing cutting edge technology and products.

Thus stay at the forefront of wellness solutions. Thank you again for joining us today. I will now turn the call over to Leon to go over the highlights of our fourth quarter financial results.

Leon Deng: Thank you, Wang. Greetings, everyone. I would like to begin by discussing the key metrics of our fourth quarter financial results. Our fourth quarter revenue coming at the lower end of our guidance range, approximately RMB1.1 billion reflecting a 35.5% year-over-year decrease. As we all know, this quarter was marked by macro headwinds as ongoing geopolitical tensions and lower discretionary spending positions, particularly in Europe and the U.S. As a result, consumers remained cautious with their household budgets, hearing a recession and inflationary pressures. Our sales in China were also impacted by lower consumer spending, specifically during the month of November and December, the COVID-19 pandemic outbreak and policies dampened consumer confidence, uncertainty.

Furthermore, our supply chain was affected by the sudden lifting of COVID-19 restrictions in China, causing delays in some of our new self-branded product launches. Consequently, this had net adverse impact on our first quarter sales as well. At the same time, we’re encouraged by the bright spots we have seen in many parts of our business. As Wang mentioned, our self-branded products comprised 77.4% of total sales, compared to 57.7% for the same period last year. Moving forward, we’re confident that our self-branded products will gain more traction as we continue to improve our product capabilities and increase brand awareness on a global scale. Let’s now take a closer look at our gross margin, another bright spot in the quarter’s performance.

Our gross margin can be influenced by various factors such as product mix, product launch timing, and product life cycles, including model upgrades. Despite the challenges we faced during the quarter, we achieved a year high gross margin of 20.7%, compared to 19.3% in Q4 2021 and 19.1% in Q3 2022. This improvement was mainly driven by the successful launch of our margin accretive new products and the optimization of our product and channel mix. As we continue to implement these proven initiatives, we’re confident that we can sustain our positive gross margin trends into 2023. Turning now to costs. As we have discussed, costs have been a key focal point for our company, both in terms of their absolute amount and then as a percentage of sales.

Since Q3 2020, we have been pleased to see a trend towards a decrease in total operating expenses, while still making strategic investments to fuel growth. Our company’s adjusted operating expenses, excluding share based compensation for the fourth quarter of 2022 were RMB277.6 million, reflecting a year-over-year decrease of 5.9% and a quarter-over-quarter decrease of 6.1%. However, if we exclude severance payments of RMB10 million, our Q4 operating expenses would be RMB267 million. While we acknowledge that reducing fixed costs can be challenging, we’re taking further steps to control our expenses and have already made good progress in cutting our expenses run rate. Looking ahead, we expect our total operating expenses to reach approximately RMB250 million or lower in the coming quarters, which represents a significant decrease of around 20% or more from the average of RMB300 million per quarter in 2022.

We’ll continue to right-size our organization and streamline our cost base in order to achieve profitability in the coming quarters. Spending our R&D in Q4 2022 was RMB114.3 million, of 21.9% year-over-year, which was partly due to the lower government subsidy received. If we exclude that factor, our R&D expenses remained slightly down versus the fourth quarter of 2021. Thanks to our efficient product developed processes. Selling and marketing expenses were RMB125. 1 million 17. 8% lower year-over-year, mainly due to pruning of our retail channels in Q4. At the same time, we continue to make investments selectively in various international markets and sales channel expansion through digital marketing initiatives and also partnerships with leading global sales platforms.

These investments are critical to drive our long-term organic growth. Our Q4 expenses were RMB53. 4 million, which is almost in-line with the third quarter of 2022 and a 17.5% decline compared with RMB64. 7 million in the fourth quarter of 2021. We believe that this decrease reflects our execution excellence and reconfirms the effectiveness of our expense control strategies. Our non-GAAP operating results improved throughout the year, in Q4 being the best performing quarter in 2022 from a percentage perspective. These result demonstrated a sequential improvement in our cost control given Q4’s smaller revenue scale. Our adjusted net loss in the quarter was RMB60.3 million, compared with RMB52 million in the fourth quarter of 2021. In the fourth quarter, the company wrote down RMB30.1 million valuation allowance of deferred tax assets.

Excluding share based compensation, the one-off severance packages and the deferred tax asset impact, the adjusted net loss was RMB20.1 million in the fourth quarter. Now turning to the balance sheet. Our cash flow has remained strong, thanks to our enhanced efficiency in working capital management. In Q4, we generated positive cash flow from operations, some of which were used to retire certain short-term debts. During the fourth quarter, we continue to manage our inventory with precision, successfully reducing our inventory balance to RMB1 billion, compared to RMB1.25 billion at the end of 2021 and down from its peak of RMB1.5 billion in 2022. In November 2021, the board approved the allocation of up to US$20 million toward a share repurchase program.

In Q4 2022, we continued our repurchase program, a testament to our ongoing our long-term growth prospect. We had bought back US$10. 3 million worth of shares by the end of December and we intended to carry-out with this buyback program. Moving on to our outlook. In-light of ongoing macroeconomic challenges, our guidance for the first quarter of 2023 currently projects net revenue to be between RMB0.6 billion and RMB0.75 billion, compared with RMB0.76 billion for the first quarter of 2022. Please note that this outlook reflects continued uncertainty around the potential effects of the COVID-19 pandemic on sales, and lower discretionary consumer spending, especially in our international markets and global macro weakness. However, we have seen some positive signs and the year may be somewhat back-end loaded as we gradually release our new products.

This concludes our prepared remarks. We will now open the call for questions. Operator, please go ahead.

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Q&A Session

Operator: Thank you. The first question comes from . Please go ahead.

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

Leon Deng: Thank you, Lisa. I mean, let me quickly come back on your first question. Yes, the gross margin improvement in Q4 is driven by the gross margin performance of the self-branded product. So, there are two things to it. Number 1, we improved on the product mix, as we mentioned that in the past, the Xiaomi products has always been standing for a majority part of our revenue base, but in Q4 2022, it’s actually reversed. Actually our self-branded products stands for more than 77% of the overall mix for the quarter. So, I think product mix definitely plays a role and you all know that our self-branded products carries a higher margin than the Xiaomi branded products. Number 2 is also on the channel mix. So, what we did in Q4 and also in the second half of 2022 is to gradually pruning our channel, our retail partners, right?

We try to look at the probabilities selectively on the retail partners and try to prune those ones, which are not making money. So, in essence, the product and channel mix has been one of the reasons driven the overall gross margin up for the company for the Q4 and we see this actually this trend to continue in 2023. And then on 2023 full-year, normally without for the full-year performance, we only guide for the upfront one quarter performance, but I think I could give you a few €“ some colors on how we look at the full-year. So, I think at this moment we’re cautiously optimistic about the full-year because according to IDC data and some other third party market research institutions report the overall wealth of market for 2023 is still pointing to a small growth, I think it’s a single-digit growth for the full-year for 2023.

And then what I can say is that our market share among the global players has remained relatively stable and also improving in the course of 2022. So, we’re cautiously optimistic about the full-year of 2023, but however, I think the year is probably going to be a little bit back-end loaded because also from a seasonality perspective, the high season, sales season for our industry always centered around Q3 and Q4. So, in this case, I think over a full-year, we’re still seeing probably our revenue is going to be cautiously optimistic, but more skewed towards second half of this year. On the gross margin, I have mentioned that our gross margin performance, we have seen that there’s an increasing trend quarter-by-quarter in 2022 and we expect that I think 2022 Q4, we with 20.7%.

I think we see this trend gradually improving also into 2023. So, because we also think the product mix and the channel mix is going to continue to improve for our company. On the cost, operating cost overall, I think I also just mentioned that we have managed to tune the cost down to a level in Q4, whereby if you exclude the severance cost, it stands at RMB270 million per quarter, while by the full-year run rate was 300 million per quarter for 2022. And we expect that this number is going to be further tuned down to a level of 250 million per quarter or even lower per quarter for 2023. Overall, I think given all the things which I just mentioned, we think we are on a good track to return to profitability in 2023, hopefully in the second half of the year, if not earlier.