Zepp Health - Q4 2023

Transcript

Operator (participant)

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 Zhang, Director of Investor Relations for the company. Please go ahead, Grace.

Grace Yujia Zhang (Director of Investor Relations)

Hello, everyone, and welcome to Zepp 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 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 zepp.com. Participating in today's call are Mr. Wang Huang, our Chairman of the Board of Directors and Chief Executive Officer, and Mr. Leon 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 provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involving 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-F for the fiscal year ending December 31st, 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 Zepp's earnings press release and this conference call include discussions of unaudited GAAP financial information, as well as unaudited non-GAAP financial information.

That press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited, most directly comparable GAAP measures. I will now turn the call over to our CEO, Wang. Please go ahead.

Wang Huang (Chairman and CEO)

Hello, everyone. Welcome, and thank you for joining our call. In 2023, amidst global macroeconomic 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, wearable healthcare solutions. 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 profitable quarters.

Looking at 2024, building on the actions we have taken in the past, we are excited to be making a strategic leap and harnessing 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 Amazfit athletes and increasing sponsorships 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 firm value 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, growing 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 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 Q4, 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 prove our retail channels and enhance our product mix to sustain the higher gross 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 wearables, 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 APAC. These smartwatches, tailored for today's urban, urbanites, branding elegance with powerful functionality, incorporates the AI-powered Zepp Coach, and effortlessly integrate into our users' hectic life. As that innovation is at the core of everything we do, to reflect this vision, I would like to highlight some of our success in smart wearable technology at CES 2024. The CES 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 epitomize our commitment to empowering individuals to take control of their health and well-being through our smart wearables. Building on the momentum of our product expansion, we remain dedicated to elevating Zepp OS. We recently introduced Zepp OS 3.5 with Zepp Flow 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. Zepp Flow offers seamless natural language recognition 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 card payment in Europe, enhancing both the sporting experience and general daily convenience. Our blood pressure measurement software has been expanded to a broader range of products, including the Amazfit Falcon, Active, Cheetah Pro, Amazfit T-Rex Ultra, Amazfit T-Rex 2, and GTR 4, aiming to deliver personalized and advanced wellness support to a greater number of users. Our product's seamless integration of hardware and software not only assists users to improving their wellbeing, 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 T-Rex 2 guided him safely back. He shared his experience on YAMAP, 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 satisfaction 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 non-GAAP net loss, marking a pivotal shift, for as we achieved profitability in both Q3 and Q4, leveraging our gross margin and cost management strategies. Another operational milestone in Q4 2023 was the successfully completed mass production of our Amazfit Bip 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 Zepp. Our relentless drive for innovation and strategic expansion of our product offerings, positions us to effectively address 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 resilient growth and secure greater bottom line sustainability. This approach not only strengthens our competitive edge, but also ensures our long-term success in the ever-evolving smart wearable industry.... I will now turn the call over to Leon to go over the highlights of our fourth quarter financial results.

Leon Cheng Deng (CFO)

Thank you, Wang. 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 broader 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 the APAC regions. However, we saw some modestly improved performance in the smartwatches for outdoor/sports category, though the market remains highly competitive. Amidst these challenges, we steadfastly adhered to our strategic plan. This holiday season, we took an unconventional approach by launching the 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, who 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 laser 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 are 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 Wang highlighted earlier, you will see our brand featured more prominently at sports events, and we'll welcome more athletes to join our Amazfit family. The 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 $85 million/RMB 6 billion, aligns with the lower end of our guidance as we navigated the cyclical challenges in our categories and a highly promotional environment. 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 Wang 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 costs. As we have discussed, cost management remains as a critical area of focus for our company, both in terms of their absolute amount and as a percentage of sales. Hence, we continue to exercise disciplined control over our expenses during the quarter. Since Q3 2020, we have consistently reduced our 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 $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 $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 access resources efficiently to maximize return on investment and product 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 $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 staff 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 Cecilie Bahnsen Contemporary Play at the launch of the Amazfit Balance special edition watch, drawing significant media attention. This concept was also highlighted in the Zepp Health Ten 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 $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 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 at or below our current levels. We'll 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 $2.4 million, RMB 17 million, which includes a non-cash $3.5 million valuation allowance of deferred tax assets, versus the operating loss of $8 million in the same period last year, as a result of the expansion in our self-branded 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 $140 million/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 $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 macroeconomy. 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 $4.8 million, RMB 34 million of debt in Q2, and $16 million, RMB 170 million in Q3. In Q4, we continue to reduce our debt levels by another $12 million, RMB 84 million. As our operating cash continue to strengthen, we intended to do more in the coming quarters. Furthermore, by the end of December 31st, 2023, 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 $42 million to $49 million, RMB 300 million to RMB 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, has been 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 call for any questions. Operators, please go ahead.

Operator (participant)

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 speakerphone, 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 in English. Once again, it is star and then one to ask a question. Our first question today will come from Nicola Jones of Brooks Investments. Please go ahead.

Nicola Jones (Analyst)

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

Leon Cheng Deng (CFO)

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

Nicola Jones (Analyst)

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

Leon Cheng Deng (CFO)

Okay. On the regional strategy. Thank you. Now, so, let me take this question. I think on 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-$49 million, or RMB equivalent to RMB 300- RMB 350 million, for the top line. And normally, our guidance stops at giving the guidance only for the revenue. But, in this call, I think I want to provide some color on full year 2024, as you asked.

I think looking at the full year 2024, if we start from the big picture, both IDC and Canalys actually are projecting overall market value growth for the smartwatch 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. Right? So I think that's the guidance on the 2024 for the full year for the sales.

Coming to gross margin, as you heard, what we just mentioned, that our overall gross margin, percentage as a percentage of sales, actually hovered in the second half of 2023, somewhere between 30%-35%. And we expect this gross margin to expand in the upcoming quarters and throughout 2024. Therefore, I think you, 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.

We have actually maintained this run rate for more than four quarters throughout 2023. We have been demonstrating that we're able to keep on with this cost level and adjust it this level if we need in the year to come. So I think that should give you a feeling on where the FY 2024 would bring us on the bottom line in this case. I think that should give you a sense on 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 Asia Pacific region, right? So, 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 the June-July timeframe in Europe.

So Europe will be a big sports year for us, and for sure, we'll also bank on that, 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.

Nicola Jones (Analyst)

Thank you.

Operator (participant)

Our next question today will come from Siddharth Rajeev of Fundamental Research Corp. Please go ahead.

Siddharth Rajeev (Analyst)

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, 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?

Leon Cheng Deng (CFO)

Yes, Sid, I think you were referring to the China A stock-listed company, which we invested, and we took a minority share in that company. I think that company, if you look at 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 smartwatch product, right?

In the future, I think having this company as a A-share 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. 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 in the smartwatch domain and a strong player in the smartwatch domain, would like to actually open up more to the ecosystem within China on the wearables domain. Right?

And I think 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, to some extent, I think our—if you look at the market value of the A-listed company, multiply our shareholding, the value is already bigger than the our market cap per se, right? Which is unfortunately, there's something in the equation which does not play, or the value has to be fully unleashed in order to realize the full value of this company.

Siddharth Rajeev (Analyst)

Got it. Thanks.

Leon Cheng Deng (CFO)

But we have no intent to sell that stake at this moment of time.

Siddharth Rajeev (Analyst)

Okay. Your cash position is very strong. You know, someone would expect you to be paying down your debt sooner than, you know, what you've been doing. How much of debt would you pay down this year?

Leon Cheng Deng (CFO)

I think overall, in 2023, as I mentioned, actually, we paid down more than RMB 200 million 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, right?

If you look at 2024, we also have similar intent as the profitability 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, if we did, if we do that, by the end of 2024, that will give us no debt or close to no debt situation by year-end.

Siddharth Rajeev (Analyst)

Okay, perfect. Thank you so much, Leon.

Leon Cheng Deng (CFO)

Thank you, Sid.

Operator (participant)

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 Zhang, for closing remarks.

Grace Yujia Zhang (Director of Investor Relations)

Thank you once again for joining us today. If you have further questions, please feel free to contact Zepp Health 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.