Zepp Health Corporation (ZEPP) Q4 2022 Earnings Call

Zepp Health Corporation (NYSE:ZEPP) Q4 2022 Earnings Conference Call March 21, 2023 8:00 AM ET

Company Participants

Grace Zhang - Director, Investor Relations

Wang Huang - Chairman of Board of Directors and Chief Executive Officer

Leon Deng - Chief Financial Officer

Conference Call Participants

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 [ir.zepp.com] [ph].

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 [watch lines] [ph]. 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 [marked variable] [ph] 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 [sets us apart] [ph] 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 [indiscernible] consumer electronics in the [performance award] [ph] 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 [indiscernible] 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. 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 [defined] [ph] 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, [indiscernible] 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, [an increase] [ph] 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 [competence on] [ph] 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.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] The first question comes from [Lisa Lee with Alpha Research] [ph]. 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 [majorly] [ph] 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 [guidance] [ph] 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 [had the third quarter] [ph] 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.

Unidentified Analyst

That's very clear. Thank you. And if I may, can I add one more question? Can you also discuss your performance in different regions? For example, now we're seeing I guess, the recovery trends in China, but not so much in Europe and North America. Can you talk about your performance in different regions, and give us more colors there? Thank you.

Leon Deng

Okay. No, I think, yes, in China you see gradually recovering trend, although relatively slow in Q1 2023. And I think this is going to improve as we go in the year, but China actually stands to a small part of our overall self-branded product portfolio. Our biggest market is actually in the European markets whereby we are, kind of impacted a little bit by the discretionary income cut because of the inflation pressures in Europe and also to some extent by the Ukraine and Russia war.

We're actually mitigating that. And then in February this year, we even opened a regional office in Warsaw on top of the other satellite offices, which we already had in Europe. And we see certain bright spots in Europe, especially in Eastern Europe areas, actually our market share has went up quite dramatically during the year in Poland especially. And we see that in southern Europe market we're also actually maintaining our share and improving our share.

So, Europe has and will remain as a cornerstone for our regional performance for our company. And then there's a bright spot in United States as mentioned by Wang just in his script before. We won one of the third party's consumer electronics industry performance award for a fitness tracker category for the top e-commerce U.S. market share gain in 2022. So, actually, we gained the market share from nowhere to a double-digit number in the course of 2022.

So, we think USA will continue to act as a growth engine for ourselves in 2023 and beyond. So, I think those are – and obviously, the SCL market is good emerging market, whereby we think we still have quite some opportunities, especially in Korean and Japanese markets to actually grow ourselves even further than what we currently have. So, I think there are – yes, we're living in inflationary and consumer discretionary cuts type of environment.

However, we still see bright spots in different parts of the world, whereby we believe there's still a huge potential for us to tap in 2023 and beyond.

Unidentified Analyst

Thank you.

Operator

The next question comes from [indiscernible]. Please go ahead.

Unidentified Analyst

Hi management. Thank you for taking my questions. And congratulations for the fourth quarter and a very good result. I have two questions. First is about your gross margin. We have noticed many ICE prices have [indiscernible] significance since last year, and how can we measure the impact on the company’s gross margin? Thank you.

Leon Deng

Yeah, Ian. Thank you. I think in, so far, at least in Q1, we haven't seen too much of a price decrease. In other words, the benefits of IC price going down, which should in-turn translate into a better margin, per se, for ourselves, because: number 1, I think it takes a few quarters for the price to be reflected in our [indiscernible] material cost because most of the purchase we make is a long lead time purchase, especially on ICs, which we're locking the price already a few quarters before the current quarter.

So, I think in so far we didn't see too much of that benefit in our gross margin. But as you mentioned, we noticed that there's a cost price going down for the ICs in the industry, and I think in the coming quarters, we probably would see that benefit flowing into our gross margin and that will in-turn also increase our gross margin performance even further than what we have mentioned just now.

Unidentified Analyst

Okay, understood. Thank you. And the second is about [indiscernible], very positive popular [topic this year] [ph], and we think this is a good – very good opportunity for [Zepp OS] [ph]. Could you give us a more detailed outlook on your product future plan about the ChatGPT application? Thank you.

Leon Deng

Yeah. No. ChatGPT is actually a very interesting thing, but it's not only a buzz word for us. It really has been used in many parts of our operation. So, I think there are [two parts] [ph] to it. Number one is, we have applied ChatGPT in our basic processes. Think about consumer care. Think about listening to consumer insights. Think about linking the APIs towards our research and the development processes and help us to find out errors and [code better] [ph], for example. Right?

So, I think we have integrated ChatGPT in our basic day-to-day working processes in our company because we are – we have always been a technology driven companies and we use most advanced technology whenever we saw there's a potential to it. Right? Number 2, I think which is different than the other parties.

So, for example, if you look at Apple, they also have a ChatGPT application, but the only thing what it does is basically run-in ChatGPT on the watching setup on the phone, and then it's just a different platform. But what we have done is, we have integrated ChatGPT into our Zepp OS and in-turn that actually helps us to tailor and look at the user's data and help user to make a tailor made program, and for example, on the watch basis, getting to know their insights, sleep insights, AI coaching, goal tracking, etcetera, etcetera, better than what we can do without the [ChatGPT] [ph]. Right

I think we’re one of the first wearable companies to apply GPT to this extent in the industry and we'll continue to do so.

Unidentified Analyst

Okay. Thank you. Thank you, very clear.

Operator

As there are no further questions now, I'd like to turn the call back over to the company for closing remarks.

Grace Zhang

Thank you once again for joining us today. If you have further questions, please feel free to contact Zepp’s Investor Relations department through the contact information provided on our website. This concludes this conference call. You may now disconnect your lines. Thank you.

Operator

Again, the conference has ended. You may disconnect your line. Thank you.