Q4 2023 Zepp Health Corp Earnings Call

Participants

Grace Zhang; IR Contact Officer; Zepp Health Corp

Presentation

Operator

Hello, ladies and gentlemen, thank you for standing by for Zepp Health Corporation fourth quarter and full year 2023 earnings conference call. (Operator Instructions) Today's conference call is being recorded.
I will now turn the call over to your host, Mr. Chris Shaw, Director of Investor Relations for the company. Please go ahead, Chris.

Grace Zhang

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 from 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. Wayne 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 does include with a Q&A session. Mr. Mike Yeung, our Chief Operating Officer, will join us for the Q&A session.
Before we come to a quick note that today's discussion will contain forward-looking statements made under the Safe Harbor provisions of the US 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 these and other risks and uncertainties are included in the company's annual report on Form 20-F for the fiscal year and the December 31, 2023, and other filings filed with the US Securities and Exchange Commission. The Company does not assume any obligation to update any forward-looking statements except as required under applicable law.
Please note that GAAP 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, Wayne. Please go ahead.

Hello, everyone. Welcome and thank you for joining our call. In 2023 amidst global macro economy uncertainties, our Ally oriented strategy and ongoing business model transformation began to yield fruit. This strategy shift has enabled us to strengthen our commitment to becoming a global provider of cutting-edge smart wearable health care 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 transformation test, a journey to become less dependent on Xiaomi branded products and is that develop a self-reliant company driven by its sales branded product sales.
This shift is starting to show promising results, as evidenced by our two consecutive non-GAAP operating profit. Looking at 2024 voting 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 channel.
This leap forward is grounded in three core pillars. First, we are putting greater emphasis on R&D and product driven innovation, 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 realize from each and every product showed. 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 Active and increasing sponsorship of big sports events. I believe you will see the Amazfit brand more visible across the worlds in the coming quarters.
These three pillars, I am confident we can propel our flying wheel and generate a higher return from our employees and shareholders in the long run.
In the first quarter of 2023, our focus on strategic transformation towards a more self-reliant revenue stream has gained traction and 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 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 prior position of profitability our scale. This significant achievement was largely driven by our higher margin self-branded products, launch of the Amazfit Active and Amazfit Active Edge series in Q4 as well as the Amazfit Balance special edition, enhance 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 smart watches, the Amazfit Active and the Amazfit Active Edge in Europe and APAC.
These smart watches prepared for today's urban urbanized branding elegance with powerful functionality, incorporates the AI powered web coach and for lastly integrated into our users [haptic launch]. Adapt 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 underlies our dedication to providing pioneering accessible health care solutions.
The Amazfit Helio Ring to offer and pillar recoveries that part of athletes. These developments in pet or mice, 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 leveraging Zepp OS. We recently introduced Zepp OS 3.5 with Zepp Flow at MWC Barcelona 2024 in February. A substantial update carried by large language model AI, marking a significant lead in wearable intelligence devices and bringing unprecedented levels of interaction.
Zepp Flow offers seamless natural language liquidation to provide users with exactly what they want from starting an alarm, the activating, the always-on display feature to providing feedback on last night's sleep quality and at analyzing the readiness score from the previous day's activities and offering recommendations for improvement in the following days. All can be done by activating this 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 chaining templates, new scheme map functions and enables smart NFC card payments in Europe, enhancing both the sporting experience and general daily convenience.
Our drop pressure measurement software has been expanded to a broader range of products, including the Amazfit Falcon Active Shooter Pro, Amazfit T-Rex Archer, Amazfit T-Rex 2 and [GDFL], all aiming to deliver personalized and advanced wellness supports to a greater number of users.
Our product's seamless integration of hardware and software not only assist users to improving their well-being, but also updates their live style. I'm happy to share a comparing example that comes from one of our Japanese users who found himself in a snowstorm during a hiking trip in Mont Blanc. Fortunately, our T-Rex 2 guided him safely back.
He share his experience on YAMAP, Japan's leading outdoor app and even send us a thank-you e-mail. 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 tab G wall oven disposed challenges and tie in some. 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% dilution in non-GAAP net loss, marking a pivotal shift for us to be achieved profitability in both Q3 and Q4, leveraging our cost 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. These achievements not only underscores the execution of our multi-sourcing global supply chain strategy, but also pave 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 in documents, including a growing market presence and as demand 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 adjust evolving demands of our global user community.
Despite headwinds posed by macro-economic challenges, our focus remains steadfast on bolstering profitability and seeking dynamic opportunities to propel our resilience growth and secure greater profitability. This approach not only strengthens our competitive edge, but also ensures our long-term success in the ever-involving smart wearable industry.
I will now turn the call over to Leon to go over the highlights of our fourth quarter financial results.

Thank you, Wayne. 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 remain 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 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 that extended pre-Christmas promotion in selected products. Traditionally, we're focused our 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 are 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 multiyear 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 are 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 we'll 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 expansion in the years to come.
Now turning to Q4 sales, our overall sales for the quarter was USD85 million/ RMB0.6 billion, aligned 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 Wayne indicated earlier, our Q4 2023 gross margin reached an impressive 34.7%, the pricing 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 (technical difficulty) 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 a critical area of focus for our company, both in terms of their absolute amount and as a percentage of sales.
As we continue to exercise disciplined control over our expenses during the quarter, since Q3 2020, we have consistently reduced overall 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 USD27 million, RMB191 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 strategy as we constantly access resources efficiently to maximize return on investment and productivity. Also, we integrated 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 USD12 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 the amount was mainly due to our ongoing efforts to improve profitability and refine ourselves channel mix in addition to the in-depth enhancement of our retail channels, such efforts also included a strategic allocation of stuff throughout our South region.
Additionally, we launched Amazfit Wellness Wonderland and a pop-up store in Berlin to spotlight offerings during the holiday season. We showcased our brand concept through a collaboration with Siciliano Contemporary Ballet at the launch of the Amazfit Balance Special Edition watch, joined significant media attention.
This concept was also highlighted in the Zepp house 10 years of innovation campaign. We are committed to making smart investments in marketing and branding initiatives that will fuel our long-term growth.
Adjusted G&A expenses amounted to USD4.0 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 investments critical for our long-term growth.
In Q4 2023, we reported adjusted operating profit of USD2.4 million, RMB17 million, which includes a non-cash USD3.5 million valuation allowance of deferred tax assets versus the operating loss of USD8 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 31, 2023, our cash and cash equivalents, along with restricted cash balance, totaled approximately USD140 million/ RMB1 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 USD85 million, RMB600 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 six consecutive quarters of positive operating cash flow, and we expect to continue this position in the coming quarters.
Since Q2 2023, we have been initiated the retirement of portions of our short and long-term debt portfolio, successfully retiring USD4.8 million, RMB34 million of debt in Q2 and [USD16 million], RMB170 million in Q3.
In Q4, we continued to reduce our debt levels by another USD12 million, RMB84 million. As our operating cash continue to strengthen, we intended to do more in the coming quarters. Furthermore, by the end of December 31, 2023, we had repurchased shares [$12.9 million].
We remain committed to continuing 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 USD42 million to USD49 million, RMB300 to RMB350 million. With self-branded products accounting for about 90% of the revenue.
In conclusion, the fourth quarter presented challenges that we overcome by prioritizing profitability over scale. This strategy, combined with 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. Operator, please go ahead.

Question and Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions)
[Nicola Jones, Brooks Investments]

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

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

Yes, I'd like to get more details on the regional strategy.

Okay. On the regional strategy, Thank you. So let me take this question. I think on your first question on the outlook for first quarter and also on 2024. And I think on the first quarter, I just mentioned that typically it is a relatively soft quarter for the customer electronics industry.
Therefore, our guidance for the fourth quarter was between the range of [$42 million to $49 million] or equivalent to RMB300 million to RMB350 million for the top line. And normally, our guidance stops at giving the guidance only for the revenue. But in this call, 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 catalyst actually are projecting overall market value growth for the smart watch sector, which is the sector which are 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.
And coming to gross margin, as you heard what we just mentioned that our overall gross margin as a percentage of sales 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.
And 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 costs, which is, I think we have mentioned that the run rate of our quarterly operating cost is around our RMB200 million-ish.
And we have actually maintained this run rate for more than four quarters throughout 2023. And we have been demonstrating that we are able to keep up with this cost level and digested this level if we need in the year to come. So I think that should give you a feeling where the year 2024 would bring us on the bottom line in this case. I think that should give you assess 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 the Asia Pacific region, right.
And so I think looking at a 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 back on those big sports events in order to boost our sales for the company.
And now to mention that USA actually stands as another bright spot for growth for us because we have and made quite some advancement in the off-line channels in US, for example, we are a featured in Best Buy target and many offline channels in -- and also including Walmart in US 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's 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.

Operator

Sid Rajeev, Fundamental Research Corp.

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. Where do you plan these investments on a long-term basis? Any plans to divest at least a portion of it in the near term?

Yeah, Sid. It's I think you're 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 a place 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.
And then in the future, I think having this company as a listed company in China, has it benefit because it cannot only supply goods to us, but also it 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 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 this -- and a strong player in the smart watch domain, we would like to actually open up more to the ecosystem within China on the wearable's domain.
And I think also having this listed company in China would benefit this company and our company on this specific semiconductor push, which we're going to get from the Chinese market and it's a highly competitive market.
So I too 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 our market cap per se, right? Which is unfortunately, there's something in the equation which does now play, or the value has to be fully unleashed in order to realize the full value of this company. But we have no intent to sell that stake at this moment of time.

Okay. Your cash position is very strong, someone would expect will 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've paid down more than 2 -- If I remember clearly, I think more than RMB200 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 the 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 any assets that doesn't play into the health of the overall cash flow I have on the power. And if you look at 2024, we also have similar intent as the profitability I just mentioned and I give 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 year end.

Okay, perfect. Thank you so much, Leon.

Thank you, Sid.

Operator

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 Zhang

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

Operator

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