Zepp Health Corporation (ZEPP) Earnings Call Transcript & Summary

Hello, ladies and gentlemen, thank you for standing by for Zepp Health Corporation's Third Quarter 2022 Earnings Conference Call. [Operator Instructions] 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.

Hello, everyone, and welcome to Zepp Health Corporation's Third Quarter 2022 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 ir.zepp.com. Participating in today's call are Mr. Huang Wang, 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 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 of 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 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 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. Huang Wang. Please go ahead.

Hello, everyone. Thank you for joining our call. First, I would like to provide some context by adjusting the macro environment, which continued to worsen during Q3 and impacted our operations amid heightened geopolitical uncertainties and COVID-19 containment measures in China. Against this backdrop, our third quarter revenues came in within our expectation at RMB 1.2 billion, down 24.9% year-over-year primarily due to decreased sales of Mi Band products. Despite these challenges, we continue to grow during the quarter, with top line up 8.8% quarter-over-quarter, a significant reflection of the resilience of our business. I would like to highlight that despite the macro headwinds we faced during the quarter, our self-branded products have returned to their growth trajectory with a 4.2% year-over-year and 35.6% quarter-over-quarter increase in revenue. This growth was underpinned by increased recognition from global consumers as we made progress in enhancing our product value and expanding our sales channels. In the North American market, as we have expanded into more retail channels, our revenue grew by 23% year-over-year and 54% quarter-over-quarter. In Europe, we also had several bright spots. In Poland, for example, where our revenue growth rate was 222% year-over-year. We were also the official partner of the 44th Warsaw Marathon, which has further raised our brand value and recognition. In France and Spain, we enjoyed 36.4% and 26.2% revenue growth, respectively, against macro challenges. In September, we debuted our brand-new Amazfit GTR 4 and GTS 4 at the IFA event. The Amazfit GT 4 Series expected with premium features for both sections and functions. [ Over 119 million OLEDs ] in the EMEA region reported our launch event at IFA, and our GT 4 Series was named by 3 media sources as the best IFA product. Our new GTR 4 and GTS 4 are equipped with the industry's first dual-band circularly polarized GPS antenna technology, enabling movement tracking and positioning up to 99% as accurate as handheld GPS locators in open-air scenarios. This generation also features our new BioTracker 4.0 with a high-precision PPG optical sensor. And both models heart rate tracking performance is enhanced to match that of heart rate [ valves ]. We believe these upgraded product features will prove attractive to users worldwide, enabling more people to reach their fitness goals and better managing their health in their daily life. Furthermore, we are excited to team up with adidas Runtastic, a well-established digital platform that serves 182 million athletics, to empower users to synchronize workout data to adidas Running via the Zepp App. This function became available on our newly released Amazfit GT 4 Series in October and will gradually become accessible on our other smartwatches going forward. By partnering with global brands that share our passion for helping users achieve their fitness goals, we hope to further expand our user community and achieve continued growth. In October, we introduced our flagship premium multisport GPS watch, the Amazfit Falcon. It features the new AI-powered Zepp Coach providing users with scientific and tailored fitness guidance through our self-developed smart coaching algorithm. Crafted with a tough aircraft-grade titanium unibody and 20 ATM water resistance a first for Amazfit smartwatches as well as 150 built-in sports modes, accurate dual-band GPS tracking and 6 satellite positioning systems. Amazfit Falcon is devoted sports companion built to breaking limits. Beyond smart wearables, we forged ahead with the expansion of our new health care solutions product lineup with Zepp Clarity, which features discreet invisible in-ear technology up to 18 hours of battery life and 12 unique settings to choose from for optimized effect. Apart from [ audiology ] health, we believe this is crucial to mental health and overall well-being, as an innovative AI-generated sleep aid soundscape that adapts to users' biological state, our newly developed Zepp Aura solution can help users fall asleep faster and sleep more deeply. We are confident that these new innovations represent an important milestone in our expansion into the health care sector and will usher in a new growth stage for us. Additionally, we have always been passionate about technology innovation and fostering a more vibrant developer community while striving to reinforce our brand identity on the global stage. Accordingly, we were proud to join past sponsors such as Microsoft and Google Cloud in launching the world's largest collegiate hackathon, Cal Hacks 9.0, held in October. During the event, we talked to more than 5,000 plus attendees and have successfully attracted more than 1,500 top talent students to visit our booth and learn more about who we are. We also awarded cash prizes and our Amazfit Smartwatches to winners in the Watch Faces and Apps categories in order to recognize their ingenuity and encourage their use of technology to creating solutions that improve our work. As we anticipate continuing macroeconomic headwinds in Q4 and potentially began increasing organizational efficiency has also been a key focus of our management team this year. And our measures have delivered concrete results in cost efficiency in R&D and G&A expenses as we will take additional measures when needed to hit the fixed cost base in the check. All in all, our fruitful third quarter results including new product launches and encouraging performance from our self-branded products highlight our organization's resilience in the face of multiple external challenges. We will further expand our products and services offering while improve organizational efficiency to maximum the value of our shareholders as well as help more users to live a healthy life. Thank you again for joining us today. I will now turn the call over to Leon to go over the highlights of our third quarter financial results.

Thank you, Huang. Hello, everyone. I would like to start by highlighting some of the key metrics of our third quarter financial results. As mentioned by Huang, in the third quarter, we saw persistent challenges associated with high input and freight costs, the evolving geopolitical situation and ongoing COVID-19 containment and control measures in China. These adverse conditions weighed on our revenue generated and our overall gross margin. Against the macro volatilities and uncertainties, our Q3 revenue come in line with our guidance at RMB 1.2 billion, down 24.9% year-over-year, which consists of 53.5% of self-branded product sales and 46.5% of Xiaomi product sales versus 38% of the self-branded product sales and 61.4% of Xiaomi product sales in the same period last year. The decline in revenue at large is mainly driven by the lower-than-expected Mi Band sales in the third quarter. However, our self-branded products restored their growth with a 4.2% year-over-year increase in revenue despite the headwinds. We have seen bright spots in many parts of our business. For example, in North America markets, our revenue grow 23% year-over-year and 54% quarter-over-quarter. Quarter-over-quarter, we continued to improve on both our top line and the bottom line with 8.8% revenue growth and a narrowed loss during the quarter. Our adjusted net income for the quarter is minus RMB 8.8 million, which included a one-off severance cost of RMB 10 million. This almost breakeven result demonstrated our organization's resilience and the effectiveness of our continued measures to streamline our cost base. On a sequential basis, third quarter 2022 revenue was better than the second quarter 2022 revenue and our operating profit also improved, reconfirming our solid execution capabilities. Notably, our self-branded product revenue in the third quarter grow 35.6% sequentially, boosted by our newly launched products, including the new Amazfit GT 4 Series, the Amazfit Bip 3, the Amazfit Bip 3 Pro, and the Amazfit T-Rex 2. Now let's turn to our third quarter gross margin, which can be affected by the product mix, product launch timing and product life cycles, including model upgrades. Our Q3 gross margin was 19.1%, 1.1 percentage points lower year-over-year affected by higher freight costs compared with the same period last year and clearance of our previous generation products, partially offset by higher gross margin coming from our new product introductions. However, given the 1.2 percentage points increase quarter-over-quarter, we can see a positive gross margin development trend now. It's also worth mentioning that given the new product launches, our gross margin for self-branded products exhibited continuous growth month-over-month in the third quarter. Turning now to costs, which has been a key focal point for the company, both in terms of absolute amount as well as the percentage of sales. While we have to balance cost controls carefully with expenditures to fuel growth, we have already seen a decrease in trend in total operating expenses since Q3 2020. As a portion of the operating expenses is fixed and takes time and creativity to reduce them gradually, we expect to achieve further cost reductions in absolute terms for the remainder of the year. Going forward, we'll continue to rightsize our operating expenses from their current level in order to deliver profitability in the coming quarters. Our third quarter 2022 operating expenses were RMB 303.9 million, representing a 1.6% quarter-over-quarter decline. Spending on R&D in Q3 2022 was RMB 127.4 million, an increase of 17.2% year-over-year. The increase was mainly driven by the lower government subsidy received. Excluding the above factors, the R&D expenses remained slightly down versus the third quarter of 2021 due to strict productivity measures applied. Selling and marketing expenses were RMB 123.9 million, 36% (sic) [ 36.5% ] higher year-over-year, mainly due to our increased investments in various international markets and sales channel expansion through digital marketing initiatives and partnerships with leading global sales platforms. These actions are critical to drive our long-term organic growth. Q3 G&A expenses reduced 14.8% compared with the third quarter of 2021 and 26.5% compared with the second quarter of 2022. This decrease illustrates the effectiveness of our expense control strategy. As we look ahead, cost structure optimization will continue to be our primary focus. It's especially aimed at the complex and the high volatile macro environment. With higher productivity, ROI-based operations and more disciplined cost reduction measures, we expect to reduce our operating expenses further. As our revenue improved and expense declined sequentially, adjusted operating loss for the third quarter of 2022 improved further to RMB 65 million compared with the adjusted loss of RMB 98 million in the second quarter and the adjusted loss of RMB 142 million in the first quarter of 2022. We also paid close attention to the foreign exchange fluctuations and recorded a positive FX contribution year-to-date, thanks to our proactive management of the FX risks. Our adjusted net loss in third quarter was RMB 8.8 million, which includes a RMB 10 million severance payment, narrowed compared with a loss of [ RMB 90.4 million ] in the second quarter and a loss of RMB 75.7 million in the first quarter of 2022. Now turning to the balance sheet. Our cash flow also remained strong with cash flow from operations in Q3 standing positive at RMB 115.3 million. As of September 30, 2022, cash and cash equivalents were RMB 1.01 billion compared with RMB 997 million as of June 30, 2022. During the quarter, we continued to manage our working capital and inventory more efficiently and realized lower inventory levels quarter-over-quarter. We're targeting to reduce our inventories by year-end to be on par or lower than the levels we expected in 2021. In November 2021, the Board approved the allocation of up to USD 20 million toward a share repurchase program. In Q3 2022, we continued the repurchase program reflecting our confidence in our growth strategy and financial performance. We have bought back USD 9.2 million worth of shares until September 30, 2022, and intend to carry out with this buyback program. Moving on to our outlook. In light of the ongoing challenges, our guidance for the fourth quarter of 2022 currently projects net revenue to be between RMB 1.1 billion and RMB 1.35 billion compared with RMB 1.66 billion for the fourth quarter of 2021. Please note that this outlook reflects the continued uncertainty of the potential effects of the China COVID-19 pandemic policy ourselves and the lower discretionary consumer spending, especially in our overseas markets aimed global macroeconomic weakness. Please also note that this guidance is based on existing market conditions and reflects the management's current and preliminary estimates of the market and operating conditions as well as the customer demand, which are all subject to change. This concludes our prepared remarks. We'll now open the call to questions. Operator, please go ahead.

[Operator Instructions] The first question today comes from Clive Cheung with Credit Suisse.

This is Clive from Credit Suisse. I have 3 questions. I'll ask them all at once. So number one, I saw the sales and marketing expenses disproportionately grew this quarter. I noticed in the prepared remarks, Leon already mentioned it was -- it has gone into channel expansion and specific markets -- in specific markets. Could you share a little bit more color on where geographically this has gone into, and what kind of digital channels are we targeting at the moment? That's number one. Number 2, with regards to our staff force right now and with a reduced capacity, how does that impact our R&D assets and product delivery intensity? And lastly, number 3, I think there was a mention on supply chain constraints. And my question is what components in particular, are we facing the most delays and impacting our fourth quarter shipments or for next year as well?

Thank you, Clive. I mean let me answer the easiest question first on the supply chain constraints, right? So I think in Q3, all the supply constraints we have seen at the beginning of the year -- for the first half of the year has been elevated. So basically, the supply constraints issue no longer applies to us starting from the second half of Q3, and then we don't see any of that would impact us in Q4 anymore. And similarly, also the freight cost, we also see a trend that the freight cost is going down, especially on the sea freight. So that additional freight cost situation versus last year, which we have experienced for the first 3 quarters of this year should also kind of resolved to a certain extent in Q4. So I think that hopefully answers your third question. And then let me turn to the first question, which is on the marketing and sales expenses. Yes, we have invested quite a bit in the international marketing and sales expansion, i.e., investing on the digital platforms, for example, on Amazon and on some local online platforms, the big ones regionally, right, for example, Coolblue in the Netherlands, [ mediamarkt.com ] in a lot of the European countries, right? And we will continue to invest on those online platforms as we see the shopping pattern from most of the international clients we have are more turning to the big online channels, right? And also given our DNA, we believe that investing on digital campaigns and digital marketing and investing in our online platforms will probably going to yield a bigger return for ourselves. And additionally, we also increased our investments on offline channels. For example, in United States, we have seen quite a growth year-over-year, a large part of that is driven by our offline channel investment. For example, we're actually getting listed in big offline channels like Best Buy, Target, et cetera, et cetera, in United States, and we are also deepening our presence in offline channel growth in Europe as well. And nevertheless, we also have expanded in the Asian countries expansion, for example, in India and in the rest of the [ ASEAN ] countries. And to give you approximation, I think we kind of invested around 10% of the sales and marketing expenses relative to our self-branded sales value in this quarter. And I think we will continue with that run rate in the upcoming quarters as well. So that's -- and then turning to your second question on the reduced capacity with regard to the R&D resources. I think we have also mentioned in our prepared remarks, we are actually looking at how to optimize our R&D efforts. For example, in the past, since we don't have Zepp -- before we had the Zepp OS, each and every product we need to kind of engineered a separate software platform for it in order to sell the -- our smartwatches. And now with Zepp OS, we can apply a more platforming approach with less people in order to deliver a high-quality product, right? And we're also trying to streamline our operations to try to generate more efficiencies on applying a so-called legal approach in working out our R&D projects and our new smartwatches. So I think that's why at a reduced R&D spending level, we are able -- we believe we're going to churn out same quality of R&D efforts or even more with a reduced sales force -- workforce. I think that's in a nutshell what we're trying to do. I hope those give you a flavor on what it is.

Yes. Very clear.

[Operator Instructions] The next question comes from [ Lisa Lee ] with Alpha Research.

I just have one question. You mentioned further cost reductions going forward. Can you please elaborate on your measures? And how should we think about -- how should we quantify further cost reductions in the fourth quarter and next year?

Thank you, Lisa. I think we have identified a few areas to streamline our costs. Number one is what I just mentioned in the area of R&D, we're trying to apply a so-called platforming approach and a legal block to make sure that we can kind of realize the similar goal with a reduced workforce, right? Number 2 is on the sales and marketing expenses part, we are trying to look at the return on investments on our marketing investments. For example, if we're going to sports, a sports activity, a marathon, for example, we want to look at the return on investment very closely to make sure that we're just -- we're not investing on certain things just for the sake of investing on it, right? And also we're actually looking at the channel performance to -- in different offline channels to trying to see what type of products we should sell in which channel and then try to get the best return out of that. And the third one is on the G&A expenses part. We are proactively looking at where we can save and what we can leverage more from either third-party services or looking at whether or not we could streamline the service and actually prioritize certain requests or opportunities rather than the other, right? So I think to answer your question, we are currently standing at operating expenses overall of RMB 300 million per quarter. And then we -- and in Q3, this includes a RMB 10 million severance cost. So basically, if you strip that one out, we're probably at RMB 290 million kind of operating expenses level for Q3. And in Q4, we're more looking at streamline the cost base towards the RMB 250 million level. And hopefully, that will be a first step. And then going into next year, we're going to proactively check the cost base and see if we need to reduce the cost base even further if the macro environment is not improving.

So that's very helpful. I actually have another question. Can you also give us some guidance on your gross margin going forward?

Yes. So you have seen our gross margin is actually picking up, although it hasn't come back to the 2021 level yet, I think there's 2 folds of rationale here. Number one is, we try to -- we understand that inventory level is a big problem for us because we exit the year with high ambitions. But in Q1, we got hit by the Russian and Ukraine war, by the lower consumer spending issues in most of our international markets. So therefore, actually, we have put a lot of resources and effort in cleaning up all the old generation products, if you want to put it in that way. So what you see here in the mix of our Q2 and Q3 gross margin, it actually carries a big chunk of the lower gross margin coming out of clearing our previous generation products, right? But I think we're looking at the end of this exercise, so that our self-branded products gross margin should improve or increase from their current level going forward as we head into the high season in Q4. And that's number one. Number 2, you also noticed that our mix has skewed from in the past. It was Xiaomi products play in the majority weight of our sales revenue mix and our self-branded, I think Xiaomi used to account for 70%, and I think in 2021, it was 60% of our overall revenue. But then this year, as we head into Q1, Q2, Q3, I think year-to-date, we're at more self-branded product stands for around [ 55-ish percent ] of the overall mix, and Xiaomi is actually becoming the minority part of our product mix, right? So I think we intended to actually continue this trend going forward. And then the self-branded products going into Q4 and next year, as you noticed that in Q3, our self-branded products start the growth trajectory again, and I think we expect that trend to continue for the upcoming quarters as well. And in the meantime, we will try to see if we can get more revenue from the Xiaomi side. And then by playing that mix and then playing it more towards self-branded products accounts for the majority of the revenue mix of the company together in improving the margins of the self-branded products, I think where you're going to look at the gross -- overall gross margin for the company is going to gradually improve from its current level as we reported in Q3. So I hope that will give you some color on what it is going to be in the upcoming quarters.

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

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.