Zepp Health Corp

NYSE:ZEPP

Hello, ladies and gentlemen. Thank you for standing by for Zepp Health Corporation's 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, Ms. Grace Zhang, Director of Investor Relations for the company. Please go ahead, Grace.

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 our press release via the Newswire services earlier today are posted online. You can also view the earnings press release and slides refer 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 the 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 involve inherent risks and uncertainties. As such, the company's actual results may be materially different from the views expressed today.

Further information regarding and other risks and uncertainties are included in the company's annual report on Form 20-F for the fiscal year ended December 31, [ 2022 ], and other filings as filed with the U.S. Securities and Exchange Commission. The company does not assume any indication to update any forward-looking statements, except as required under prepaid.

Please do note that Zepp earnings press release and this conference call include discussions on audited GAAP financial information as well as on unaudited non-GAAP financial information. Zepp press release contains reconciliation of the other 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.

Hello, everyone. Welcome, and thank you for joining our call. In 2023, amidst global macroeconomy, 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 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 last 2 years, we have been on a transformative journey to become less dependent on Xiaomi-branded products and instead develop a [indiscernible] driven by its self-branded product sales. These [indiscernible] is starting to show promising results as evidenced by 2 [indiscernible] sector non-GAAP profit quarter.

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 the 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 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 [indiscernible] and increasing sponsorship of big sports events. I believe you will see the Amazfit brand more visible across the world in the coming quarters.

These 3 pillars I am confident we can propel our firm view 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 [indiscernible] self-reliance revenue stream has gained traction, and at reducing dependency on a single customer rolling revenue concentration and shifting our emphasis increasingly on self-branded products with 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 of 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 enhance our product portfolio and significantly elevated our market presence.

At the same time, we will continue to improve 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 man.

In October, we launched to new lifestyle smart watches, the Amazfit Active and Amazfit Active Edge in Europe and APAC. With smart watches payer for today's urbanized bring elegance with powerful functionality incorporates the AI-powered life coach and effortlessly integrated into our users' hectic life.

Adapt innovation is a core of everything we do. To reflect this vision, I would like to [indiscernible] 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 health care solutions.

The Amazfit Helio Ring is designed to offer unparallel 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 leverage Zepp OS.

We recently introduced Zepp OS 3.5 with web flow at MWC Barcelona 2024 in February, a substantial update powered by large language model AI, marking a significant lead in wearable intelligence devices and bringing unprecedented levels of interaction. That flow offers seamless natural language [indiscernible] to provide users with exactly what they want from setting an alarm to activating 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 integrating with the watch using human natural language and the [indiscernible]need to memorize any pre-defined commands.

Additionally, we provide our users with consistent software upgrades. For example, the Amazfit Balance now features new training templates, new scheme app functions and enables smart NFC payments in Europe, enhancing both the setting experience and general daily convenience.

Our blood pressure measurement software have been expanded to a broader range of products, including the Amazfit Falcon Active, T-Rex Pro and Amazfit T-Rex offer Amazfit T-Rex 2 and GTR, aiming to deliver personalized and advanced wellness support to a greater number of users.

Our product seamless integration of hardware and software not only assist users to improving their well-being, but also their lifestyle. I'm happy to share a compelling example that comes from one of our Japanese users who found himself lost in snowstorm during a hiking trip in [indiscernible]. Fortunately, our T-Rex 2 guided him safely back . He shared his experience on YAMAP, Japan's leading outdoor app and even set us a thank you e-mail. 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 changes and [indiscernible]. 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 [indiscernible] 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 5 at our Vietnam factory. These achievements not only underscores the execution of our market sourcing, global supply chain strategy also paves the way for further global expansion.

Additionally, we have witnessed a surge in product visibility particularly on social media platform through key opinion leaders endorsements, including a growing market presence and tightening consumer engagement.

Looking to the future, we see a healthy and sustainable growth trajectory for that. 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 having posed by macroeconomic challenges, our focus remains steadfast on bolstering profitability and seeking dynamic opportunities to propel our resilient growth and secure greater [indiscernible]. 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.

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 smart watches for outdoor/sports category though the market remains highly competitive. And aim these challenges with that vastly adhered to our strategic plan.

This holiday season, we took a nonconventional approach by launching the extended pre-Christmas promotion in selected products. Traditionally, we 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 the successful promotion occurred later in the fourth quarter, it is likely that it might have advanced some sales from Q1 of 2024. This 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 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're 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 we highlighted earlier, you will see our brand featured more permanently at sports events, and we'll welcome athlete to join our Amazfit family. Such 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 USD 85 million/RMB 0.6 billion, aligned with the lower end of our guidance as we navigated the cyclical challenges in categories and the 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 the 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 society and resilience.

Moving on to gross margin, which can be influenced by various factors such as product mix, product launch timing and product cycles, including model upgrades. As we indicated earlier, our Q4 2023 gross margin reached an impressive 34.7% price in Q3 and marking the highest gross margin in the company's history. This [indiscernible] can be attributed to a favorable product mix, a higher performance of new product launches such as Amazfit Active and Amazfit Active S series and reduced [indiscernible] 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 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 USD 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 strategy as we constantly assess resources efficiently to maximize return on investment and productivity.

Also, we integrated an AI-based R&D platform to improve our efficiency. At the same time, we are committed to investing in new technologies and AI functions to maintain our competitive edge against our peers.

Adjusted selling and marketing expenses in the fourth quarter of 2023 was USD 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 stuff 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 Siciliano Contemporary Ballet at the launch of the Amazfit Balance special edition watch, drawing significant media attention. This concept was also highlighted in the Zepp Health 10 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 USD 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 -- are largely attributed to our efforts in optimizing personnel and enforcing strict cost control over administrative commitment to prudent cost management in the coming quarters with anticipated costs remaining at 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 growth.

In Q4 2023, we reported net adjusted operating profit of USD 2.4 million, RMB 17 million. which includes a noncash USD 3.5 million valuation allowance of deferred tax assets versus the operating loss of USD 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 31, 2023, our cash and cash equivalents, along with restricted cash balance, totaled approximately USD 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 USD 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 the 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 USD 4.8 million, RMB 34 million of debt in Q2 and USD 16 million RMB 170 million in Q3. In Q4, we continued to reduce our debt levels by another USD 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 31, 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 USD 42 million to USD 49 million, RMB 300 million to 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 discipline 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.

[Operator Instructions] Our first question today will come from Nicholas Jones of Brooks Investments.

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

If you could repeat the second question, one more time for me, please?

Yes. I'd like to 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, 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 to $49 million or RMB equivalent to RMB 300 million to 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 Catalyst actually are projecting overall market value growth for the smart watch 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 progress or of 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 percentage 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. 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 cost which is, I think we have mentioned that the run rate of our quarterly operating cost is around RMB 200 million-ish, and we have actually maintained this run rate for more than 4 quarters throughout 2023, and we have been demonstrating that we are able to keep on with this cost level and adjust this level if we need in the year to come. So I think that should give you a feeling on where the year 2024 would bring us on the bottom line in this case.

I think that should give you -- assess the first quarter guidance at 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 U.S.A. and the other half coming out of the Asia Pacific region, right?

So -- and 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 in -- also in July -- June, July time frame in Europe. So Europe will be a big sports year for us, 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 U.S.A. actually stands as another bright spot for growth us because we have made quite some advancement in the off-line channels in U.S. For example, we are featured Best Buy, Target and many off-line channels in, and also including Walmart, in U.S. at this point, and we're actually expanding into more stores and also more off-line channels in the U.S.A. as we speak, which we believe in 2024, we should see a reasonable growth coming out of U.S.A. 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 revenue in the year to come.

Our next question today will come from Sid Ragi Fundamental Resource Corp.

Congratulations on your strong results. I have a couple of questions on your balance sheet. We 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'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?

Yes. 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 plays into the vertical integration of our big plan for the wearables because company, to be specific, actually is making the sensors and producing the chips for, not only us but also other wearable manufacturers for the smart watch product, right? And in the future, I think having this company as A-listed company in China has its benefit because it cannot only supply goods to us, but also we can 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 Apple chip strategy, but the only difference is that Apple doesn't open it to the others. And we, as a player and a strong player in the smart watch domain, we 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 -- and to some extent, I think our -- the look at the market value of the listed company, multiply our shareholder the value is already bigger than 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. But we have no intent to sell that stake at the moment of time.

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

I think overall, in 2023, as I mentioned, actually, we paid down more than 2 -- if I remember clearly, I think 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 assets that doesn't play into the health of the overall cash balance I have on that part.

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 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.

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

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 confirmation provided on our IR website.

This concludes this conference call. You may now disconnect your lines. Thank you.

The conference has now concluded. Thank you for attendance and you may once again now disconnect.