Zepp Health Q1 2023 Earnings Call Transcript

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May 23, 2023

There are 6 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by for ZEP Health Corporation's First Quarter 2023 Earnings Conference Call. At this time, all participants are in listen only mode. Today's conference call is being recorded. I will now turn the call over to your host, Ms. Grace Zhang, Director of Investor Relations for the company.

Operator

Please go ahead, Grace.

Speaker 1

Hello, everyone, and welcome to ZEP Health Corporation's Q1 2023 earnings conference call. The company's financial and operating results were issued in a press release via the newswire services earlier today and are posted online. You can also view the earnings press release and slides referred to on this call by visiting the IR section of the company's website atir.zep.com. Participating in today's call are Mr. Wang Huang, our Chairman of the Board of Directors and Chief Executive Officer and Mr.

Speaker 1

Liang Chen Zeng, our CFO. The company's management will begin with prepared remarks and the call will conclude with a Q and A session. Mr. Mike Young, our Chief Operating Officer, will join us for the Q and 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.

Speaker 1

S. Private Durative 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 are included in the company's annual report on Form 20 F for fiscal year ended December 31, 2022, and other filings as filed with the U.

Speaker 1

S. Securities and Exchange Commission. The company does not assume any obligation to update any forward looking statements, except as required under applicable law. Please also note that ZEP's earnings press release and the conference call include discussions of unaudited GAAP financial information as well as unaudited non GAAP financial information. ZEP's press release contains reconciliation of the audited non GAAP measures to the unaudited most directly comparable GAAP measures.

Speaker 1

I will now turn the call over to our CEO, Mr. Wang Fang. Please go ahead.

Speaker 2

Hello, everyone. Thank you for joining our call. In the Q1, we recorded revenue of RMB RMB645.2 million with RMB391 million from our self branded product and RMB254 1,000,000 from the Xiaomi ODM Business. Our total revenue declined as cautious consumers limited discretionary spending due to volatile geopolitical and macroeconomic conditions in Europe and in U. S.

Speaker 2

As we mentioned in the earlier quarters, we anticipate that the Xiaomi ODM business will diminished further and that our self branded product lines will become the main growth driver in the future. In the quarter, we made progress globally by strengthening our go to market capabilities and increasing brand awareness. This, along with The value of our products drove higher shipments and market share gains with a 20% increase in the Southeast Asia and East Asia region, Despite experiencing a decline in the consumer electronic device market During the Q1 of 2023, we maintained our optimism that macro headwinds will subside and we expect to see a market recovery during the second half of the year. Furthermore, another cause for optimism is that analyst recently forecasted an increase in the smartwatchmarketin2023. We strongly believe in Amazis' long term potential in the smartwatch market, presenting a significant opportunity to boost sales by enhancing our product competitiveness by leveraging our vertical integrated mix size based chip and ZEP OS in all product lines.

Speaker 2

We can reduce product costs and improve product gross profit margins. Our high end products offer similar performance to premium competitors, but at a fraction of the most of the cost and with longer battery life. This all help us generate higher revenue and profit margins along with our integrated supply chain and efficient R and D. We will secure our position in the US100 dollars to US200 dollars market segment while expanding into premium segments and enhancing our sales channels and supply chain management for increased profitability. With these enhancements now implemented.

Speaker 2

I am thrilled to share that our new products has achieved a remarkable 34.6% margin in the current quarter. We remain confident that the overall margin will improve in the future as we work towards achieving a more optimal inventory level. Moreover, the rapid implementation of OpenAI LLM Technology sets us apart from our competitors in the industry. By utilizing sports watches powered by generated AI, We will position ourselves as a trailblazer in the market, emphasizing our advanced grade technology rather than traditional sports watches. For example, as we mentioned last quarter, we have been the industry pioneer in integrating GBT technology into our products and services such as ZEP Coach and ZEP Aura.

Speaker 2

On March 29, we launched the better version of an AI powered ZEP Coach chat function for Amazfit Falcon user, powered by its constantly learning and evolving AI chat capability. ZEP Coach chat can provide users with abundant personalized and updated exercise recommendations. In recent quarters, we have implemented refreshed marketing and product strategies that include creating communities for sports and outdoors insurances by leveraging generative AI technology. We have not only supported the growth and development of athletes both in services and outdoor in services, but also builds a thriving user community in the sports and outdoor sectors. This has resulted in the organic spread of positive word-of-mouth and distribution, which has further boosted our brand and reputation in the mid to high end market.

Speaker 2

As a result, We have also gained brand premium in the mid to low end market, driving higher profit margins in the future. Alongside our endeavors to equip our products with cutting edge technologies. We have also been striving to expand our product portfolio aiming to offer more diverse products to adjust different cohosts, fitness, health and lifestyle needs. In Q1, we launched the Amazfit T Rex Outro, our Automate Outdoor GPS Smartwatch on March 10 Q. It received positive feedback from outdoor sports insurers for its logic design, premium materials and 160 plus sports modes.

Speaker 2

We have other exciting product clients for the year ahead aiming to bring the 1st features to more users. For example, on May 4, we released a significant firmware update for the Amazfit TLX2 smartwatch. It includes heart rate recovery information, terrain metrics, aptitude, water temperature, slope and automatic slope analysis. These enhancements improve the user experience, making our smartwatches reliable fitness companion for indoor and outdoor activities. For the past few months in 2023, we have seen some signs of economic recovery in certain markets.

Speaker 2

That said, the fragile economic environment in many other markets remains an uncertain factor, dampening consumer confidence and potentially our sales performance in the growth as we aspire to become a leading global healthcare solution provider and it will enable us to deliver incremental value to our users and shareholders. Thank you again for joining us today. I will now Turn the call over to Leo to go over the highlights of our Q1 financial results.

Speaker 3

Thank you, Wang. Greetings, everyone. Let me walk you through some key metrics of our Q1 2023 financial results. In the Q1, we recorded revenue of RMB645.2 million within our guidance range and down 14.8% year over year. The decrease was mainly due to the global macroeconomic uncertainties that dampened discretionary consumption in the Q1.

Speaker 3

According to Canalys, the value of the global wearable markets, including basic band, basic watch and smartwatch decreased by 8% in the 1st quarter. And more specifically, the basic band subcategory lost more than 30%. Also, as I mentioned a few times before, Q1 is typically the lowest seasonal quarter of our financial year. Before diving into our financial performance, I would like to provide a brief overview of the macro environment. In the Q1, we experienced a shift in China's COVID-zero policy.

Speaker 3

The reopening disrupted our new product launch schedule due to the factory closures. As a result, we had to postpone the release of some of our new product lines to subsequent quarters, which has a negative impact on our Q1 sales. At the same time, consumer spending was rather tippet, especially as the pendulum has swung away from goods and toward travel and services as the consumer enjoys some of the activities that they were deprived of during the pandemic. The consumer electronics space, in particular, continues to experience softness to this matter, which together with the geopolitical risks in Europe, pressure on our top line in North America and Europe. Despite the challenging start of the consumer Despite these headwinds mentioned above, as Wang just mentioned, in some of our global markets, our self branded products achieved encouraging year over year sales growth during the quarter.

Speaker 3

Thanks to our enhanced brand value and product features. We remain confident in our ability to drive our self branded products to grow further in the coming quarters. Moving on to our gross margin, which can be influenced by various factors such as product mix, product launch timing and product life cycles, including model upgrades. As we took ROI oriented approach to optimizing our product and sales channel portfolio, the gross margin for our sales branded products remained relatively healthy. Meanwhile, gross margin for Xiaomi products declined significantly in the quarter as a result of its multi year pricing strategy.

Speaker 3

Above factors combined drove our overall gross margin to 15.9% in the Q1, down lowered by 4.2% year over year and 4.8% versus previous quarter. We believe with the launch of our new higher margin products and continued pulling up our low ROI products at Cello's, the gross margin of our self branded products will expand further for the remainder of the year. Now let's look at our costs. As we have always mentioned in our past earnings calls, costs remain a main forecast for the company, both in terms of their absolute amount and as a percentage of sales. 6Q3 2020, we have been pleased to see a trend toward a decrease in total operating expenses, while still making strategic investments in new products, technologies and footprint expansions to fuel our long term growth.

Speaker 3

In Q1, we made good progress in cutting our expenses run rate further by reflecting a year over year decrease of 17.5% and a quarter over quarter decrease of 13.3%. Non GAAP operating expenses decreased to RMB229.8 million, which is the lowest level in the past 2 years. As a percentage of revenue, our 1st quarter adjusted operating expenses rate decreased by 3.3 percentage points year over year. Going forward, we'll continue to manage our expenses in a disciplined manner and enhance our operating efficiencies, targeting to cut our expenses run rates to approximately non GAAP RMB200 1,000,000 or lower in the coming quarters, which represents a significant decrease of around 33% or more from the average of RMB300 1,000,000 per quarter in 2020 2, as we aim for our turnaround in profitability in the coming quarters. Spending R and D in Q1 'twenty three was RMB117.9 million, decreasing by 19.5% year over year.

Speaker 3

Benefiting from our enhanced R and D efficiency, it is also worth mentioning that R and D expenses now account for nearly half of our total operating expenses, as we remain committed to investing in our future by investing in new technologies to enhance offerings for our users. Selling and marketing expenses were RMB86 1,000,000, declined by 16.6% year over year as we carefully review our sales channel strategy, while still investing opportunities with higher ROIs to fuel growth. Q1 G and A expenses were RMB49.9 million, lowered by 14.2% versus RMB58.2 million in Q1 2022 and down by 6.5% compared with RMB53.4 million in Q4 2022 due to organization delayering and strong cost control measures. We believe that our progress in cost optimization is a strong testament to our execution capability and will benefit our long term growth. That's due to decreased operating expenses.

Speaker 3

Our adjusted operating loss narrowed by 10.9% year over year. However, our reduced cost did not fully offset the impact of a smaller revenue scale and lower RMB112.7 million versus a loss of RMB75.7 million in the Q1 of 2022. While our Q1 2022 loss include $60,600,000 investment income generated by our sci fi investment. We will continue to enhance our cost control policies by implementing more comprehensive measures, specifically targeting areas such as travel expenses, personnel related costs and other expenditures incurred by the company. Simultaneously, we are dedicated to refining our product pricing strategy to optimize both our gross margin and sales revenue, ultimately leading to an improvement in our bottom line performance.

Speaker 3

Despite a bottom line loss, Our cash flow remains strong, thanks to our working capital management efficiency. We have sustained positive operating cash flow for 3 consecutive quarters since Q3 2022. Now turning to the balance sheet. Cash and cash equivalent restricted cash and term deposits as of March 31, 2023 were RMB1 1,000,000,000, an improvement from RMB973 1,000,000 as of December 31, 2022. As we continue to execute our precise inventory management strategy, we further reduced our inventory balance to RMB800 1,000,000 by the end of the quarter from RMB1 1,000,000,000 at the end of the year 2022, and it is the lowest level in the past 6 quarters.

Speaker 3

In November 2021, the Board approved the allocation of up to US20 $1,000,000 toward a share repurchase program. In Q1 2023, We continued our repurchase program as we remain confident in our business prospects in the longer term. We had bought back $11,100,000 worth of shares by the end of March 31, 2023, and we intend to carry on with this buyback program. Now let's discuss our outlook. In light of the ongoing geopolitical and macroeconomic challenges, our guidance for the Q2 of 2023 currently projects net revenue to be between RMB 650 1,000,000 and RMB850 1,000,000 compared to RMB1 $100,000,000 for the Q2 of 2022.

Speaker 3

We expect roughly 65% to 75% of the revenue will be contributed by our self branded products in the 2nd quarter. Please note that this outlook reflects continued uncertainty around lower discretionary consumer spending, especially in our international markets and global macroeconomic weakness. That said, we have seen some positive signs and much of the year lies ahead of us. Furthermore, as we mentioned last quarter, the year may be somewhat back end loaded as we gradually release our new products. And with that, I would open it up for questions.

Speaker 3

Operator, please go ahead.

Operator

Thank you. We'll now begin the question and answer session. For the benefit of all participants on today's call, if you wish to ask your question to the company's management in Chinese, Please immediately repeat your question in English. The first question comes from Nicolette Jones with Brooks Investments. Please go ahead.

Speaker 4

Thank you for taking my questions. So I have three questions. Firstly, Can you please provide some color on the revenue trend of self branded products in the Q2 and beyond? And then secondly, I'd like to ask if you can discuss factors that impacted your margins in the Q1 and margin outlook in the remainder of the year? And lastly, I'd like to understand a bit more about the revenue breakdown by region.

Speaker 3

Yes, It's a lot of questions. So let me start with the first question. I think it's on the self branded product margin sorry, I think it's around self branded product revenue outlook for Q2 and the quarters ahead of us, correct?

Speaker 4

Yes. Thank you.

Speaker 3

Okay. Now I think as We just guided, we're looking at roughly RMB 650,000,000 RMB850 1,000,000 for Q2 as our revenue range. And then we out of that number, there's going to be around 65% to 75% of the revenue, which is going to be contributed by our self branded products. So if you take the mid number over there, in essence, we're looking at the 2nd quarter revenue, which is going to be around, let's take a number, RMB 7.5, sorry, RMB 750,000,000 and out of that 70% would be our self branded products. If that number is correct, I think that is actually going to be indicating that our self branded products revenue is going to start to grow versus the same period of last year.

Speaker 3

And looking ahead, We have mentioned a few times that we're actually transforming more into self branded driven revenue kind of company rather than in the past majority of our revenue is actually consists of the ODM Xiaomi product. And you will see this trend starting to take its shape more in I think we have already started to you have already seen this trend, but I think after a few quarters, especially Q2, Q3, Q4. This year, you will start to see a solid trend of majority of our sales revenue is going to be generated by self branded products. Well, we still have a small portion of Xiaomi and ODM products revenue. And in return, that sales mix change is going to help us to deliver a higher gross margin.

Speaker 3

So I think that naturally goes into your 2nd quarter, which is on the margin outlook. I think one of the things I would like to call out in the Q1 this year is that we have already I think we have already seen consecutively a few quarters in the past that our self branded product gross margin is starting to recover and we see this trend progressing into Q1 this year. And we have already mentioned in our prepared remarks that in Q1, our new product sales gross margin is around 35%, which is a lot higher than what we have sold in the past. But our overall gross margin for the self branded products in quarter 1 was still flat year over year, largely because we still have some of the old inventories from the previous generation products, which we carried over from previous years, which we try to sell off, right? And I think we're coming and that's why you also see our inventory balance decreased dramatically in the past 6 quarters and we are now at $800,000,000 worth of inventory, Right.

Speaker 3

And I think coupled with the clearance of the old inventory, which come more or less to the end right now, plus the newly launched product of self branded products, which is going to take its shape in quarter 2 and ultimately into the high season of Q3 and Q4, we see the gross margin of our self branded products as well as the overall gross margin is going to shoot up or continue to improve in Q2 and ultimately in Q3 and Q4. I think that should answer your second question. And your third question, If I remember, clearly, it's about the revenue breakdown by region. I think we have mentioned several times that Our biggest sales region for our sales branded products is in Europe and that actually stands for around 60% of the overall self branded revenue for us. And in many of the big European countries, For example, Spain and Italy, we hold a very dominant market share position in those countries.

Speaker 3

So and we will continue to expand in Europe, especially in the East part of Europe as well as in the countries like traditionally a very strong brand awareness for Our premium competitors, for example, Apple and Samsung brands. You're more looking at countries like Germany and UK, etcetera, etcetera, right? And apart from Europe, I think we also see United States as one of the countries and regions, which can give us quite a growth opportunity because we have been operating in U. S. In North America market for roughly close to 2 year, less than 2 year.

Speaker 3

And we have already developed our market in the U. S. So I think U. S. Will continue to push up after Europe.

Speaker 3

And the 3rd biggest sales region for us is the ASEAN countries. You're looking at Japan, Korea and Malaysia, Singapore and India. These we actually group them as one of the Asia Pacific countries and then they also play as an important part of our self branded revenue. And last but not the least is China. And I think we also want to play Smartly in China by selling selectively our premium products in China and try to look at the profitability rather than the scale because the competition in China is quite fierce, Especially in the smartwatch domain.

Speaker 3

But I think in certain premium price segment, we have a unique position to compete over there. So that altogether, hopefully would give you view on where we're going to push for this year's revenue for self branded products.

Operator

The next question comes from Lisa Lee with Alpha Research. Please go ahead.

Speaker 5

Thank you for taking my question. I have two questions. The first one is On the very strong margin that you just mentioned for your new products, you said it was around 35% in the Q1. I'm just wondering what are the drivers behind this performance and are there any further upside to this number? And the secondly second question is on the run rate of your operating expenses.

Speaker 5

You I think talks about a target of RMB200 1,000,000 on the adjusted basis in the coming quarters. But I noticed in the Q1, your total operating expenses have reached Around $225,000,000 I think on the adjusted basis. So are you being a little bit conservative on this target? And what is your run rate currently? Thank you.

Speaker 3

Yes. So let me try to answer the easy ones. Let's start with the run rate of the expenses, then I'll get back to the margin Because that's probably is going to be a little bit longer story here. Yes, you're right, Lisa. So If you look at our 2022 and 2021 quarterly expenses run rate were around RMB300 million per quarter, which is adding up the R and D, G and A plus the sales and marketing expenses altogether.

Speaker 3

So this is actually one of the key KPIs, the management play a lot of focus into our day to day operation. So we have done a few things. We actually look at our search so there's number 1, is definitely the personnel, right? So we look at our workforce and we try to streamline our workforce and then we try to get it in line with our revenue scale. So that's definitely the one which we did in the past quarters.

Speaker 3

I think that's more or less coming to the end. And the second one is what we did is to look at our expenses based on so called ROI return on investment approach. And we Always look at the discretionary expenses in a way that whenever we could save, we ask people to be a little bit more cautious in, for example, traveling, for example, spending on our marketing campaign by looking twice or three times whether or not it makes sense and what's the return on that, okay? And the last thing which we did is on R and D part. We are more applying a so called platforming approach, whereby we look at our vertically integrated chips, OS and everything together and try to lower the overall cost of delivery of our products, right?

Speaker 3

So that all translates into a lower R and D expenses and lower sales and marketing expenses and lower G and A expenses. And you're right. We have I think last quarter, we have guided that our target for this year probably is going to be achieving a run rate of 250,000,000 per quarter and then we have already achieved that number and we have over delivered in assets this quarter at RMB200 around RMB229 1,000,000 for the quarter. And where, As we mentioned in our prepared remarks, we're looking at operating expenses run rate of $200,000,000 for the year. And yes, I still think by applying more target approach like what I just described, we still have room to push for a little bit lower than that number.

Speaker 3

But at this moment, we're more looking at a run rate of RMB200 1,000,000 per quarter for that? And going back to your first question on the margin and then the margin development for our products for this year, I think there are a few drivers. Number 1 is that we are actually looking at As you know, we have 3 different product lines, which are targeting different type of consumers, right? Number 1 is our so called spots and outdoor range, which is supported by our watch like T Rex and Falcom theories. These are the so called the Apple Ultra and Garmin Watch competitors, which we want to use these type of and we offer the D Swatch at a relatively lower price with similar functionalities versus our competitors.

Speaker 3

And these watches actually have gained great traction in the marketplace right now. And we want to actually deepen on building on those reputations we generated through this watch and also the functionalities we have achieved out of this watch and we want to actually use these type of reputation to sell our and increase our ASPs of our overall product portfolio at large, right? And number 2 is actually what I mentioned just now on applying a vertical integrated supply chain as well as the chips, the OS and the R and D effort altogether, so called platforming approach in our R and D, right. In the past, if you have 10 platforms that in essence you need to spend the money 10 times. But if you can actually single everything into one platform, then you are going to reduce your costs dramatically and at the same time deliver a user experience and functionalities much better than a scattered software and hardware landscape in the past.

Speaker 3

So I think with that 2nd labor on vertically integration, we should be able to gain market share in those price segments between $100 $200 range, That which is also the part which our competitors like Huawei, like Xiaomi and other brands, there's a fierce over there. So number 1 is to increase the ASP on our premium watches. Number 2 is to use our vertical integrated system platforms and everything to increase our competitiveness on the lower tier price points so that we can actually gain market share at the bottom from the Xiaomi, Huawei and Samsung guys and at the top from Apple and the Garmin guys. Then altogether, that should be the path on how we're going to increase our gross margin for our products in the future.

Speaker 5

I hope

Speaker 3

that gives you a view.

Speaker 5

That's very helpful. Yes, it did. Thank you.

Operator

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

Speaker 1

Thank you once again for joining us today. If you have further questions, please feel free to contact Gap's Investor Relations department through the contact information provided on our website. This concludes this conference call.

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