Hello, ladies and gentlemen. Thank you for standing by for Zepp Health Corporation's Q1 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.
Please go ahead, Grace.
Hello, everyone, and welcome to Zepp Health Corporation's Q1 2023 earnings conference call.
The company's financial and operating results were issued in a press release by 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. Wang Huang, our Chairman of the Board of Directors and Chief Executive Officer, and Mr. Leon Cheng Deng, our CFO. 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 provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. 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 the fiscal year ended December 31st, 2022, 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 as required under applicable law.
Please also note that Zepp's earnings press release and the 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 will now turn the call over to our CEO, Mr. Wang Huang.
Please go ahead.
Hello, everyone. Thank you for joining our call.
In the Q1, we recorded revenue of RMB 645.2 million, with RMB 391 million from our self-branded products and RMB 254 million 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 the U.S. As we mentioned in the earlier quarters, we anticipate that the Xiaomi ODM business will diminish 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 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 maintain 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 Canalys recently forecasted an increase in the smartwatch market in 2023. We strongly believe in Amazfit's 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 of self-developed chip and Zepp OS in all product lines, 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&D. We will secure our position i n the $100-$200 market segments while expanding into premium segments and enhancing our sales channels and supply chain management for increased profitability. With these enhancements now implemented, I am thrilled to share that our new products have 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 in-inventory level. Moreover, the rapid implementation of OpenAI's LLM technology sets us apart from our competitors in the industry. By utilizing sports watches powered by generative 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 GPT technology into our products and services, such as Zepp Coach and Zepp Aura. On March 29th, we launched the beta version of an AI-powered Zepp Coach chat function for Amazfit Falcon users.
Powered by its constantly learning and evolving AI chat capability, Zepp 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 enthusiasts. By leveraging generative AI technology, we have not only supported the growth and development of athletes, both enthusiasts and outdoor enthusiasts, but also built 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. 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 address different cohorts, fitness, health, and lifestyle needs.
In Q1, we launched the Amazfit T-Rex Ultra, our ultimate outdoor GPS smartwatch on March 20th. It received positive feedback from outdoor sports enthusiasts for its logic design, premium materials, and 160+ sports modes. We have other exciting products planned for the year ahead, aiming to bring advanced features to more users.
For example, on May Fourth, we released a significant firmware update for the Amazfit T-Rex 2 smartwatch. It includes heart rate recovery informationTerrain metrics, attitude, 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.
That said, the fragile economic environment in many other markets remains an uncertain factor, dampening consumer confidence and potentially our sales performance in the coming quarters. Nevertheless, we remain confident in our strategy described above, and we believe this is the right path leading to the company's sustainable 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 Leon to go over the highlights of our Q1 financial results.
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 RMB 645.2 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. According to Canalys, the value of the global wearable markets, including basic band, basic watch, and smartwatch, decreased by 8% in the Q1. 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 zero-COVID policy. 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. Consumer spending was rather tepid, 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 electronics market during the Q1 of 2023, we remain optimistic about the smart wearable market's recovery in the second half of the year. 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.
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 a ROI-oriented approach to optimizing our product and sales channel portfolio, the gross margin for our self-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. 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 pruning of our low ROI products and channels, the gross margin of our self-branded products will expand further for the remainder of the year. Let's look at our costs.
As we have always mentioned in our past earnings calls, costs remain a main focus for the company, both in terms of their absolute amount and as a percentage of sales. Since Q3 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. In Q1, we made good progress in cutting our expenses run rate further by successfully reducing our quarterly operating expenses to RMB 253.8 million, reflecting a year-over-year decrease of 17.5% and a quarter-over-quarter decrease of 13.3%.
Non-GAAP operating expenses decreased to RMB 229.8 million, which is the lowest level in the past two years.
As a percentage of revenue, our Q1 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 RMB 200 million or lower in the coming quarters, which represents a significant decrease of around 33% or more than or more from the average of RMB 300 million per quarter in 2022, as we aim for our turnaround in profitability in the coming quarters. Spending R&D in Q1 2023 was RMB 117.9 million, decreasing by 19.5% year-over-year.
Benefiting from our enhanced R&D efficiency, it is also worth mentioning that R&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 RMB 86 million, declined by 16.6% year-over-year, as we carefully review our sales channel strategy while still investing on opportunities with higher ROIs to fuel growth. Q1 G&A expenses were RMB 49.9 million, lowered by 14.2% versus RMB 58.2 million in Q1 2022, and down by 6.5% compared with RMB 53.4 million in Q4 2022 due to optimization, 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. Thanks to decreased operating expenses, our adjusted operating loss narrowed by 10.9% year-over-year. Our reduced cost did not fully offset the impact of a smaller revenue scale and lower gross margin for Xiaomi products during the quarter. Our adjusted net loss in the Q1 was RMB 112.7 million, versus a loss of RMB 75.7 million in the Q1 of 2022. While our Q1 2022 loss include RMB 64.3 million investment income generated by our SiFive 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're 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. 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 three consecutive quarters since Q3 2022. Turning to the balance sheet. Cash and cash equivalents, restricted cash and term deposits as of March 31, 2023, were RMB 1 billion, an improvement from RMB 973 million as of December 31, 2022. As we continue to execute our precise inventory management strategy, we further reduced our inventory balance to RMB 800 million by the end of the quarter, from RMB 1 billion at the end of the year 2022.
It is the lowest level in the past 6 quarters. In November 2021, the board approved the allocation of up to $20 million towards 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 have bought back $11.1 million worth of shares by the end of March 31st, 2023, and we intend to carry on with this buyback program. 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 million and RMB 850 million, compared to RMB 1.1 billion for the Q2 of 2022.
We expect roughly 65% to 75% of the revenue will be contributed by our self-branded products in the Q2. 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. With that, I would open it up for questions. Operators, please go ahead.
Thank you. We'll now begin the question and answer session.
To ask a question, you may press Star then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press Star then two. 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.
At this time, we will pause momentarily to assemble our roster.
The first question comes from Nicolette Jones with Brooks Investments. Please go ahead.
Thank you for taking my questions.
I had three questions. Firstly, can you please provide some color on the revenue trend of self-branded products in the Q2 and beyond? Secondly, I have, 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. Lastly, I'd like to understand a bit more about the revenue breakdown by region. Thank you.
Yeah, it's a lot of questions. Let me start with the first question. I think it's on the self-branded product margin. So sorry. I think it's around self-branded product revenue outlook for Q2 and the quarters ahead of us. Correct?
Yes. Thank you.
Okay. Now, I think, as we just guided, we're looking at roughly RMB 650 million, RMB 650 million and RMB 850 million for Q2 as our revenue range. Out of that number, there's going to be around 65%-75% of the revenue, which is going to be contributed by our self-branded products. If you take the mid number over there, in essence, we're looking at the Q2 revenue, which is going to be around, let's take the number 7.5, no, sorry, 6, RMB 750 million. 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. 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.
You will see this trend starting to take a 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 the Xiaomi and ODM products revenue. In return, that sales mix change is going to help us to deliver a higher gross margin. I think that naturally goes into your Q2, 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 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. 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.
Our overall gross margin for the self-branded products in quarter one 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 tried to sell off. Right? That's why you also see our inventory balance decrease dramatically in the past six quarters. We're now at $800 million worth of inventory, which is, if you put it into perspective, that's just equivalent to the sales outlook of a quarter out sales for us. Right?
I think coupled with the clearance of the old inventory, which come more or less to an end right now, plus the newly launched product of self-branded products, which is going to take its shape in Q2 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. 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 self-branded products is in Europe, and that actually stands for around 60% of the overall self-branded revenue for us. In many of the big European countries, for example, Spain and Italy, we hold a very dominant market share position in those countries. 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 the Samsung brands. You're more looking at countries like Germany and UK, et cetera, et cetera. Right?
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 US, in the North America market for roughly close to 2 year, less than 2 year. We have already developed our market share from 0 towards 11%. That's actually ranked ourselves among the top 5 players in the US. I think US will continue to push up after Europe. The third biggest sales region for us is the ASEAN countries. You're looking at Japan, Korea, and Malaysia, Singapore, and all, and India. These, we actually group them as one of the Asia Pacific countries.
Then, they also play as an important part of our self-branded revenue. Last but not the least, is China. I think we also wanna 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. But I think in certain premium price segment, we have a unique position to compete over there. That altogether, hopefully would give you a view on where we're going to push for this year's revenue for self-branded products.
Yes. Thank you.
That's very helpful. Thank you.
Again, if you have a question, please press star then one.
The next question comes from Lisa Lee with Alpha Research. Please go ahead.
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? The second question is on the run rate of your operating expenses. You, I think, talks about a target of $200 million on the adjusted basis in the coming quarters. I noticed in the Q1, your total operating expenses have reached around $225 million, I think, on the adjusted basis. Are you being a little bit conservative on this target?
What is your run rate currently?
Thank you.
Yeah. 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 margins because that's probably is gonna be a little bit a longer story here. Yes, you are right, Lisa. If you look at our 2022 and the 2021 quarterly expenses run rate were around RMB 300 million per quarter. Yeah. Which is adding up the R&D, G&A, plus the sales and marketing expenses altogether, right? This is actually one of the key KPIs, the management play a lot of focus into our day-to-day operation. Okay? We have done a few things.
We actually look at our search, so there's number one, is definitely the personnel, right? 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. That's definitely the one which we did in the past quarters. I think that's more or less coming to an end. The second one is what we did is to look at our expenses based on our so-called ROI return on investment approach.
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. Right? The last thing which we did is on R&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 on our products. Right? That all translates into a lower R&D expenses, a lower sales and marketing expenses and a lower G&A expenses. Right?
You are 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 RMB 250 million per quarter. Then we have already achieved that number, and we have over-delivered in essence this quarter on RMB 200, around RMB 229 million for the quarter. Where, as we mentioned in our prepared remarks, we're looking at operating expenses run rate of RMB 200 million for the year. Yes, I still think by applying a more target approach, like what I just described, we still have room to push for a little bit lower than that number.
At this moment we're more looking at a run rate of RMB 200 million per quarter for that. Right? Going back to your first question on the margin and the margin de-development for our products for this year, I think there are a few drivers. Number one is that we are actually looking at, as you know, we have three different product lines which are targeting different type of consumers, right? Number one is our so-called sports and outdoor range, which is supported by our watch, like a T-Rex and Falcon series. These are the so-called the Apple Ultra and Garmin watch competitors, which we want to use these type of...
We offer these watch at a relatively lower price with similar functionalities versus our competitors. These watches actually have gained a great traction in the marketplace right now, right? 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. We wanna actually use this type of reputation to sell our, and increase our ASPs of our overall product portfolio at large. Right? Number two is actually what I mentioned just now on applying a vertical integrated supply chain as well as the chips, the OS and the R&D effort all together, so-called platforming approach in our R&D. Right?
In the past, if we have ten platforms, then in essence you need to spend the money just ten times. If you can actually single everything into one platform, then you are going to reduce your cost dramatically and at the same time deliver a user experience and functionalities much better than a scattered software and hardware landscape in the past. I think, with that second lever 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 competition over there.
I think through a vertical integration and a pure player, we should have a better competitive edge over there. Number one is to increase the ASP on our premium watches. Number two 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. Altogether, that should be the path on how we're going to increase our gross margin for our products in the future.
Right. Thank you.
I hope that gives you a view.
That's very helpful.
Yes, it did. Thank you.
As there are no further questions now, I'd like to turn the call back over to Grace Zhang for any 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 line. Thank you.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.