Yatsen Holding Ltd Q2 FY2021 Earnings Call

Ladies and Gentlemen good day and welcome to the Yatsen Second Quarter 2021 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Irene Lyu, Head of Strategic Investment and Capital Markets. Please go ahead.

Thank you, operator. Please note that the discussion today will contain forward-looking statements relating to the Company's future performance and are intended to qualify for the Safe Harbor from liability as established by the U.S. Private Securities Litigation Reform Act. Such statements are not guarantees of future performance and are subject to certain risks and uncertainties, assumptions and other factors. Some of these risks are beyond the Company's control and could cause actual results to differ materially from those mentioned in today's press release and this discussion. A general discussion of the risk factors that could affect Yatsen's business and financial results is included in certain filings of the Company with the Securities and Exchange Commission. The Company does not undertake any obligation to update this forward-looking information except as required by law. During today's call, management will also discuss certain non-GAAP financial measures for comparison purposes only. For a definition of non-GAAP financial measures, a reconciliation of GAAP to non-GAAP financial results, please see the earnings release issued earlier today. Joining us today on the call from Yatsen's senior management are Mr. Jinfeng Huang, our Founder, Chairman and CEO; and Mr. Donghao Yang, our CFO and Director. Management will begin with prepared remarks and the call will conclude with a Q&A session. As a reminder, this conference is being recorded. In addition, a webcast replay of this conference call will be available on Yatsen's Investor Relations website at ir.yatsenglobal.com. I will now turn the call over to Mr. Jinfeng Huang. Please go ahead.

Irene, and thank you, everyone, for participating in Yatsen's second quarter 2021 earnings conference call today. Our total net revenue grew 53.5% year-over-year in the second quarter in line with our guidance due to steady contributions from our flagship Perfect Diary brand and better-than-expected performance of our newly launched and acquired brands. The number of DTC customers increased by 13.3% year-over-year to 10.2 million. Average net revenue per DTC customer went up by 17.6% to RMB117 from RMB99 during the second quarter of 2020. This solid result came despite intensifying competition and rising customer acquisition costs even as China's beauty market grew at about 20% overall during the second quarter, with growth in the premium segment and in skincare being notably stronger than other market segments. We believe this market development validates a set of strategic growth initiatives we launched in May to sharpen our growth model. Specifically, we are optimizing internal resources and organizational structures to enhance the power of our brands, facilitate positive innovation, capitalize on new growth channels, and optimize cost structures and efficiencies. This ongoing transformative process will continue into mid September, even though we have already seen some early signs of success in the latest quarter. With our proven ability to disrupt the traditional beauty industry using a digitalized latest DTC model, we are now building a portfolio of durable, iconic brands supported by consumer insights and innovation. These strategic initiatives are essential tools to position us on the path of high-quality sustainable growth, particularly as we prepare for a busy season in the lead-up to Singles Day in the fourth quarter. During the second quarter, we launched several new products under our flagship Translucent Blurring Loose Powder with Smartlock technology and the Ultra-light Purifying Cleansing Oil. All of these new products featured Perfect Diary technology and received very encouraging user feedback. Despite this competition from both international and domestic peers during the June 18 Shopping Festival, Perfect Diary was one of the top two best-selling domestic Chinese color cosmetic brands, selling more than 400,000 lip glosses among other similar products. The launch of our higher-priced Slim Heel Lipstick Treasure Box was also a success during the May 20 Chinese Valentine's Day campaign with sales of more than 100,000 units. This also introduced the Perfect Diary brand to male customers who are buying for their significant others. Heading into the second half of the year, we plan to make a strong push into the base makeup category and have premiumized the Perfect Diary brand among our new and existing users. Speaking of brand building, we continue to be recognized by the industry for our achievements. This quarter, the 2021 Tmall Beauty Awards, known as the Oscars of the beauty industry, named Perfect Diary the most sought-after brand of the year, and Yatsen the fastest-growing beauty group in 2021. World Brand Lab recognized Perfect Diary as one of China's 500 most valuable brands of 2021, where we are the only color cosmetic brand and the youngest beauty brand in the business. Now turning to other brands in our portfolio, we continue to optimize return on investment for Little Ondine and Abby's Choice during the second quarter. Our newly launched cosmetic brand, Pink Bear, has seen fast growth since its development in March 2021. This sensational new brand sold over 500,000 lip glosses during the first June 18 campaign, garnering the award as the fastest-growing new cosmetic brand on Tmall in 2021. As we head into the second half of the year, we will continue to expand Pink Bear into the eye and face makeup categories. We are also excited about our progress in skincare, which has grown to represent more than 20% of our gross sales in the second quarter. Our new innovative skincare products resonated strongly with our consumers. Galenic pure brightening vitamin C powder quickly sold out following its initial launch in Mainland China this April. After a relatively short period of integration into our platform, DR.WU's sales in Mainland China grew dramatically during the second quarter, becoming the number one in its category on Tmall. During the June 18 Shopping Festival, DR.WU's sales increased around 700% from the same period last year. Meanwhile, Eve Lom was the number one premium cleanser brand on Tmall during the second quarter, and sales of this classic cleansing cream product grew by 53% year-over-year during the June 18 Shopping Festival on Tmall. The rapid progress we've made so far clearly shows that there is great growth potential for this brand in the future. We continue to focus on improving our sales and marketing expenses across the firm. Throughout the June 18 Shopping Festival, we maintained discipline on pricing and discounts, as well as allocated resources to brands and channels with higher ROI. The end result was a decline in our sales and marketing expenses to 51% of total net revenues based on non-GAAP measures compared to 71% last quarter and 6.7% in the fourth quarter of 2020. Our investment in R&D increased to 2.3% of total net revenues this quarter from 1.4% a year ago. Our increased investment in R&D has already borne fruit, as demonstrated by the Smart Lock technology developed in-house and used in the new Translucent Blurring Loose Powder line. Besides launching this innovative product, we also recently announced the establishment of a joint research laboratory with the National Engineering Research Center for Nano Medicine, which was formed under the Huazhong University of Science Technology to further enhance our R&D capabilities in advanced skincare, particularly the nano-based thermal delivery system for active ingredients. Looking ahead, the lower year-over-year growth rate in Q3, as reflected in our guidance, is largely due to the unusual quarterly seasonality pattern caused by the COVID-19 pandemic last year. In a typical year, the China online beauty market is characterized by higher sales in Q2 and Q3 as a result of the June 18 promotions across all sales channels. This pattern was disrupted in 2020 due to social distancing and quarantine policies during the COVID-19 pandemic in Q2, followed by relatively stronger sales in Q3 as the market recovered, helped by the pent-up demand from the previous months. This creates a low base in Q2 and a high base in Q3 for year-on-year comparisons this year. However, if you compare our combined sales in Q2 and Q3 this year, which represents 53.5% and year-over-year growth rates of 5 to 10 days on August, respectively, the year-over-year growth is projected to be 26% to 29%. We believe this is a more accurate picture of our growth trend, taking last year's unusual seasonality into account. We expect to have a normal basis of comparison in Q4 and our year-over-year growth will resume its normal trajectory. We are confident that the successful execution of our strategic growth initiatives, our expanding talent pool, and the solid financial results on our balance sheet position us to continue playing a leading role in China's evolving beauty market. Thank you everyone. With that, I will now turn the call over to our CFO, Donghao Yang, to discuss our financial performance.

Thank you, David, and hello everyone. Before I get started, I would like to clarify that all financial numbers presented today are in renminbi and all percentage changes refer to year-over-year changes unless otherwise noted. Total net revenue for the second quarter of 2021 grew by 53.5% to RMB 1.53 billion from RMB 993.2 million in the prior year period. The growth was primarily attributable to increased contributions from diversified sales channels and newly launched and acquired brands. Gross profit for the second quarter of 2021 increased by 65.1%, approximately RMB 1 billion from RMB 607 million in the prior year period. Gross margin improved by 4.6 percentage points to 65.7% in the second quarter of 2021 as compared with 61.1% in the prior year period due to increased sales generated from higher margin brands and products. We have also seen the continuation of the premiumization plan for the Perfect Diary brand in the quarter, enabling us to achieve higher average order value and better margins. Total operating expenses for the second quarter of 2021 increased by 51% to RMB 1.41 billion from RMB 935.3 million in the prior year period. As a percentage of total net revenues, total operating expenses decreased to 92.6% from 94.2% in the prior year period. Fulfillment expenses for the second quarter of 2021 were RMB 118 million as compared with RMB 81.7 million in the prior year period. As a percentage of net revenue, fulfillment expenses decreased to 7.7% from 8.2% in the prior period. This was mainly attributable to the high base effects of the prior year period during which logistics costs were high due to the COVID-19 pandemic last year. Selling and marketing expenses for the second quarter of 2021 were RMB 972.5 million as compared with RMB 622.5 million in the prior year period. As a percentage of total net revenue, selling and marketing expenses were 63.8% as compared with 62.7% in the prior period. However, on a non-GAAP basis, excluding expenses related to share-based compensation and amortization of intangible assets, selling and marketing expenses were 61.4% of total net revenue, as compared with 71% in the prior quarter and 62.7% in the same period last year. The decrease in selling and marketing expenses as a percentage of total net revenue resulted from a focus on improving the ROI of our selling and marketing expenses. General and administrative expenses for the second quarter of 2021 were RMB 286.4 million compared with RMB 216.8 million in the prior year period. As a percentage of total net revenue, general and administrative expenses for the second quarter of 2021 decreased to 18.8% from 21.8% in the prior year period. This decrease was primarily due to lower FCC expenses compared to the same period last year. Research and development expenses for the second quarter of 2021 were RMB 35.2 million compared with RMB 14.3 million in the prior year period. As a percentage of total net revenue, research and development expenses for the second quarter of 2021 increased to 2.3% from 1.4% in the prior year period. The increase was primarily due to higher personnel costs and share-based compensation expenses, reflecting our commitment to enhancing our R&D capabilities. Loss from operations in the second quarter of 2021 increased by 24.9% to RMB 409.9 million from RMB 328.3 million in the prior year period. The operating loss margin was 26.9% as compared with 33.1% in the prior year period. Non-GAAP loss from operations for the second quarter of 2021 increased by 70.7% to RMB 211.4 million from RMB 479.6 million in the prior year period. Non-GAAP operating loss margin was 13.9% as compared with 18.1% in the prior year period. Net loss for the second quarter of 2021 increased by 21.6% to RMB 291.2 million from RMB 321.7 million in the prior year period. Net loss margin was 25.7% as compared with 32.4% in the prior year period. Non-GAAP net loss from the second quarter of 2021 increased by 12.6% to RMB 194.9 million from RMB 173.1 million. Non-GAAP net loss margin was 12.8% as compared with 17.4% in the prior year period. Net loss attributable to Yatsen's ordinary shareholders per diluted ADS for the second quarter of 2021 increased to RMB 0.62 from RMB 5.68 in the prior year period. Non-GAAP net loss attributable to Yatsen's ordinary shareholders per diluted ADS for the second quarter of 2021 increased to RMB 0.31 from RMB 1.28 in the prior year period. As of June 30, 2021, the company had cash and cash equivalents, and restricted cash of RMB 4.11 billion compared with RMB 5.73 billion as of December 31, 2020. Looking at our business outlook for the third quarter of 2021, we expect our total net revenue to be between RMB 1.3 billion and RMB 1.39 billion, representing a year-over-year growth rate of approximately 5% to 10%. This forecast reflects our current and preliminary view on the market and operational conditions, which is subject to change. With that, I would now like to open the call for Q&A.

And our first question will come from Dustin Wei of Morgan Stanley. Please go ahead.

Hello, management. Thanks for taking my questions. So the first question is really regarding the third quarter guidance. It sounds like it's because of the base issue in the third quarter last year that provides the company with a conservative or low guidance. It sounds like it's not because of the current COVID outbreak, so that's a little confusing. I appreciate if you can clarify that point. If we are looking for 5% to 10% sales growth, should we assume that Perfect Diary could be declining in the third quarter? Could you provide some insight by brand or by channel? That's my first question regarding the guidance. The second question concerns the margin or profit for the third quarter. If we assume like 5% to 10% sales growth, does that mean the company will also control the variable costs? Should we expect to see a rationalization of ROI and a reduction in the net loss ratio, or due to operating leverage, might we see a bigger loss or larger loss ratio in the third quarter? And the third point relates back to David's prepared remarks discussing the transformation plan. I would appreciate if management can provide some details about the goals of that transformation, the operational target or financial target, and how long you expect the changes will take to yield better financial results. Those are my three questions. Thank you very much.

Thank you so much for the questions, Dustin. Let’s discuss the guidance first. As I mentioned before, we need to take Q2 and Q3 combined to look at the growth rate. One of the key reasons is the unusual seasonality of last year due to COVID. When looking at Q3 guidance, we cannot provide an average breakdown of brands, but we still see a very healthy growth trend of Perfect Diary remaining. Due to ROI adjustments, we now have more brands in the skincare category; therefore, we continue to shop in the ROI. As for the second question regarding the COVID impact on Q3, we see some moderate impact on our offline stores as less than one-third of the offline stores were impacted by COVID. We are factoring in the impact of COVID when acquiring offline sales. Regarding the transformation plan, we have taken initiatives to sharpen our growth model. This means a few things. We continue to improve our ROI, reflected in the sales and marketing percentage of total revenue and improvements on the bottom line. In the past quarter, we assigned our internal resources to skincare brands, moving some of the best performers from cosmetics to the skincare business unit. This is under the assumption that we think growth in the color cosmetic category will continue. However, we are facing more intense competition in color cosmetics. Right now we are focused on the growth of Perfect Diary while taking very good initiatives to grow the skincare brand. We see momentum in DR.WU, Galenic, Eve Lom, and Abby's Choice.

Thank you, David. If I can follow up on the margin or profit aspect in the third quarter, should we consider the third quarter's margin somewhat abnormal because of this low growth? Do you believe that ROI and margin improvement will continue despite a little bit of low growth for that quarter?

If we think about Q3 and Q4 growth, typically, the Q4 growth comes from the investment made in Q3 because we need to take the repeat purchase rate into consideration. Normally, the new users acquired in Q3 will return during the Singles Day promotional event. For Q3, investments on our flagship brand, such as Perfect Diary and the skincare brands, will still be high. We see changes due to optimized ROI and lower sales and marketing percentages of revenue. Therefore, the improvement in the bottom line will continue.

Okay, thank you very much, David.

Thank you so much, Dustin.

The next question comes from Christine Cho of Goldman Sachs. Please go ahead.

Thank you so much, David. I have three quick questions. To follow up on guidance, if I simply add the second quarter actual revenue plus your third quarter guidance, it implies around 25% to 30% growth on a year-over-year basis. Is this around the level of normalized growth we should look for going forward beyond the fourth quarter? That’s my first question. For my second question, do you have any updates on offline store expansion? I recall you had a target of around 100 new openings for this year, but due to the COVID situation and other factors, the store openings seem to have been slower than targeted. Lastly, I wanted to hear your thoughts on the weaker July numbers across the industry. Do you think this is more of a pull forward of demand towards June 18, or are there other factors we should consider regarding July and August numbers? Thank you.

Thank you so much. To answer your first question about the guidance for Q4 and beyond, we believe that taking into consideration Q1 would give a more accurate reflection of our growth looking forward. Regarding the second question about offline stores, by the end of Q2, we had opened around 273 stores compared to 241 at the end of last year, resulting in a net increase of 32 stores. We expect to continue to open more stores, but given the repeated COVID situations, the number of stores we plan to open may drop a little bit compared to our earlier target. Your third question about the overall growth of the cosmetic industry in July shows slower growth versus previous months, which is lower than our expectations. One key reason that drove the growth of previous months stems from skincare and premium brand growth. We think this growth trend is now slowing down, which is why overall market growth appears weaker. However, if we look at the August data, we remain confident in color cosmetics growth as we see some newly emerging channels, such as live broadcasting, growing rapidly. Our focus is to capitalize on these new category entrants and emerging channels like Douyin.

Thank you. That is super clear. Thank you.

Thank you.

The next question comes from Louis Li of Bank of America Securities. Please go ahead.

Hi, David. Hi, Donghao. Thank you for taking my questions. My first question is about the second quarter. You mentioned that the key driver of quarterly sales growth is from channel diversification and new products. Could you provide insight on the channel diversification? Compared to last quarter, have we seen further expansion in sales contributions from outside of Tmall, particularly Douyin? What is Douyin’s gross contribution now? I recall you mentioned that Douyin’s ROI in Q1 was still at the trial period. Have we seen an improvement in ROI from this channel? This is my first question. Second question is also about guidance. It seems like the Q3 guidance is lower. However, if we look at the past 2 years, Q3 has had stronger growth. How should we view Q4 when competition becomes even tougher? Is the 20% to 25% to 30% a normalized growth expectation? My third question pertains to our transformation strategy. Are we prioritizing net loss control versus sales growth, and how do we plan to balance these two aspects moving forward?

Thank you, Louis, for the question. To address your first point on channel diversification, we are seeing a higher growth rate outside Tmall, particularly with Douyin experiencing significant growth due to live streaming. In Q1, as we were in a testing period, ROI was not high. In Q2, we saw significant improvements in ROI. The growth in Douyin is on the right track, which I believe will reflect sustained revenue growth, and also optimize sales and marketing percentages of total revenue. Regarding Q3 guidance, I discussed that while responding to Christine’s question, we believe that combined growth in Q2 and Q3 will give us a more accurate reflection of our growth expectations for the future quarters.

How about my last question? So moving forward, are we prioritizing net loss control versus sales growth, or how do we strike a balance here? Thank you.

We are currently adopting a more sustainable growth strategy. The focus remains on growth, but we realize that the value of growth from skincare brands and premium skincare brands is more valuable for our group. Therefore, we will continue to allocate more resources to grow skincare brands. For our flagship brand, Perfect Diary, we have reassigned some talented individuals to the skincare business unit, but due to intensifying competition, we need to refocus on the growth trend of our main brand. While growth is a key priority for the company, optimizing our bottom line is essential, which is reflected in our disciplined ROI and resource allocation approach across all our brands.

Just to add some clarification on your second question, we note that historically, in 2019, our Q3 revenue was 11% higher than Q2 due to high growth rates. In 2020, Q3 revenue was 27% higher than Q2, reflecting the disruptions in seasonal patterns due to COVID-19 causing pent up demand. The seasonality we're discussing this year is quite different from last year compared to previous years.

Got it. Thank you very much. Very clear.

Sure.

The next question comes from Ingrid Zhang of UBS. Please go ahead.

Hi, management. Thanks for taking my questions. I have three questions. The first is about the brand. I recall that last quarter we mentioned that Pink Bear was expected to deliver strong growth this year among all color brands. Can you provide an update on the sales trend in the past quarter for Pink Bear? Additionally, we are glad to see DR.WU's sales taking off in the second quarter; could you share any new product launch plans in the second half as well as expectations for the growth of Eve Lom and Galenic brands? The second question concerns marketing costs. Can you share some insights on ROI at the company level or by channels versus peers? I want to get a sense of where we stand compared to the industry. Lastly, could you discuss the organizational structure a bit more, particularly regarding resource allocation among different online channels and social marketing strategies in terms of personnel, marketing budgets, etc.

Thank you, Ingrid, for the question. Regarding our investment plan for the skincare category, we are dedicating more resources to grow our skincare brands, with DR.WU showing rapid growth. Pink Bear has also exceeded our expectations in sales over the past four months, as the brand has resonated well with younger consumers. Pink Bear has been primarily focused on the lip gloss category. For the second half of this year, we plan to expand into the eyeshadow and base makeup categories, supporting our value share gain in color cosmetics. For DR.WU, we aim to expand its product offerings to include essence items and facial masks while continuing to improve our R&D capabilities to create new hero products. Regarding ROI, the expansion into Douyin has allowed us to optimize costs effectively, which in turn positively impacts our overall ROI. As long as we continue prioritizing revenue growth on Douyin, we expect to maintain a good ROI.

My last question pertains to the organizational structure. Can you provide insight regarding our resource allocation among different online channels, especially concerning Douyin operations?

I cannot recall the exact number of people currently working with Douyin and Kuaishou, but we have recognized the need to allocate more talent toward fast-moving channels and brands. We have a proficient talent pool from our management trainee program, along with experienced individuals from the industry joining us. In terms of brand building, it is a key focus for Yatsen group, and we have been hiring talented individuals to strengthen brand equity in Perfect Diary and our other brands. We will continue to invest in brand building, which will take an increasing share of our sales and marketing expenses.

Thank you very much, David.

Thank you.

The next question comes from Casper of CICC. Please go ahead.

Hi, this is Casper from CICC, and thank you for taking my questions. My first question is about the pace of introducing new products or brands. Recently it seems the pace of introducing new brands is slower than before. Is the time span for new product development longer now? Secondly, regarding skincare products from the main brand, Perfect Diary, could you provide insight on sales performance in Q2 and guidance for Q3 and Q4?

In the first half of this year, we invested considerable effort into developing competitive products for our brands. Initially, we adopted a better and fewer strategy to launch innovative and long-lasting SKUs. For instance, our Loose Powder took more time to develop, but we now believe it will drive significant market share. In the second half of this year, we expect a higher frequency of product launches, having prepared extensively for innovative product introductions. For skincare, we are expanding our Perfect Diary line to include male skincare and category expansion in stores. We received positive feedback from consumers, and we see a percentage of skincare items growing in total revenue as we move forward.

Thank you very much for the detailed explanation. I have no other questions.

Thank you.

The next question comes from Kevin Xiang of 86 Research. Please go ahead.

Hi, management, thanks for taking my questions. I have two quick questions. The first concerns data security. How does the company evaluate the potential impacts of data security-related regulations, considering our customer insight and product development is data-driven while our spending on targeted marketing remains high? Are we at risk of diluted marketing ROI due to these regulations? My second question is about the management team, specifically regarding our former COO Vincent’s resignation due to health reasons. What measures are we taking to ensure stable operations and a smooth transition, especially with reallocating COO responsibilities?

Kevin, thank you for your questions. Regarding the first question, our legal counsel is reviewing draft legislation on data security. The preliminary view suggests that data security will not significantly impact us, as we primarily obtain customer data through online platforms like Tmall, which are well protected. We also have strict data security measures in place. As for your second question about Vincent's departure, we initiated the transition in Q2 after he left in April. We have the second key management, my co-founder, taking on most of his responsibilities. Despite facing a competitive environment and a challenging macroeconomic backdrop, the team's morale and efficiency remain in line with our expectations, and we are confident in our initiatives moving forward.

Thank you, David. That's very helpful. I have no more questions.

Thank you so much.

And that concludes the question-and-answer session. I would like to turn the conference back over to management for any additional or closing comments.

Thanks everyone for joining us today. If you have any further questions, please feel free to contact us directly at Yatsen or TPG Investor Relations. Our contact information for IR in both China and the U.S. can be found on today's press release. Thanks and have a great day.

The conference is now concluded. Thank you for attending today's presentation, and you may now disconnect.