Yatsen Holding Ltd Q1 FY2022 Earnings Call

Ladies and gentlemen, good day, and welcome to the Yatsen First Quarter 2022 Earnings Conference Call. Today’s conference call 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 nor 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 with 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 the definition of non-GAAP financial measures and 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 team are Mr. Jinfeng Huang, our Founder, Chairman and CEO; and also Mr. Donghao Yang, our Director and CFO. Management will begin with prepared remarks, and the call will conclude with a Q&A session. As a reminder: This conference call is being recorded, and a webcast replay 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.

Thank you, Irene, and thank you, everyone, for participating in Yatsen’s conference call for the first quarter of 2022. The first quarter of 2022 was a challenging one for Yatsen and the entire beauty industry. According to the China National Bureau of Statistics, beauty retail spending grew by 1.8% in the first quarter, one of its lowest growth rates since the pandemic recovery from the second quarter of 2020, due to weak consumer spending and the economic uncertainties in China. The resurgence of COVID-19 in March led to widespread restrictions in major Chinese cities such as Shanghai. And with the restrictions continuing well into the second quarter, it is clear that we are facing one of the toughest business environments in recent years. Against this market backdrop, our potential net revenues in the first quarter declined by 38.3% year-over-year to RMB 891 million, in line with our previous guidance. Market turbulence notwithstanding, we remain committed to our strategic evolution plan, a process that began in 2021. Fundamentally, we believe strong brands are highly resilient across market cycles. Strong brands also deliver higher margins which in turn can be reinvested into branding and R&D, perpetuating a virtual cycle. Therefore, our evolution strategy is simple: bolstering a portfolio of strong brands with highly differentiated, effective products to drive sustainable growth. We are allocating the talent and the resources needed to achieve these goals; and our team executed with passion, tenacity and resilience during the first quarter. Thanks to the team’s efforts, we are already seeing some signs of progress. One such sign is the improvement in our gross margin, which reached 69% in the first quarter, an increase of 0.4 percentage points on a year-over-year and quarter-over-quarter basis. We achieved these gross margin gains by relentlessly focusing on building brand equity and reducing unprofitable discounts and promotions. Encouragingly, our Perfect Diary Loose Powder won the Makeup of the Year award and was included on the National Business Daily 2022 China Gen-Z brand list. These awards not only underscore the ongoing strength of Perfect Diary’s brand and product but also a powerful validation of our brand-building approach. We have expanded our brands and launched new products for the new year. Starting with skincare in March, DR.WU released its new triple-action repaired serum along with a campaign highlighting the product’s efficacy in repairing acne marks and enhancing DR.WU’s dermatologist brand credentials. In April, Eve Lom launched a new branding campaign with breathtaking visuals centered around Muslin Cloths from a British botanical garden, awakening customers' senses of sight, smell and touch, while reinterpreting a vision of radiant skin beauty for a new generation. Not to be outdone, in May, Galénic introduced its new Secret D’ Excellence product series, an anti-aging serum featuring exceptional ingredients, combining the breathtaking fragility of the brand with an insistence on brand precision and science to reinforce its reputation for elegant yet effective skincare products. The energy and excitement of these campaigns are matched by robust financial results for our skincare brands, with net revenues growing by 68.5% year-over-year to RMB 183 million in the first quarter, representing 20.5% of total net revenues, up from 7.5% in the prior year period. While our transformation is rooted in brand building, we are laser-focused on executing it effectively. Under the current economic conditions, marketing efficiency is key for our color cosmetic brands. The tough market environment and our relentless efforts to optimize marketing ROI led to a large decline in revenues in the first quarter. However, our color cosmetic brands are now operating with a much improved profitability profile for online business compared with last year. Specifically, we significantly improved Little Ondine's profitability profile by streamlining operations and concentrating on the zero product category, namely the eyeliner, where it enjoys strong brand recognition among our core group of loyal customers. For Pink Bear, we developed a strategy combining good product offerings with breakthrough reasons to buy and IP crossovers appealing to its age-target customers to attract new customers while keeping performance marketing expenses at a reasonable level. We are also exploring several operational levels for both Little Ondine and Pink Bear, from increasing third-party online and offline distribution to tailoring our marketing strategies on Tmall and Douyin as we seek incremental uplift opportunities for revenue and profitability amid this difficult market environment. This marketing efficiency enhancements across the brand portfolio help us significantly reduce our selling and marketing expenses in the first quarter. Our total non-GAAP selling and marketing expenses declined by 44.4% year-over-year to RMB 570 million. As a percentage of total net revenues, our non-GAAP selling and marketing expenses reached 54%, a decrease of 7 percentage points year-over-year. While we continue to pursue further improvements in marketing efficiency, there’s also much we can do operationally to build on this progress. At the moment, we are focusing on mitigating the adverse impact of pandemic-related disruptions on our offline stores. During the first quarter, many of our offline stores were shut down due to pandemic restrictions, while those stores that remained open witnessed reduced traffic and in-store spending. We expect this situation to persist and possibly worsen in the second quarter. Accordingly, we proactively initiated a number of optimizations in the first quarter and accrued and recorded certain store closure-related expenses as a result. We may continue to optimize the size of our offline stores network throughout the year. We believe this plan will put our offline business on a more sustainable footing given the dynamic retail environment in China this year. COVID-19’s adverse impact also extends to our logistics and supply chain. To ensure that we can obtain critical orders ahead of the crucial May 20 and June 18 promotional holidays in the second quarter, our team has worked tirelessly with our logistics and supply chain partners to find creative solutions. Additionally, given the weakening consumer demand outlook for the rest of 2022, we made certain optimization adjustments to the size of our logistics footprint and reduced the scope of our supply chain expansions during the first quarter. Looking elsewhere within our cost base, we also overhauled our organizational structure to align with our new sustainable growth objectives. During the first quarter, we comprehensively updated our management structure, revamped our compensation structure and optimized our talent pool. As a result, our total headcount stands at approximately 3,000 as of the end of March 2022 compared with 4,200 employees a year ago. Our non-GAAP general and administrative expenses totaled RMB 113 million, approximately RMB 32 million lower than the fourth quarter of 2021. The accumulated effect of our various cost optimization initiatives is we achieved a non-GAAP net loss of RMB 156 million in the first quarter, a 38.3% reduction compared to the net loss of RMB 234.3 million in the prior year period. We expect the operating environment to become even more challenging in the second quarter of 2022 due to the effect of prolonged COVID-19 impacts on the economy. We will remain focused on those aspects of our business and the environment that we can control, optimizing costs, upgrading our capabilities and investing for the future, while continuing to adapt to a dynamically evolving market. As the outcome of our product differentiation efforts, R&D continues to be a key area of investment. We recorded RMB 36 million in R&D expenses in the first quarter, representing 4% of total net revenues. We are working on several exciting initiatives to strengthen our R&D capabilities in 2022, and we look forward to sharing updates on our new partnerships and milestones as they become available. We are also working to upgrade our Douyin live streaming operations. Building on the previous quarter’s momentum, total net revenue from our Douyin channel grew by over 150% year-over-year in the first quarter of 2022, making it our third largest channel by revenues, behind Tmall and our offline sources. After more than a year of extensive testing and optimization, we have developed and honed various techniques to maximize ROI across our various brands. In particular, Perfect Diary ranked third in color cosmetic sales on Douyin during the first quarter, demonstrating the progress we have made since last year. As pleased as we are with this result, we won’t be resting on our laurels. Given the fast-moving nature of the Douyin platform, we will continually adapt and innovate to stay ahead of the curve. Last but not least, integral to our sustainable success is our continued effort to be socially responsible corporate citizens. Yatsen is passionate about promoting women’s public welfare and empowerment. On International Women’s Day, Yatsen and another organization jointly launched the Women Without Limits campaign. We invited women from different industries and diverse identities to share their life experiences, encouraging more women to explore their own possibilities and pursue their dreams. Additionally, our efforts to ensure the safe and efficient delivery of goods have continued during the recent COVID outbreaks, with Perfect Diary cooperating with logistics companies to develop a code, improving the transparency of transported goods and helping to ensure on-time delivery to customers. For detailed information on how we are adjusting the environmental and social impact of our business and putting in place corporate governance best practices, please refer to our inaugural ESG report which was released on May 15. This first annual report provides a comprehensive review of our ESG activities. In a world full of uncertainty, we believe Yatsen serves a vital social mission to discover, protect and elevate beauty, which creates happiness and inspires our minds. To that end, 2022 will be an important year for Yatsen as we embark on our new 5-year plan. Although the current and foreseeable market conditions remain challenging, we plan to evolve, narrow our operating loss and continue to delight customers in China and around the world with our primary high-quality beauty products. With that, I will now turn the call over to our CFO, Donghao Yang, to discuss our financial performance. Thank you, everyone.

Thank you, Jinfeng. And hello, everyone. Before I get started, I would like to clarify that all financial numbers presented today are in renminbi amounts, and all percentage changes refer to year-over-year changes unless otherwise noted. Total net revenues for the first quarter of 2022 decreased by 38.3% to RMB 891 million from RMB 1.44 billion in the prior year period. The decrease was primarily attributable to the 45.6% decrease in net revenues from our color cosmetics brands, partially offset by the 68.5% increase in net revenues from our skincare brands. Gross profit for the first quarter of 2022 decreased by 38% to RMB 614.5 million from RMB 991.6 million in the prior year period. Gross margin for the first quarter of 2022 increased to 69% from 68.6% in the prior year period. The increase was primarily attributable to our continuous efforts to improve our gross margin, including through increasing sales from our higher-gross-margin products as well as through optimization of pricing discounts and promotions. Total operating expenses for the first quarter of 2022 decreased by 30.9% to RMB 922.5 million from RMB 1.33 billion in the prior year period. As a percentage of total net revenues, total operating expenses for the first quarter of 2022 were 103.5%, compared with 92.4% in the prior year period. Fulfillment expenses for the first quarter of 2022 were RMB 73.9 million, compared with RMB 92.7 million in the prior year period. As a percentage of total net revenues, fulfillment expenses for the first quarter of 2022 increased to 8.3% from 6.4% in the prior year period. The increase was primarily attributable to a decrease in the economies of scale of our fixed fulfillment expenses, partially offset by certain cost-saving initiatives related to fulfillment assets instituted during the first quarter of 2022. Selling and marketing expenses for the first quarter of 2022 were RMB 604.7 million, compared with RMB 1.04 billion in the prior year period. As a percentage of total net revenues, selling and marketing expenses for the first quarter of 2022 decreased to 67.9% from 72.1% in the prior year period. The decrease was primarily attributable to our continuous efforts to optimize the efficiency of our marketing spending, partially offset by the expenses related to the closure of certain offline experience stores. General and administrative expenses for the first quarter of 2022 were RMB 208.1 million, compared with RMB 172.3 million in the prior year period. As a percentage of total net revenues, general and administrative expenses for the first quarter of 2022 increased to 23.4% from 11.9% in the prior year period. The increase was primarily attributable to the increases in salaries and share-based compensation expenses. Research and development expenses for the first quarter of 2022 were RMB 35.8 million, compared with RMB 27.7 million in the prior year period. As a percentage of total net revenues, research and development expenses for the first quarter of 2022 increased to 4% from 1.9% in the prior year period. The increase was primarily attributable to the increases in personnel costs, raw materials, equipment and share-based compensation expenses, reflecting our commitment to enhancing our research and development capabilities. Loss from operations for the first quarter of 2022 decreased by 10.3% to RMB 308 million from RMB 343.3 million in the prior year period. Operating loss margin was 34.6%, compared with 23.8% in the prior year period. Non-GAAP loss from operations for the first quarter of 2022 decreased by 34.1% to RMB 170.1 million from RMB 258.3 million in the prior year period. Non-GAAP operating loss margin was 19.1%, compared with 17.9% in the prior year period. Net loss for the first quarter of 2022 decreased by 8.7% to RMB 291.4 million from RMB 319 million in the prior year period. Net loss margin was 32.7%, compared with 22.1% in the prior year period. Net loss attributable to Yatsen’s ordinary shareholders per diluted ADS for the first quarter of 2022 was RMB 0.46, compared with RMB 0.5 in the prior year period. Non-GAAP net loss for the first quarter of 2022 decreased by 33.6% to RMB 155.6 million from RMB 234.3 million in the prior year period. Non-GAAP net loss margin was 17.5%, compared with 16.2% in the prior year period. Non-GAAP net loss attributable to Yatsen’s ordinary shareholders per diluted ADS for the first quarter of 2022 was RMB 0.25, compared with RMB 0.37 in the prior year period. As of March 31, 2022, the company had cash, cash equivalents and short-term investments of RMB 2.97 billion, compared with RMB 3.14 billion as of December 31, 2021. For the first quarter ended March 31, 2022, net cash used in operating activities was RMB 104.1 million, compared with RMB 466.1 million in the prior year period. For the second quarter of 2022, the company expects its total net revenues to be between RMB 808.3 million and RMB 960.8 million, representing a year-over-year decline of approximately 37% to 47% primarily due to continued industry-wide softening of color cosmetics demand and the continued negative impact from COVID-19 on offline experience stores, online order fulfillment capabilities and supply chain. This forecast reflects the company’s current and preliminary views on the market and operational conditions, which are subject to change.

The next question comes from Dustin Wei with Morgan Stanley.

My first question is if management could quantify a little bit for the COVID impact from both sales, market consumer perspective, offline store and also, I think, from product delivery or any supply chain disruption. And do you actually see some easing situation coming from March, April, to May? Second question is based on the improvement in the loss reduction and the much better ROI, but also we have this bigger headwind from COVID. I just want to check if management still sticks to the target to maybe by 2023 to get to turnaround or making some small profits. I guess the third question is that if David could provide a little more highlights for the key brands. I think you talked about it in the prepared remarks, but just anything that you want to highlight? Especially in the current competitive environment and the current macro weakness, what’s your thoughts and initiatives for the key brands as well as for the key channel? You mentioned Douyin but I just wonder if you can elaborate more on what some of the detailed initiatives that you are focused on.

David, do you want to take the first question, on the impact of the COVID-19 on our operations?

Sure. I think, if you look at the numbers for the retailers and also the beauty industries and growth in April, we can clearly see the total retail sales declined by 11.1% and there was a 22.3% decline in the beauty industry. I think that is a very important sign about the impacts of COVID for our business, including online and offline. For our offline specifically, I think in April we saw that around 50% of our stores had been impacted by the COVID. For online, because of the logistics and also supply chain disruptions in the Shanghai area, this has had a negative impact on our new product launch and also on customer coverage. Looking ahead, we are focused on our new growth model and shifting more resources into brands. As for your third question regarding initiatives to strengthen our brand portfolios in skincare, I think right now Galénic and DR.WU are growing really fast. For DR.WU, the brand has a very unique and distinctive brand equity which is focused on dermatologists' expertise. This year, the brand launched a very important product, the triple-active repair serum, which helps the product cover a larger group of the customer base. We see strong momentum for DR.WU. For Galénic, we just launched the Snow Algae Serum, which is expanding the brand's benefits. Based on the initial launch results for these two new products on Douyin and Tmall, we foresee that they will become key pillars for both brands' growth in the future. Additionally, one of the most important initiatives this year is a brand relaunch for Eve Lom. The brand equity has been expanding from being print-centric to a more luxury skincare brand. The campaigns we just launched have been well received by consumers. Looking forward, we will devote more resources into Galénic, DR.WU, and Eve Lom, which we believe have high gross margins and can contribute to the company's overall profitability.

Yes. And Dustin, regarding your second question, we are still aiming to break even or turning profitable by the end of next year, but that depends on how the COVID-19 situation improves. If it’s resolved by the end of this year, our chances of achieving our goals would improve significantly, but that will depend heavily on the situation with the virus.

May I have just one follow-up on the Perfect Diary brand? This year is obviously very important for the Perfect Diary brand itself to go through many changes in terms of the way you do marketing and launch new products. Could you also share some insights on what’s the current focus on the Perfect Diary brand?

Sure. For Perfect Diary, we are looking at a number of growth drivers to alleviate the sales decline. The most important thing is to improve the brand’s profitability. We are continuing our momentum on Douyin and have developed stronger direct relationships with top KOLs. Additionally, we are improving our own brand live streaming capabilities. Moreover, we are launching new products, including a series that is part of the 6/18 promotion period. Based on our social media operations, the product has been well received by our core customers. Lastly, we aim to expand our third-party distribution through major offline beauty retailer chains while optimizing the offline stores network throughout the year.

The next question comes from Christine Cho with Goldman Sachs.

I have two quick questions. First, you mentioned that the operating environment remains quite challenging in the second half, but how should we think about the recovery path in the second half and next year? What are the key drivers to monitor for industry re-acceleration and potential market share gains? That’s my first question. Secondly, can you elaborate on your plans for selling and marketing spend in the first half of this year versus the second half?

For the whole industry, one of the key indicators is still the year-on-year growth rate. Currently, we see a significant decline in April. Our focus will be on the numbers in the third and fourth quarters to reflect the health conditions of the industry. However, we need to be cautious of supply chain impacts, as many manufacturers, especially OEMs and ODMs in the Shanghai area, have faced strict COVID-19 policies. This poses a significant challenge for new product innovations or existing product supplies in the second half of this year.

Any voluntary follow-up?

Yes. And for the second question that Christine asked about changes to sales and marketing expenses going forward, currently, this quarter, we have seen a 7 percentage point reduction in sales and marketing expenses compared to a year earlier. The actual number and reduction is higher, but some of it was offset by one-time expenses related to the closure of offline stores due to the resurgence of COVID-19. Going forward, we expect a couple of drivers to help us continue to reduce our sales and marketing expenses as a percentage of revenue. The first is ongoing optimization of offline stores, and the second is the continued optimization of ROI, which will help reduce traffic expenses across all brands in our portfolio. These will be the primary drivers for sales and marketing going forward.

Next question comes from an unidentified analyst from CICC.

My first question is about the company’s strategies for the June 18 shopping festival, such as pricing and marketing strategies. How much will we leverage top KOLs? How does management view the competition this year? My second question is about Yatsen's establishment of OpenLab in 2021 and the increased investments in R&D. Can management provide updates on our R&D results and how those results will be applied in future product development?

For our preparation for the June 18 promotion, one of the key initiatives we are taking is to launch new products and upgrade brands for the big promotion event. In May, we launched several important new SKUs for Perfect Diary, Little Ondine, and Pink Bear, basically across all our brands. We are looking forward to the performance of these new initiatives during the promotion. At the same time, we are strengthening our brand equity because the June 18 promotion has seen increasing discounts and price competition. To address this, we are focusing on enhancing brand equity to maintain a healthy gross margin for sustainable growth. Regarding R&D, yes, we have increased our R&D expenses, and if we look at new initiatives or products that we have just launched, we can see that the patents and technologies we developed based on our OpenLab strategy, like DR.WU's triple-active repair serum co-developed with Huazhong Science and Technology University, uniquely position us in the market. The Snow Algae Serum is also a product co-developed with Pierre Fabre. Going forward, we foresee more patents and technologies developed through R&D will be incorporated into our newly launched products, particularly in skincare, which will enhance our competitiveness and reflect in both gross margin and repurchase rates.

The next question comes from Olivia Tong with Raymond James.

This is Devin Weinstein on for Olivia. First, I wanted to ask a little bit more about the guidance. Presumably, the impact of COVID will be more substantial in Q2 than Q1, but your guidance for the next quarter implies only a slight increase in the slowdown rate; and on a 2-year stack, a sequential improvement, so I was hoping to get more context on the environment, the category and your positioning. Then if you could also comment on the second half expectations, I appreciate earlier comments on pent-up demand expected with lockdowns ending and easier comps going into the second half. My second question is around the cost environment. It sounds like you’ve done quite a bit of work in terms of reducing headcount and rightsizing your personnel. I’m curious where you think you stand in terms of your long-term headcount goals and what other actions you plan to take to optimize COGS or other operating expenses, if any.

Regarding the beauty industry's decline in April, color cosmetics faced a larger decline compared to skincare. Therefore, we offer this guidance reflecting our estimation of skincare brands' growth for Q2. We believe the skincare sector will gradually resume and mitigate the impact of COVID from Q2 to Q3. That’s why we invest more resources in skincare brands, which we believe could help make the business profitable. On the other hand, Perfect Diary and Little Ondine have experienced declines in the past months largely due to raising the sales and marketing ROI standards. Looking forward, we will focus on optimizing marketing ROI, sales and marketing expenses, and G&A to improve overall efficiency and performance. This includes optimizing talent performance and our organizational projects, which will positively affect G&A as a percentage of total revenue.

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.

Thank you once again for joining us today. If you have any further questions, please feel free to contact us at Yatsen directly or through TPG investor relations. You can find our contact information for IR in both China and the U.S. in today’s press release. Thank you and have a great day.

The conference has concluded. You may now disconnect. Thank you.