Yatsen Holding Ltd Q3 FY2022 Earnings Call

Ladies and gentlemen, good day, and welcome to Yatsen's Third Quarter 2022 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. Please see the earnings release issued earlier today for a definition of non-GAAP financial measures and a reconciliation of GAAP to non-GAAP financial results. Joining us today on the call from Yatsen's senior management team 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, sir.

Thank you, Irene, and thank you everyone for participating in Yatsen's third quarter 2022 earnings conference call today. We started the year by launching a five-year strategy outlining our plans to evolve our business and drive long-term sustainable growth. With this strategy as our roadmap, the management team continued to fine-tune our business model. Although negatively impacted by the softening beauty market and the resurgence of COVID-19, our Skincare Brands recorded solid growth in the third quarter of 2022. We have also seen improvements in gross margin, net loss, and non-GAAP net loss due to our cost optimization plan. Overall, our sales in the third quarter of 2022 continued to experience slowdowns as a result of challenging macro headwinds and lower levels of consumer spending, which have been exacerbated by the resurgence of COVID-19. Beauty retail sales in the third quarter of 2022 fell by 3.2% year-over-year according to the latest data published by the China National Bureau of Statistics. Sales of both color cosmetics and skincare products on Tmall fell by double digits year-over-year in the third quarter of 2022, extending the downward trend observed in the second quarter of 2022. Our total net revenues for the third quarter of 2022 declined by 36.1% year-over-year to RMB857.9 million, meeting the high end of our revenue guidance. Let’s look at our revenue mix in detail. Net revenues from Skincare Brands increased by 33% year-over-year to RMB269.4 million. Notably, total net revenues from our fast-growing clinic and premium brands, DR.WU, Eve Lom, and Galénic, delivered solid growth of 69% year-over-year this quarter. In revenue contribution terms, our Skincare Brands accounted for 31.4% of total net revenues for the third quarter of 2022, exceeding 30% of total net revenues for two consecutive quarters, compared with 15.1% for the third quarter of 2021. Our Color Cosmetics Brands, on the other hand, experienced a 48.8% decline year-over-year in total net revenues to RMB559.3 million, reflecting the continued softness in market demand for our color cosmetics as well as intensified competition from both domestic and international brands. Gross margin for the third quarter of 2022 increased by one percentage point to 58.9% from 57.9% for the same period in 2021, due to increased sales of higher gross margin products from our Skincare Brands, cost optimization, and stricter pricing and discount policies across all brand portfolios. Our net loss margin was 24.6% in the third quarter of 2022, representing an improvement of 3.2 percentage points from the second quarter of 2022, or 2.4 percentage points from the prior year period. Our non-GAAP net loss margin was 14.7% in the third quarter of 2022, showing a 7.1 percentage point improvement from the second quarter of 2022 or 1.4 percentage points from the prior-year period. This improvement is attributable to our continued cost optimizations. Now, I'll share some of the major initiatives and developments from the quarter. In Q3 2022, our business teams were active in developing and strengthening our portfolio of high-performing brands tailored to Chinese consumers' evolving needs and styles. DR.WU recently launched new products infused with triple-action repair technology which demonstrate proven efficacy, particularly on the iconic Repair Serum. We celebrated the brand's 19th anniversary with its loyal customers across China, especially those with sensitive skin who seek efficient products designed for their skin types. Eve Lom achieved robust growth despite the challenging industry environment. While the brand remained strong in the premium cleanser category, we expanded to the serum category by launching a Radiance Repair Retinol Serum. In September, Eve Lom partnered with a renowned event in Shanghai to cultivate a world-leading and luxurious experience for the celebrated brand. Galénic also recorded strong online growth in Q3 2022 with increased market share, maintaining the number one position in the premium serum category. Our hero VC serum has maintained its leading position, while the Secret D'Excellence active serum also demonstrated steady growth. The launch of the Secret D'Excellence active serum in Q3 2022 was attended by industry experts and thought leaders, raising awareness of the brand and amplifying its leadership in the premium dermatological skincare segment. While our Color Cosmetics business faced a year-over-year decline of 48.8%, we observed an improvement in gross margin overall. Our Color Brands went through channel optimization and promotion control to develop a sustainable business model. Sales of Perfect Diary achieved strong year-over-year growth of 97%, ranking number two among all Color Cosmetic Brands, an improvement from the number three ranking last year. Underperforming offline stores were closed in 2022 as a result of this strategy. As of September 30, 2022, we were operating a total of 193 experience stores of the Perfect Diary brand, representing a reduction of 88 stores since the beginning of the year. In Q4, this offline store optimization program will continue, and we are closely monitoring the market situation in the offline retail space to better support our brand strategies moving forward. Besides channel optimization, we are also addressing our category mix to increase market share in facial makeup and complexion products. Perfect Diary's Translucent Blurring Loose Powder, an upgraded product that adds anti-dullness efficacy to the original SmartLOCK technology, gained more market share in the loose product category on Tmall compared to last quarter. We also applied this patented technology to the newly launched Clear Cover 3-color Concealer Palette to expand into other facial categories. Our robust new product pipeline is supported by continuous investments in R&D. R&D expenses rose to 3.9% of net revenues from 2.7% in the prior-year period. We debuted at the International Federations of Societies of Cosmetics Chemistry Congress with two cutting-edge technologies in September. We will continue efforts to strengthen our R&D capability as a core strategy for future growth. We are also reminded of the importance of our commitment to environmental, social, and governance programs. In Q3 2022, Yatsen donated computers and projection equipment to the government of a township in Guangdong province to help improve the township's IT infrastructure. We're actively involved in elevating the quality of life for those in challenging circumstances and will continue to take the initiative in corporate social responsibility going forward. While we expect the retail environment to remain challenging for the rest of 2022 and for the first half of 2023, we have sufficient resources to meet our strategic objectives. During the W11 Shopping Festival this year, we witnessed outstanding performance in our skincare brands. Galénic achieved high triple-digit year-on-year sales growth. Eve Lom and DR.WU ranked first place in the premium cleanser and acne control categories, respectively, on Tmall. In summary, we have made significant progress in our strategic evolutionary journey, with higher contributions from our skincare brand, improved gross margins, and significantly reduced net losses in Q3 2022. With cash, restricted cash, and short-term investments totaling RMB2.6 billion at the end of this quarter, we have ample resources for pursuing our long-term strategy goals. With that, I will turn the call over to our CFO, Donghao Yang, to discuss our financial performance. Thank you, everyone.

Thank you, David, and hello, everyone. Before I begin, I would like to clarify that all financial numbers presented today are in Renminbi and all percentage changes referred to year-over-year changes unless otherwise noted. Total net revenues for Q3 2022 decreased by 36.1% to RMB857.9 million from RMB1.34 billion in the prior year period. This decrease was primarily attributable to a 48.8% fall in net revenues from our color cosmetics brands, partially offset by a 33% increase in net revenues from our skincare brand. Gross profit for Q3 2022 declined by 35.2% to RMB591.3 million from RMB911.8 million in the prior year period. Gross margin increased for Q3 2022 to 68.9% from 67.9% in the prior year period, primarily driven by increased sales of higher gross margin products from our skincare brand, cost optimization, and stricter pricing and discount policies across all brand portfolios. Total operating expenses for Q3 2022 decreased by 33.1% to RMB857 million from RMB1.28 billion in the prior year period. As a percentage of total net revenue, operating expenses for Q3 2022 were 99.9% compared to 95.4% in the prior year period. Fulfillment expenses for Q3 2022 were RMB63.8 million compared with RMB102 million in the prior year period. As a percentage of total net revenues, fulfillment expenses for Q3 2022 decreased to 7.4% from 7.5% in the prior year period. This decrease was primarily due to lower warehouse and logistics costs achieved through procurement optimization. Selling and marketing expenses for Q3 2022 totaled RMB564.8 million compared with RMB911.3 million in the prior year period. As a percentage of total net revenues, selling and marketing expenses for Q3 2022 decreased to 65.8% from 67.9% in the prior year period. This decrease was mainly due to the improved efficiency of online marketing activities, partially offset by expenses related to store closures and provisions. General and administrative expenses for Q3 2022 were RMB194.5 million compared to RMB233.9 million in the prior year period. As a percentage of total net revenue, these expenses increased to 22.7% from 17.4% in the prior year period due to lower total net revenue creating a low base effect. Research and development expenses for Q3 2022 were RMB33.9 million compared to RMB35.8 million in the previous year period, with R&D expenses as a percentage of total net revenue rising to 3.9% from 2.7% in the prior-year period, again influenced by the low base effect caused by decreased net revenues. Loss from operations for Q3 2022 decreased by 28.1% to RMB265.7 million from RMB369.3 million in the prior year period. Operating loss margin was 31% compared to 27.5% in the prior year period. Non-GAAP loss from operations for Q3 2022 decreased by 26.6% to RMB152.6 million from RMB221.7 million in the previous year period, with a non-GAAP operating loss margin of 19% compared to 16.5% last year. Net loss for Q3 2022 decreased by 41.7% to RMB210.7 million from RMB361.8 million in the previous year period. The net loss margin was 24.6% compared to 26.9% in the prior year period. The net loss attributable to Yatsen's ordinary shareholders per diluted ADS for Q3 2022 was RMB0.37 compared to RMB0.57 in the previous year period. Non-GAAP net loss for Q3 2022 decreased by 41.5% to RMB126.5 million from RMB216.3 million in the prior year period, with a non-GAAP net loss margin of 14.7% compared to 16.1% in the previous year. Non-GAAP net loss attributable to Yatsen's ordinary shareholders per diluted ADS for Q3 2022 was RMB0.22 compared to RMB0.34 in the prior year. As of September 30, 2022, the company had cash, restricted cash, and short-term investments totaling RMB2.6 billion compared to RMB3.14 billion as of December 31, 2021. Net cash generated from operating activities for Q3 2022 was RMB21.8 million compared to net cash used in operating activities of RMB225.3 million in the prior year period. Looking at our business outlook for Q4 2022, we expect our total net revenues to range between RMB916.7 million and RMB1.07 billion, representing a year-over-year decline of approximately 30% to 40%. This forecast reflects our current and preliminary views of the market and operational conditions, which are subject to change. With that, I would like to open the call to Q&A.

Yes, thank you. And today's first question comes from Dustin Wei with Morgan Stanley.

Thanks for taking my questions. First question is related to the W11 performance. I'm wondering if management can comment on the performance by brand or by Skincare Brands and the Color Brands. And do we expect that the GP margin in the fourth quarter to be sequentially lower versus the quarter because of the promotion for W11? And the second question related to the performance for the Skincare Brands in the third quarter, it sounds like, excluding Abby's Choice, the other three major skincare brands performed pretty strongly. But could you elaborate a little more in terms of maybe provide a range of the performance or some of the different strategy and their progress? And from a management perspective, is the key Skincare Brands performance slightly ahead of expectations or is there something more to do?

Thank you. For the first question regarding the W11 results, our Skincare Brands; currently, our Galénic, Eve Lom, and DR.WU achieved robust sales growth in W11 with substantial results for each brand. Some of the hero products of each brand are performing quite well. Galénic has achieved high triple-digit year-on-year sales growth and also ranked as the top of the new brands for Tmall W11. For the VC serum, it also showcased a high triple-digit year-on-year sales growth. Additionally, we launched a new product, the Secret D'Excellence serum, which has gained acclaim. Eve Lom continues to dominate the premium cleanser category, and DR.WU’s Renew Serum is performing strongly in the acne control category. Some of DR.WU’s new products are also performing excellently; particularly the triple-action repair serum is ranking in the top four repair serums on Tmall. I believe that some of the hero products of our Skincare Brands will help contribute to the growth of the brands and will, in aggregate, improve the percentage of our total revenue in the future. Regarding Color Cosmetics, we acknowledge it's facing significant challenges, and thus Perfect Diary has been undergoing a turnaround. Our priority is profitability, so we are applying very strict pricing and discount policies across all our Color Brands to enhance gross margin and profitability while protecting our brand image. Looking ahead to Q4, we are on the right track to continue optimizing gross margin and also the bottom line.

On your second question concerning gross margin, several factors influence it, including category mix and inventory provisions, among other elements. We're unable to make definitive comments on Q4 gross margin now. However, for the long-term outlook, as the skincare business grows stronger and takes a higher percentage of the overall product mix, we believe our gross margin will trend upward in the long run.

Got it, thank you. Can I ask one more question related to the expenses and the restructuring? So, understanding that the company has focused on store closures, organizational optimization, etc., can we have an update on the status now? Do we expect these exercises to be mostly completed in Q4 this year, or will some continue into 2023 depending on the macro environment? Can you also share some numbers regarding the one-off costs for this full-year or year-to-date, including human resource severance costs or one-off store closure costs—things that we likely won’t see in 2023?

We have been proactive in reducing the number of underperforming stores, primarily due to challenges in the macroeconomic environment, particularly from COVID-19. At the beginning of this year, we had nearly 300 stores. By year-end, we plan to have a little over 100 stores, including both self-operated and franchise stores. The expenses incurred during this process have been significant. We can provide a breakdown after this call. Moving into next year, I do not foresee incurring substantial losses or excessive expenses related to store closure provisions, as we have now reduced the total number of stores to a more manageable level.

Got it. Thanks a lot for answering my questions.

Sure, thank you.

Thank you. The next question comes from Quan Yu Lin with CICC.

Hi, and thanks for taking my questions. I've got two questions. The first one concerns Color Cosmetics. Sales of Color Cosmetics seem to keep decreasing each quarter. However, we still believe in the company's competitive edge in color cosmetics and the brand assets of Perfect Diary. At what point or sales size does management expect Color Cosmetics to return to growth? This is the first question. My second question relates to guidance for the fourth quarter. The total net revenue is expected to decrease by 30% to 40%. Could you elaborate on the trends in color cosmetics and skincare, specifically by category? Thanks.

Yes, sure. For Perfect Diary, we can observe that the year-over-year decline in Color Cosmetics has remained stable over the past three quarters. We are not altering our strategies; rather, we are aiming for stability at present. In terms of achieving profitability for Perfect Diary, we are focusing on two major plans: channel optimization and product category optimization. Regarding channels, we're closing a number of stores that have contributed to sales decline due to the challenging macro environment but expect stabilization by year-end. Additionally, we’re investing heavily in Douyin to promote growth and attract new customers, and we've seen a 97% year-over-year increase in Douyin for this quarter. In essence, we are making strong efforts to grow our online channels. As for product category optimization, Perfect Diary previously held high market share in lip and eye categories, but we believe there’s a larger market for complexion and facial makeup that we need to tap into to increase our market share. As mentioned in our conference call, we are introducing several complexion products utilizing our SmartLOCK technology. We are seeing quarter-over-quarter market share increases in facial makeup, which should help Perfect Diary's brand turnaround and contribute to more stable trends next year.

Regarding your second question about our guidance for Q4, we are advising the market that total revenue will decline by 30% to 40%. This decline will primarily stem from our color cosmetics business but will be offset by the rapid growth of our skincare business. Overall, we anticipate fast and healthy growth in our skincare business, while we are diligently working to turn around the color cosmetics sector.

Got it. Thanks a lot. I have no other questions.

Thank you.

Thank you. Our next question comes from Olivia Tong with Raymond James.

Great. Thanks. Good morning. I wanted to ask you about your view on the competitive environment between local brands and international brands, particularly with the 11.11. Also, what are your thoughts as you head into next year? Specifically regarding fiscal '23, the Q4 guide suggests decelerating sales. As you think about the next 12 months, do you believe this represents a steady state or could there be substantial changes as we move into fiscal '23? Thank you.

As for the market, total beauty market growth is nearly zero and even declining at times. Therefore, competition is intense, yet that is typical for this market. Looking at international players, they have been stable throughout the year since W11 last year. On the domestic front, emerging new brands have kept challenging the industry in the last two or three years, particularly on fast-growing platforms. Our focus will remain on our strategy rather than external competition. We have a clear strategy to grow our skincare brands and turn around our color business. Profitability remains a priority, and skincare brands will be our focus. Moving forward, I feel confident about our implementation of this strategy.

Regarding your second question about next year's outlook, we do not provide guidance beyond the next quarter. However, I don't expect the growth rate decline to be as severe as this year for several reasons. Firstly, we are making significant strides in turning around our color cosmetics business, and positive signs have emerged from our efforts. Secondly, we are experiencing strong growth in our skincare business, which we believe will continue well into next year. Considering these two trends, I anticipate that overall growth rates will stabilize, if not turn positive, year-over-year.

Thank you so much.

Thank you.

Thank you for joining us today. If you have any further questions, please feel free to contact us at Yatsen directly or through our TPG Investors. Our contact information for IR in both China and the U.S. can be found in today's press release. Have a good day. Thank you.

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.