Yatsen Holding Ltd Q2 FY2023 Earnings Call

Ladies and gentlemen, good day, and welcome to Yatsen's Second Quarter 2023 Earnings Conference Call. Today's conference call is being recorded. At this time, I would like to turn the conference over to Irene Lyu, Vice President, Head of Strategic Investment and Capital Markets. Please go ahead.

Thank you, operator. Please note 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 US 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 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'll now turn the call over to Mr. Jinfeng Huang. Please go ahead.

Thank you, Irene, and thank you, everyone, for participating in Yatsen's second quarter 2023 earnings conference call today. The beauty industry experienced a modest post-COVID recovery during the second quarter of 2023. According to the National Bureau of Statistics of China, total retail sales of consumer goods grew by 10.7% year-over-year while declining by 2% quarter-over-quarter. More specifically, beauty retail sales rose by 11.5% year-over-year and 0.8% quarter-over-quarter in the second quarter. The year-over-year growth was partially affected by the prior year's low base, while quarter-over-quarter growth indicated a mild recovery pattern during the quarter. Online beauty sales also rebounded and demonstrated by the beauty sales growth on Tmall and Douyin on both a yearly and quarterly basis, mainly driven by promotional activities during the June 18 shopping festival. Against the industry backdrop, we continued to focus on rebalancing our category mix, expanding gross margins, and improving net margins through enhanced operational efficiency. Our business transformation remained largely on track, evidenced by our second quarter revenue beating the guidance we provided previously. Net revenues from our Skincare Brands increased by 2.3% year-over-year to RMB325.2 million. Within Skincare, our clinical and premium brands delivered another solid performance, with Galenic, DR. WU, and Eve Lom recording 13.3% year-over-year growth in combined net revenues. With respect to revenue contribution, our Skincare Brands accounted for 37.9% of total net revenues in the second quarter, up from 33.4% in the prior year period. Revenues from Color Cosmetics declined in the second quarter as Perfect Diary continued to undergrow our brand transformation. Furthermore, the number of Perfect Diary offline stores totaled 136 as of the end of the second quarter compared with 228 a year ago as a result of targeted closures of underperforming offline stores. Our product mix optimization, as well as our disciplined approach to discounts and promotions, continued to drive improvements in our overall gross margin, which has demonstrated a clear upward trend over the past four quarters. We also improved our net margin year-over-year, reflecting our effective cost reduction and channel optimization strategies. Turning to our products, beyond our investments in existing hero products, we also introduced new Skincare products during the quarter. One highlight was Galenic's Secret D'Excellence active cream, a new anti-aging product enhanced with our patent SnowLG-peptide to promote collagen reproduction. Additionally, several of our existing hero products received recognition this quarter with Galenic antioxidant Number 1 VC serum ranking number one in both Tmall, Austin Li's livestream premium brightening serum category and Douyin premium serum category during the June 18 shopping festival. Eve Lom also turned in a solid performance during June 18, with the Eve Lom cleanser coming in first among premium cleanser products on Tmall. For our Color Cosmetics brands, we continued to advance product development, releasing high-quality products with strengthened functional features. During the second quarter, Perfect Diary launched its Denim Holiday collection, tailored for summer wear, as well as translucent blurring long-wear foundation that delivers a long-lasting flawless finish. We also rolled out new and upgraded products for Little Ondine and Pink Bear, driving growth in both brands. Little Ondine made the Tmall June 18 top 100 best-selling list with its brand-new 3D shadow and highlighter eyeliners, while Pink Bear launched its new jelly lipstick. Brand building remains a critical component of Yatsen's long-term strategy. In July, two of our Skincare Brands, Galenic and DR. WU, participated in the World Congress of Dermatology in Singapore, raising brand awareness among an internationally renowned group of clinicians, scientists, and industry professionals. DR. WU also celebrated its 20-year anniversary this summer, a testament to its products’ enduring popularity and the strength of its brand equity. Moving on to our recent R&D achievements, our R&D expenses reached 3% as a percentage of total net revenues, reflecting our continuous efforts in scientific advancement and product development. We are pleased to report that in June, we took our partnership with Ruijin Hospital, an affiliate of the Shanghai Jiao Tong University School of Medicine, to the next level, with the official unveiling of the Yatsen Region Medical skincare joint laboratory in Shanghai. We formed this alliance with Ruijin Hospital to jointly conduct research on skin disease mechanisms and develop efficient skincare products, leveraging Yatsen's deep experience and strong capabilities as well as Ruijin’s remarkable achievements in resource integration across the beauty industry, educational and research institutions, and hospitals. We look forward to advancing the future of skincare together. Furthermore, operations of the Guangzhou manufacturing hub we established with Cosmax officially commenced on August 11, enabling further optimization of our supply chain. Powered by these developments and our enhanced capabilities, we are confident about the prospects of successfully exploring and launching more hero products in the future. Before I conclude, I would like to mention that we recently released our 2022 environmental, social, and governance, or ESG report, marking our second consecutive year of ESG reporting. We are proud to provide a comprehensive review of our ESG initiatives and developments, including corporate governance, research and development, employee rights protection, human capital development, environmental sustainability, and social responsibility, among others. We are grateful for the opportunity to demonstrate our commitment to creating a better society by fulfilling our corporate social responsibilities. To summarize, China's beauty market is still finding its footing in the post-pandemic era. We understand that the recovery pattern of consumer demand remains uncertain. However, our strategy transformation is proceeding as planned, and our portfolio of strong, distinctive brands, as well as our sufficient financial resources, will empower us to adapt with flexibility. We will continue to build our brands across the board, elevating our skincare brands' growth while positioning our Color Cosmetic brands for success in the future. 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 referred to year-over-year changes unless otherwise noted. Total net revenues for the second quarter of 2023 decreased by 9.8% to RMB858.6 million from RMB951.8 million for the prior year period. The decrease was primarily attributable to a 16.6% year-over-year decrease in net revenue from Color Cosmetics brands, partially offset by a 2.3% year-over-year increase in net revenues from Skincare Brands. Gross profit for the second quarter of 2023 increased by 7.2% to RMB641.6 million from RMB598.3 million for the prior year period. Gross margin for the second quarter of 2023 increased to 74.7% from 62.9% for the prior year period. The increase was driven by, first, increasing sales of higher gross margin products from skincare brands; second, a more disciplined pricing and discount policy; and third, cost optimization across all of our brands' portfolios. Total operating expenses for the second quarter of 2023 decreased by 11.3% to RMB776.7 million from RMB875.3 million for the prior year period. As a percentage of total net revenues, total operating expenses for the second quarter of 2023 were 90.5% as compared with 92.0% for the prior year period. Fulfillment expenses for the second quarter of 2023 were RMB58.3 million as compared with RMB69.7 million for the prior year period. As a percentage of total net revenues, fulfillment expenses for the second quarter of 2023 decreased to 6.8% from 7.3% for the prior year period. The decrease was primarily attributable to a decrease in warehouse and logistics costs due to the outsourcing of most of our warehousing and handling operations. Selling and marketing expenses for the second quarter of 2023 were RMB542.8 million as compared with RMB625.7 million for the prior year period. As a percentage of total net revenues, selling and marketing expenses for the second quarter of 2023 decreased to 63.2% from 65.7% for the prior year period. The decrease was primarily attributable to the closure of underperforming offline stores and a reduction in share-based compensation related to the decrease in selling and marketing headcount, partially offset by an increase in online advertising expenses. General and administrative expenses for the second quarter of 2023 were RMB149.7 million as compared with RMB147.8 million for the prior year period. As a percentage of total net revenues, general and administrative expenses for the second quarter of 2023 increased to 17.4% from 15.5% for the prior year period. The increase was primarily attributable to an increase in share-based compensation, combined with the deleveraging effect of lower total net revenue in the second quarter of 2023. Research and development expenses for the second quarter of 2023 were RMB25.9 million as compared with RMB32 million for the prior year period. As a percentage of total net revenues, research and development expenses for the second quarter of 2023 decreased to 3% from 3.4% for the prior year period. The decrease was primarily attributable to our efforts to maintain research and development expenses at a reasonable level relative to total net revenues. Loss from operations for the second quarter of 2023 decreased by 51.2% to RMB135.1 million from RMB277 million for the prior year period. Operating loss margin was 15.7% as compared with 29.1% for the prior year period. Non-GAAP loss from operations for the second quarter of 2023 decreased by 65.8% to RMB74.6 million from RMB218.2 million for the prior year period. Non-GAAP operating loss margin was 8.7% as compared with 22.9% for the prior year period. Net loss for the second quarter of 2023 decreased by 59% to RMB108.5 million from RMB264.3 million for the prior year period. Net loss margin was 12.6% as compared with 27.8% for the prior year period. Net loss attributable to Yatsen's ordinary shareholders per diluted ADS for the second quarter of 2023 was RMB0.2 as compared with RMB0.43 for the prior year period. Non-GAAP net loss for the second quarter of 2023 decreased by 77.7% to RMB46.3 million from RMB207.5 million for the prior year period. Non-GAAP net loss margin was 5.4% as compared with 21.8% for the prior year period. Non-GAAP net loss attributable to Yatsen's ordinary shareholders per diluted ADS for the second quarter of 2023 was RMB0.08 as compared with RMB0.34 for the prior year period. As of June 30, 2023, we had cash, restricted cash, and short-term investments of RMB2.57 billion as compared with RMB2.63 billion as of December 31, 2022. Net cash used in operating activities for the second quarter of 2023 was RMB14.4 million compared with net cash generated from operating activities of RMB111.9 million for the prior year period. Looking at our business outlook for the third quarter of 2023, we expect our total net revenues to be between RMB686.3 million and RMB772.1 million, representing a year-over-year decline of approximately 10% to 20%. These forecasts reflect our current and preliminary views on the market and operational conditions, which are subject to change. With that, I would now like to open the call to Q&A.

Thank you. We will now begin the question-and-answer session. The first question today comes from Qianye Lin with CICC. Please go ahead.

Thanks for taking my questions. This is Qianye from CICC. I have two questions. The first question is regarding profitability. Are we still on track for full-year profit? Looking ahead, what are the key drivers that will boost our profitability in the second half of the year? That's my first question. The second question is regarding growth of Color Cosmetics. We've seen the launch of Perfect Diary's new foundation product. How has the sales performance been so far? Could you provide insight into the upcoming strategies for Color Cosmetics in the second half of the year? Is there any chance that Color Cosmetics will return to growth in the second half of the year? That's my question. Thank you.

Well, thank you very much for your questions. For your first question on profitability, I think we're still on the right track to continually improve our profitability over time. If you compare this quarter with the same quarter last year, the improvement in profitability has been very significant. As for your second question about Perfect Diary's foundation product, it's still too early for us to tell how the new product will perform, but for the second half of the year, especially towards the end of Q3 and the beginning of Q4, we're going to launch a major brand upgrade campaign and new product launch for Perfect Diary. We are making preparations for that major campaign, but it's still too early to tell how the campaign will turn out. There will, of course, be some uncertainty around the success of that campaign, but we are very confident that we will try our best, and hopefully, we can make it a huge success.

Got it. Thank you very much. I have no more questions.

Yeah. Thank you.

The next question comes from Vivi Huang with Morgan Stanley. Please go ahead.

Thank you for taking my question. This is Vivi from Morgan Stanley. I have two questions. The first is on the industry part. Could management give us some insight into the industry competition as we enter the third quarter? How is it in terms of competition, especially on online and live streaming channels? I know this might be a little bit far ahead, but how should we expect the Double 11 Festival this year? Do you see any possibility that promotional levels will likely intensify on a year-over-year basis or compared to the 618 Festival this year? Secondly, I would like to ask about our offline store strategy. Do we expect further store closures when we enter the second half? This is the question that I have. Thank you.

Thanks, Vivi, for the question. On the first question, in terms of the industry outlook and the competitive landscape, we saw a modest recovery pattern during the second quarter. Even though the year-over-year growth rate was good, it was a low base last year given the lockdowns in Shanghai and other cities in Q2 last year. If you look at the quarter-over-quarter growth pattern, it is largely flat, which implies a relatively mild recovery. We think the beauty market, different segments are all growing, even within the current economic conditions, the premium segment is still growing, but at a slightly lower rate. We do expect that the China beauty market still has headroom to grow given the per capita beauty segment is still relatively low compared to other mature markets. Regarding competition, we have seen that it has been intensifying over time, with divergent performance among different categories and brands. One very obvious trend is that brands with strong product efficacy and brand equity are actually outperforming others. Consumer behavior has shifted slightly from previous impulsive buying habits to more rational behavior, which also shows that products with very strong efficacy and functional value attract more consumer attention. Those are some of the key trends we have seen in the industry.

Your second question is about our offline store strategy. In the past two years, we've closed around 150 of our offline stores, most of which were underperforming and loss-making. Going forward, I think we will continue to optimize some of our stores, but I don't think that we'll close a substantial number of stores down the road. Optimization will always be our strategy. Thank you.

Got it. That is very helpful. Thank you so much.

Thank you.

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 at Piacente Investor Relations. Our contact information for IR in both China and the US can be found in today's press release. Thank you, and have a great day.

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