Earnings Call Transcript - YSG Q1 2023

Operator, Operator

Ladies and gentlemen, good day and welcome to the Yatsen First Quarter 2023 Earnings Conference Call. Today’s conference 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.

Irene Lyu, Vice President, Head of Strategic Investment and Capital Markets

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 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 the reconciliation of GAAP to non-GAAP financial results. Joining us today on the call from Yatsen’s Senior Management CMR, 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 the 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, Jinfeng.

Jinfeng Huang, Founder, Chairman and CEO

Thank you, Irene, and thank you, everyone, for participating in Yatsen’s first quarter 2023 earnings conference call today. The first quarter of 2023 showed a positive trend for the beauty industry. Total beauty retail sales achieved year-over-year growth of 5.9% in the quarter, according to the adjusted data published by the China National Bureau of Statistics. Movement in market sentiment and the gradual recovery of off-line consumption following the lifting of pandemic restrictions were major drivers of this upward trend. While we are pleased to see signs of recovery in the retail environment, we expect a rebound in our revenue to take time as consumers gradually reengage in travel, social activities, and general consumption in the post-COVID era. Our sights remain focused on long-term sustainable growth as we continue to refine our business model. For the first quarter of 2023, our total net revenue declined by 41% year-over-year to RMB765.4 million, beating the guidance we provided previously. Net revenues from Skincare Brands increased by 34.2% year-over-year to RMB245.1 million. Our clinical and premium brands, including DR.WU, Galenic, and Eve Lom, recorded solid growth of 58.6% year-over-year for the first quarter of 2023. In terms of revenue contribution, our Skincare Brands accounted for 32% of total net revenues in the first quarter, up from 20.5% for the previous year period. Net revenues from our Color Cosmetic Brands declined by 29.1% year-over-year to RMB508 million. In terms of profitability, we achieved ongoing improvement in our gross margin and net margin. Gross margin increased significantly by 5.3 percentage points to 74.3% for the first quarter of 2023 from 69% for the prior year period, reflecting our persistent efforts to fine-tune our product mix, implement disciplined pricing and discount policies and optimize production costs. Most importantly, we recorded a net income margin of 6.6% for the first quarter of 2023 as compared with the net loss margin of 32.7% for the prior-year period. In addition, our efforts in cost optimization contributed to the net income we recognized for the first quarter of 2023, which was largely due to a reversal of recognized share-based compensation expenses of RMB109.4 million and a decrease of RMB42.2 million in recognition of share-based compensation expenses, using the graded-vesting method over the vesting term of the company’s awards. Non-GAAP net loss margin narrowed to 2.4% for the first quarter of 2023 from 7.2% for the same period last year. Moving on from our financial highlights, we made progress in our product development and brand awareness improvement initiatives. Eve Lom launched its Radiance Face Oil, featuring 10 precious plant extracts that provide spa-level nourishment, combined with 5 major reparative ingredients to firm and plump the skin. We also hosted a major brand event for Galenic to explore the legendary benefits of the brand's Platinum OG series with international fashion and beauty KOLs. During the quarter, our Color Cosmetic Brands also introduced a Valentine's Day-themed skin set to celebrate the vibrant colors and passionate emotions associated with the holiday. In terms of channel optimization, we completed most of our adjustments in our off-line footprint in 2022 as off-line consumption recovered due to the lockdown policies. Performance at our offline stores improved in terms of profitability during the first quarter of 2023. However, the market situation is still evolving, and consumption activity has not fully returned to normal. Going forward, we will closely monitor market dynamics focused on identifying the appropriate product mix and growth strategy to drive sales in the offline business and adjust our approach to optimizing our off-line channels as needed. Next, I would like to share some of our recent R&D endeavors and accomplishments. Our R&D expenses as a percentage of total net revenue were 3.2%, demonstrating our continuous commitment to scientific advancement and product development. Furthermore, to promote applied research and application in acne treatment, we officially launched the DR.WU Acne Research Fund and established the DR.WU Esper Committee. Together, these organizations will integrate resources across multiple medical fields and regions to conduct cutting-edge exploration and applied research with the goal of discovering solutions for the refined and comprehensive management of acne-prone skin. Before I conclude, I want to share an update on our environmental, social and governance performance, which continues to be a great source of inspiration for Yatsen. In January, we participated in the 2023 World Economic Forum annual meetings in Davos, Switzerland, where we highlighted Yatsen’s implementation of sustainability practices through Perfect Diary, Little Ondine lipsticks and other Yatsen’s products at the event sustainability symposium. In summary, the first quarter of 2023 was a promising start for the gradual recovery of China’s beauty market in the post-pandemic era. We are cautiously optimistic about the outlook for the remainder of 2023. We are aware that uncertainties remain. We will continue to focus on brand building and product development as we work to draw upon our Skincare Brands’ strong growth momentum and prepare to launch new Color Cosmetic products in the second half of 2023. With that, I’ll hand the call over to our CFO, Donghao, to discuss our financial performance. Thank you, everyone.

Donghao Yang, CFO and Director

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 first quarter of 2023 decreased by 14.1% to RMB765.4 million from RMB891 million for the prior-year period. The decrease was primarily attributable to a 29.1% year-over-year decrease in net revenues from Color Cosmetics Brands, partially offset by a 34.2% year-over-year increase in net revenues from Skincare Brands. Gross profit for the first quarter of 2023 decreased by 7.5% to RMB568.7 million from RMB614.5 million for the prior-year period. Gross margin for the first quarter of 2023 increased to 74.3% from 69% for the prior-year period. The increase was driven by first, increasing sales of higher gross margin products from Skincare Brands; and secondly, more disciplined pricing and discount policies and cost optimization across all of the company’s brand portfolios. Total operating expenses for the first quarter of 2023 decreased by 37.6% to RMB575.9 million from RMB922.5 million for the prior-year period. As a percentage of total net revenue, total operating expenses for the first quarter of 2023 were 75.2% as compared with 103.5% for the prior-year period. Fulfillment expenses for the first quarter of 2023 were RMB51.9 million compared with RMB73.9 million for the prior-year period. As a percentage of total net revenues, fulfillment expenses for the first quarter of 2023 decreased to 6.8% from 8.3% 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 the company’s warehousing and handling operations. Selling and marketing expenses for the first quarter of 2023 were RMB459 million compared with RMB604.7 million for the prior-year period. As a percentage of total net revenues, selling and marketing expenses for the first quarter of 2023 decreased to 60% from 67.9% for the prior-year period. The decrease was primarily attributable to the closure of underperforming off-line stores and a reduction in share-based compensation related to the decrease in selling and marketing headcount. General and administrative expenses for the first quarter of 2023 were RMB40.7 million compared with RMB208.1 million for the prior-year period. As a percentage of total net revenues, general and administrative expenses for the first quarter of 2023 decreased to 5.3% from 23.4% for the prior-year period. The decrease was primarily attributable to the reversal of recognized share-based compensation expenses of RMB109.4 million due to the forfeiture of unvested awards granted to our former Chief Technology Officer upon his resignation, and a decrease of RMB42.2 million in recognition of share-based compensation expenses using the graded-vesting method over the vesting term of the company’s awards. Research and development expenses for the first quarter of 2023 were RMB24.2 million compared with RMB35.8 million for the prior-year period. As a percentage of total net revenues, research and development expenses for the first quarter of 2023 decreased to 3.2% from 4% for the prior-year period. The decrease was primarily attributable to the company’s efforts to maintain research and development expenses at a reasonable level relative to total net revenues. Loss from operations for the first quarter of 2023 decreased by 97.7% to RMB7.2 million from RMB308 million for the prior-year period. Operating loss margin was 0.9% as compared with 34.6% for the prior-year period. Non-GAAP loss from operations for the first quarter of 2023 decreased by 63.3% to RMB62.4 million from RMB170.1 million for the prior-year period. Non-GAAP operating loss margin was 8.1% as compared with 19.1% for the prior-year period. Net income for the first quarter of 2023 was RMB50.7 million as compared with net loss of RMB291.4 million for the prior-year period. Net income margin was 6.6% as compared with net loss margin of 32.7% for the prior-year period. Net income attributable to Yatsen’s ordinary shareholders per diluted ADS for the first quarter of 2023 was RMB0.08 as compared with net loss attributable to Yatsen’s ordinary shareholders per diluted ADS of RMB0.46 for the prior-year period. Non-GAAP net loss for the first quarter of 2023 decreased by 83.2% to RMB25.8 million from RMB153.6 million for the prior-year period. Non-GAAP net loss margin was 3.4% as compared with 17.2% for the prior-year period. Non-GAAP net loss attributable to Yatsen’s ordinary shareholders per diluted ADS for the first quarter of 2023 was RMB0.05 as compared with RMB0.24 for the prior-year period. As of March 31, 2023, the company had cash, restricted cash, and short-term investments of RMB2.54 billion as compared with RMB2.63 billion as of December 31, 2022. Net cash used in operating activities for the first quarter of 2023 decreased by 80.6% to RMB20.2 million from RMB104.1 million for the prior-year period. Looking at our business outlook for the second quarter of 2023, we expect our total net revenues to be between RMB761.4 million and RMB856.6 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.

Operator, Operator

Thank you. Today's first question comes from Dustin Wei with Morgan Stanley. Please go ahead.

Dustin Wei, Analyst

Thank you for taking my questions. My first question relates to the first quarter sales beat versus the prior guidance. So may I know what’s changed for the last beat of the first quarter? Is that because of some better execution, for instance, like the skincare products, or just an industry environment that’s becoming better by the end of the first quarter? And the second question is related to the guidance for the next quarter, the second quarter. So is there any assumption behind it, for instance, on the assumption for the June 18 sales results? And also, what’s the sales trend so far in the second quarter?

Donghao Yang, CFO and Director

Well, thank you very much, Dustin, for the question. We beat our Q1 guidance by a notable margin because of the factors you mentioned. First of all, the macro environment has improved quite significantly, especially in the off-line business, and we’ve benefited from that trend. Secondly, I think we've executed our business strategy well in Q1, which involved a stronger focus on our Skincare Brands while executing a strategic transformation for Color Cosmetics Brands. In regard to your second question, as we mentioned in our call script, we are currently cautiously optimistic about the growth of our business. I think that has been reflected in our Q2 guidance, which is substantially better than our Q1 and Q4 guidance from last year. Essentially, we’re now more confident about the growth of our Skincare Brands and the success of our strategic transformation. Of course, the success in the upcoming June 18th campaign is one of the factors that we considered in giving our core guidance.

Dustin Wei, Analyst

Thanks a lot, Donghao. For the second quarter, are we somewhat reliant on the good results for June 18 to achieve the guided number? Or should we say this guided number is roughly what we are seeing from April moving into May?

Donghao Yang, CFO and Director

Well, June 18 is obviously a major event for the second quarter, like every year, and this year is no different. Hence, the success of the June 18 campaign will play a critical role in achieving the guidance. That said, we are putting more efforts into our daily sales; while campaigns are essential, daily sales also matter significantly. So to answer your question, April, May, and June are all important months. We cannot afford to do nothing in April and May, as that is definitely not the case. We are going to make genuine efforts to drive our sales growth during every opportunity we can.

Dustin Wei, Analyst

Got it. That’s helpful. May I follow up on the costs? How do you see the competition in terms of promotion and pricing? Are we seeing gradually less competition, particularly regarding price discounts, especially online and in live streaming channels, compared to last year?

Donghao Yang, CFO and Director

From our perspective, I think the competition is intensifying. As far as we know, most of the major international brands are offering greater discounts than ever to drive their sales. So, as we mentioned in our call script, while the macro environment is improving, leading to higher demand, the competition is intensifying. This is why we describe ourselves as cautiously optimistic about our business growth in the next several quarters.

Dustin Wei, Analyst

Got it. Just lastly, regarding the aim to achieve full-year profitability, can you provide some context? While we know that each quarter has its dynamics, does being profitable for the full year imply that every quarter will be profitable? Can we expect better profitability in quarters like Q2 and Q4, compared to lighter quarters like Q3?

Donghao Yang, CFO and Director

We are confident that we’re on the right track to becoming profitable in the near to mid-term future. The seasonality in our business is quite pronounced. Q1 and Q3 are generally the two lower quarters, whereas Q2 and Q4 are typically the peak seasons of the year. As you mentioned, during Q1, which is a lower quarter, our sales were lower compared to the high season. This is why in Q1, under non-GAAP measures, we recorded a net loss. However, we do expect our profitability to improve in our high seasons, Q2 and Q4.

Dustin Wei, Analyst

Got it. That’s all my questions. Thank you so much, Donghao.

Donghao Yang, CFO and Director

Yes. Thank you, Dustin.

Operator, Operator

Our next question comes from Casper with CICC. Please go ahead.

Unidentified Analyst, Analyst

Hi. Hello. This is Casper from CICC. Thank you very much for taking my questions. Firstly, congratulations on the financial results that beat market expectations, and we also see multiple positive signs in the indicators. Here, we have two major questions. The first one concerns our new products this year. What is our plan for releasing new products in this year? Additionally, is there any strategy for us to promote new products or introduce them during the June 18 campaign? Thank you.

Irene Lyu, Vice President, Head of Strategic Investment and Capital Markets

Yes, sure. Thank you for your question. Regarding our new product launch, we will share our plans by category. First, for skincare, our focus in May remains on the existing hero products. For this June 18, we’re still working to promote the existing hero products of our three main Skincare Brands, as we believe there is still significant room for growth. At the same time, we have also introduced several new skincare products. For example, Galenic launched a new facial cream, the Secret D'Excellence active cream, featuring premium active ingredients with anti-aging benefits. Also, as mentioned in the call, Eve Lom has launched a Radiance Face Oil. We anticipate more product launches for the skincare category in the second half of the year. For Color Cosmetics, as shared previously, we expect the market to gradually recover, so we have prepared a new product pipeline mostly for the second half of the year. However, for Q2, we still have a few new products, including a new gift box for Perfect Diary and a new liner for Little Ondine. There are more products to be released in the second half of the year.

Unidentified Analyst, Analyst

Okay. That’s very clear. Thank you. My second question is whether you could provide more details on the sales growth of the different Skincare Brands this year with the performance of the major hero products in Q1? How do we expect the skincare sector’s profitability to evolve this year? Thank you.

Donghao Yang, CFO and Director

Yes. Thank you very much for your question. Currently, we do not provide a breakdown of the sales growth and profitability for each of our brands. However, we can say that our Skincare Brands are experiencing strong growth with good profitability. Compared to the gross margins of our Skincare Brands, our Color Cosmetics Brands have significantly lower margins. As sales from our Skincare Brands comprise an increasing portion of our total sales mix, we expect our overall profitability to improve over time.

Unidentified Analyst, Analyst

Okay. Okay. That’s very clear. These are all my questions. Thank you again for the detailed answer. Thank you.

Donghao Yang, CFO and Director

Thank you.

Operator, Operator

Our next question comes from Olivia Tong with Raymond James. Please go ahead.

Olivia Tong, Analyst

Great. Thank you. Good morning. A couple of questions here, some of which have been answered. You talked about being cautiously optimistic about the environment. Can you describe what you’re seeing in both Skin and Color that supports that view?

Donghao Yang, CFO and Director

Okay. We are cautiously optimistic about our own business. The market has improved due to the lifting of the pandemic control policies. However, as I mentioned earlier, competition has intensified. If we analyze the data from Tmall and Douyin, we can see quite a different picture. We have been able to grow our Skincare Brands quickly, but we have also faced challenges in our Color Cosmetics business. Overall, we believe we are moving in the right direction in terms of sales growth and profitability. Therefore, we describe ourselves as cautiously optimistic about our business outlook.

Olivia Tong, Analyst

Understood. To put that in context relative to your expectation for Q2, you saw a sequential deceleration that narrowed in Q1 more than you expected. You’re guiding for Q2 at the midpoint, which assumes a similar year-over-year performance in Q2. So why doesn’t the sequential improvement in the year-over-year change continue to narrow from Q1 to Q2 if the market is now several lines more established? Given that you feel cautiously optimistic about your performance, I’m trying to understand what you see in the environment and your own business that wouldn’t drive even greater improvement in Q2 as events return.

Irene Lyu, Vice President, Head of Strategic Investment and Capital Markets

Yes. Regarding our guidance, it has been sequentially narrowing down. Last time we projected a decline of 10 to 20%, compared to the prior quarter’s decline of 20 to 30%, and before that, it was 30 to 40%. So our guidance reflects an overall narrowing trend. From what we see in the market, in Q1, as I mentioned, the entire makeup industry showed positive growth of 6% compared to a single-digit decline in the previous three quarters. However, the recovery is gradual rather than abrupt. In terms of what is behind our Q2 guidance, we expect there will still be a decline for three main reasons. Firstly, our main flagship brand, Perfect Diary, which still contributes a majority of our revenue, is currently under strategic transformation, and many of our new product launches are planned for the second half of the year. Therefore, we do not expect the brand to return to growth in Q2. Secondly, there will still be a high base for comparison compared to the previous year, due primarily to the larger scale of the offline business. For example, last year we had close to 230 stores for Perfect Diary by the end of June 2022, while now we only have around 150 stores. This closure of stores has led to a decline in the offline business. Lastly, our Skincare business is experiencing good momentum, growing at a faster pace than market averages, but Q2 is a comparatively smaller season for Skincare compared to Color Cosmetics. Therefore, these are the key reasons behind our guidance. That said, we do see a sequential narrowing of our guidance and the year-over-year decline, which indicates a healthy trend that we anticipate.

Olivia Tong, Analyst

Got it. Thank you. My last question is focused on the positioning of your mass brands versus your more prestigious brands. Could you compare and contrast the recovery of your larger mass brands with that of some of the less-publicized, prestigious brands in your portfolio? Thank you.

Irene Lyu, Vice President, Head of Strategic Investment and Capital Markets

Our observation does not reveal a clear divergence between the performance of mass and prestige segments overall. Rather, we are seeing varying degrees of performance within brands at different price points. In Q1, performance data shows that while some brands are growing quickly, more established brands are either slowing their growth or declining. Due to the intensifying competition in this industry, we are witnessing an increasing divergence of performance based on brand equity and operational excellence. We believe that the long-term performance of our brands will be driven by investments in brand building and R&D. For sustainable growth, we are committed to building our brands and focusing on R&D investments as key initiatives.

Olivia Tong, Analyst

Got it. Thank you. Best of luck.

Irene Lyu, Vice President, Head of Strategic Investment and Capital Markets

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

Operator, Operator

Thank you. This concludes today’s conference call. We thank you all for attending today’s presentation. You may now disconnect your lines and have a wonderful day.