Earnings Call Transcript - YSG Q1 2021

Operator, Operator

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

Irene Lyu, Head of Strategic Investment and Capital Markets

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

Jinfeng Huang, Founder, Chairman and CEO

Thank you, Irene. And thank you, everyone, for participating in Yatsen's first-quarter 2021 earnings conference call today. Starting off the year on a solid note, Yatsen achieved a 42.7% year-over-year growth in total net revenues in the first quarter, supported by a healthy growth of our proprietary brand and robust performance of Little Ondine and Abby's Choice and other brands in Yatsen's portfolio. During the quarter, the number of DTC customers increased 11.6% year-over-year to 9.6 million. Revenue per DTC customer also increased by 24.5% from approximately RMB98.7 to RMB 123 per customer. We ended the quarter with a gross margin of 68.6%, an improvement of approximately 7 percentage points compared to 61.7% in the first quarter last year. We went into the year with a clear execution plan to optimize our brands' performance, expand our portfolio, and enhance our core capabilities. Our key focus has been on our flagship proprietary brands, particularly to upgrade their positioning and price point from mass to a higher-end mass market in order to further extend their growth potential. We have set out to achieve this through more disciplined pricing and discount policies, which successfully raised proprietary's average selling price, average order value, and gross profit margin during the quarter. At the same time, we continue to introduce new products that excite and delight our customers, such as the new Eve Lom brand's lip gloss line as well as the Pink Fuel lipstick gift set, designed for the Chinese New Year holiday season and Valentine's Day. These new products, complemented by the launch of several proprietary skincare products in our offline stores in early May, represent refinement and premiumization of the proprietary product line this year. Looking forward, we have further plans to launch new products in existing and new categories including base makeup, colored contact lenses, and men's skincare in staggered windows throughout the year to capture a higher volume share from our customers. Overall, we see further room for average selling price and average order value improvement. The new product rollouts and category expansions will drive operational results of proprietary brands through this year. We are also making continued progress toward our multiple brand strategy by introducing new brands. With the proprietary brands shaping up, we see the need to attract and capture new entrants in the color cosmetics market, especially Gen Z and Gen X, who are more price sensitive. Hence, we launched the Pink Bear brand in mid-March, designed to meet the esteemed Young Girl brand persona with an initial focus on providing high value for money products in high volume categories for Gen Z and Gen X consumers. With the introduction of these lip gloss products, Pink Bear has achieved encouraging results during its first months of launch. Our Matte Lip Color cosmetic brand Little Ondine also experienced robust year-over-year growth in the quarter, powered by several well-received product launches such as the crossover with Pop Mart and the Chinese pop star Huang Zitao, as well as the new Vinyl Records eyeshadow palette, which was introduced in late March. Given Little Ondine's unique street fashion brand positioning, its further upside is expected to be lower than that of proprietary, which we aim to develop further as a simple brand within the group. As Little Ondine has already become a top-selling color cosmetic brand in China's online market, for its next stage of growth, we plan to optimize the investment level in this brand, focusing on sustainable growth going forward. One notable channel we observed was the increase in diversity and the balance of our channel mix compared to the first quarter of 2020, which boosted the sales contribution from non-traditional e-commerce channels, such as various short videos and 2B platforms, as well as our experience stores. We have adopted an omnichannel strategy to serve all customers at every touchpoint. As of the end of March 2021, we have a total of 245 experience stores, already achieving significant scale covering key cities and regions. We aim to open approximately 100 stores throughout the rest of the year. In addition to our color cosmetics portfolio, we are excited about the expansion of our range of skincare brands, which includes the addition of DR.WU's mainland China business and Eve Lom in the first quarter. Along with Galenic and Abby's Choice, we now have four skincare brands with different positioning and consumer bases. As part of our efforts to ensure a smooth transition and integration of the Galenic DR.WU's mainland China business in the first quarter, our team focused on putting in place the right management team and incentive structure to rejuvenate each brand product and positioning to accelerate e-commerce and optimize supply chains. The team has identified a few products that resonate with the new generation of consumers and witnessed some 30% growth for these new launches, such as Galenic's new BC serum and DR.WU's Mandelic Acid serum. Since Eve Lom's transition was completed at the end of the first quarter, we remain in the early stage of the integration process, which we will focus on over the second quarter. We believe that over time we will have significant room to apply our disruptive B2C model and core platform capabilities to our newly acquired brands as we help them realize their full potential. With four brand acquisitions since mid-2019, our strategic investment and capital market teams have developed core capabilities in sourcing, executing, and integrating new brands through these experiences and have continued to improve and upgrade. We have seen that 2020 started to showcase a number of high-quality brands emerging and becoming available globally, and we are continually seeking to identify potential attractive additions to our portfolio. We believe our process in acquiring is a testament to our rising reputation as a serious, high-quality consolidator of global beauty assets. We plan to leverage this unique window of opportunity to add to our portfolio in a prudent and cost-effective manner. Aside from operational improvements, continued investments in our core infrastructure and capabilities remain our central focus. We have increased our R&D spending during the fourth quarter to almost 2% of total net revenues, compared to 1.2% in the same period last year. The buildout of our Guangzhou manufacturing hub and research center, in the form of a joint venture with Cosmos, is on track, with construction starting in late March. As of the end of the first quarter, we held a total of 75 global registered patents, including 36 invention patents. Our open-lab R&D architecture encompasses our internal R&D division, as well as collaboration with a network of outside OEM and R&D partners, such as Sensient Technologies, Pierre Fabre, and Guangzhou University of Science and Technology. We enhance our capabilities to develop unique active ingredients, formulations, and packaging/application solutions. Finally, we would like to provide an update on our international business, where our progress in certain markets such as Southeast Asia has exceeded our expectations. Although overseas sales represent a relatively small part of our overall sales in the first quarter of 2021, it is worth noting that we have already become one of the top-selling brands in the online cosmetic categories in fast-growing consumer markets such as Mainland China, Malaysia, Singapore, and the Philippines. We are inspired by the success enjoyed by other Chinese B2C companies in the overseas market. We have already started to learn from these leaders, and it may accelerate our overseas business in the future. Thank you, everyone. With that, I will now turn the call over to our CFO, Donghao Yang, to discuss our financial performance.

Donghao Yang, CFO

Thank you, everyone, before I get started, I would like to clarify that all financial numbers presented today are in RMB amounts, and all percentage changes referred to year-over-year changes unless otherwise noted. Total net revenues for the first quarter of 2021 increased by 42.7% to RMB1.4 billion from RMB1 billion for the first quarter of 2020, primarily attributable to the increases in the number of B2C customers, as well as revenue from our B2C customers during the period. Gross profits for the first quarter of 2021 increased by 58.8% to RMB991.6 million from RMB624.4 million for the first quarter of 2020. Gross margin improved by approximately seven percentage points to 68.6% in the first quarter of 2021, compared to 61.7% in the same period of 2020, supported by disciplined pricing and discount policies. On the business end, we saw increased sales generated from higher-margin brands and through experience stores. We have also creatively premiumized our product offerings, enabling us to achieve higher average order value and better margin outcomes. Total operating expenses for the first quarter of 2021 were RMB1.3 billion, compared to RMB800.3 million for the first quarter of 2020. As a percentage of total net revenues, total operating expenses increased to 92.4% from 79.1% in the first quarter of 2020. Fulfillment expenses for the first quarter of 2021 were RMB92.7 million, compared to RMB107.1 million for the first quarter of 2020. As a percentage of net revenues, fulfillment expenses decreased from 10.6% in the first quarter of 2020 to 6.4% in the first quarter of 2021. The decrease in percentage was primarily due to the normalization of logistics expenses compared to the first quarter of 2020, during which logistics expenses were higher due to the impact of COVID-19. Selling and marketing expenses for the first quarter of 2021 were RMB1 billion, compared to RMB556.9 million in the first quarter of 2020. As a percentage of total net revenues, selling and marketing expenses were 72.1%, compared to 55% in the prior-year period. The increase was primarily due to investments in promotions and consumer awareness building for the newer brands and testing the effectiveness of new traffic acquisition channels. General and administrative expenses for the first quarter of 2021 were RMB172.3 million, compared to RMB124.1 million for the first quarter of 2020. As a percentage of total net revenues, these expenses decreased to 11.9% from 12.3% for the first quarter of 2020. The decrease in percentage is primarily due to increased economies of scale resulting from a higher level of revenue. Research and development expenses for the first quarter of 2021 were RMB27.7 million, compared to RMB12.2 million for the first quarter of 2020. As a percentage of total net revenues, R&D expenses increased to 1.9% from 1.2% for the first quarter of 2020. This increase was primarily due to an increase in personnel costs and share-based compensation expenses, reflecting our commitment to enhance our R&D capabilities as a sustainable source of competitive advantage. Loss from operations for the first quarter of 2021 was RMB343.3 million, representing an operating loss margin of 23.8%, compared to a loss from operations of RMB176 million or an operating loss margin of 17.4% for the first quarter of 2020. Non-GAAP loss from operations for the first quarter of 2021 was RMB258.3 million, representing a non-GAAP operating loss margin of 17.9%, compared to a non-GAAP loss from operations of RMB113.7 million or a non-GAAP operating loss margin of 11.2% for the first quarter of 2020. Net loss for the first quarter of 2021 was RMB319 million, representing a net loss margin of 22.1%, compared to a net loss of RMB191.7 million or a net loss margin of 18.9% for the first quarter of 2020. Non-GAAP net loss for the first quarter of 2021 was RMB234.3 million, representing a net loss margin of 16.2%, compared to a non-GAAP net loss of RMB129.4 million or a non-GAAP net loss margin of 12.8% for the first quarter of 2020. Net loss attributable to Yatsen's ordinary shareholders per diluted EPS for the first quarter of 2021 was RMB0.5, compared to net losses attributable to Yatsen's ordinary shareholders per diluted EPS of RMB4.6 for the first quarter of 2020. Non-GAAP net loss attributable to Yatsen's ordinary shareholders per diluted ADS for the first quarter of 2021 was RMB0.37, compared to a non-GAAP net loss attributable to Yatsen's ordinary shareholders per diluted ADS of RMB0.92 for the first quarter of 2020. As of March 31, 2021, the Company had cash and cash equivalents and restricted cash of RMB4.3 billion compared to RMB5.7 billion as of December 31, 2020. Looking at our business outlook for the second quarter of 2021, we expect total net revenues to be between RMB1.49 billion and RMB 1.54 billion, representing a year-over-year growth rate of approximately 50% to 55%. This forecast reflects our current and preliminary view on the market and operational conditions, which is subject to change. With that, I would now like to open the call for Q&A. Operator?

Operator, Operator

Thank you. Our first question today comes from Dustin Wei with Morgan Stanley. Please go ahead.

Dustin Wei, Analyst

Thanks for taking my questions. And my first question's regarding the guidance for the second quarter. It seems like it suggests a 3% to 7% quarter-on-quarter growth versus the first quarter. And I feel it seems weaker-than-normal seasonality for cosmetics. So, is there sort of an adjustment going on with some strategy change or so management tends to be conservative? The second question is that given the competition on color cosmetics seems to be becoming more intense, is there any strategy change for the management sort of in terms of allocating more marketing resources to skincare rather than color cosmetics? Is that kind of part of the reason that our sales growth is slightly lower than previously? And the third question is regarding the net losses in the first quarter. The net loss on the ratio is slightly higher than the fourth quarter last year. I think that's mainly because of higher selling and marketing expenses. So, is there any further elaboration on that, and how should we look at that ratio for the full year? Thank you very much.

Jinfeng Huang, Founder, Chairman and CEO

So, for the quarter-over-quarter growth, I think the first thing we want to clarify is right now, our brand portfolio has been changing dramatically. We had three brands last year, but now we have seven brands. In skincare, we now have four. So, when we are considering the resource allocation for the coming quarters, we may allocate more resources into skincare growth. The skincare growth might not be as dramatic as color cosmetics; however, we think the growth of skincare, especially in the luxury segment, is more sustainable, and that might influence the bottom line as well. Regarding the competitiveness of the color cosmetics market, last year, Yatsen as a company was ranked as No. 5, and then No. 4 in 2020. If you look at the growth rate from 2020 over 2019, based on the same database, Yatsen was growing over 30%, while the No. 1 and No. 2 were declining, and No. 3 was just growing in single digits. So, overall in color cosmetics, we still have high growth potential. We will work to continuously expand our brand in color cosmetics and continue to invest to grow our existing brands, including Perfect Diary, until we become No. 1 in terms of market share in color cosmetics. As for the increase in sales and marketing, in the first quarter this year, we acquired a couple of skincare brands, and at the early integration stage, the investment in brand building and cleaning inventory for the distributors will be two core things we need to do. We just announced the brand ambassador for Galenic in the first quarter. We believe the investment in strengthening brand equity and improving brand awareness will be reflected in growth in the coming quarters for our skincare brands.

Donghao Yang, CFO

One other thing I want to add is that in Q1 we spent some money testing the effectiveness of new traffic acquisition channels. Some channels are performing well while others were less effective, so we are figuring out the most efficient and cost-effective ways to acquire traffic and market our products. Additionally, we are trying to implement a more disciplined approach to ROI optimization. Now, we are allocating resources to maximize our ROI across different brands. Given that we just mentioned our non-GAAP net loss is at 16% in Q1, we expect our net loss to decrease moving forward, and we are actually more confident about our future profitability prospects as we build a sizable and sustainable skincare business.

Dustin Wei, Analyst

Thanks a lot, Jinfeng and Donghao. So, if I can just have a follow-up on that. Are we still aiming for break-even or even better profitability for 2022, given the focus on skincare?

Donghao Yang, CFO

We are not in a position to give guidance on profitability two or three years from now. But as I said earlier, we are now even more confident about our future prospects of turning this business profitable.

Dustin Wei, Analyst

Thank you very much again.

Operator, Operator

The next question comes from Luzi Li with Bank of America. Please go ahead.

Luzi Li, Analyst

Hi. Thank you, management, for taking my question. My first question is also on the guidance for Q2. I recognize that Q2 basically has the easiest base if we look at last year. So, is it fair to say that Q2 is likely the best quarter in terms of gross run rate? This is my first question. My second question is regarding DTC growth. In the past, we actually saw the number of DTC customers grow faster than the actual value. But in Q1 this year, we see that the higher average selling price growth exceeded the customer growth. Are we going to see a similar trend in the future or is this just a one-off? If this is the case, how can we achieve the higher average selling price in the future, particularly for the Perfect Diary? Have we seen a lower discount rate, or do we have a higher average selling price for the newly launched products while giving similar levels of discount? This is my second question. Finally, my question is also on the margin side. For Q1, we observe the higher selling and distribution ratio. Is this primarily about the newly acquired brand or do we see a similar ratio across different brands? If we focus purely on Perfect Diary, how is the trend versus the same time last year? Thank you.

Jinfeng Huang, Founder, Chairman and CEO

For the first question, regarding our Q2 guidance, if you look at the brand portfolios we have right now and launched a new skincare brand, even if its price point is lower than Perfect Diary, it targets young and Gen Z consumers who are newly adapting to color cosmetic products. Currently, we are upgrading our Perfect Diary product portfolios: we will keep a modest range for existing products and try to premiumize new offerings. Therefore, we can see a gross margin increase in the first quarter. Although Little Ondine saw dramatic growth in Q2 last year, we are considering adjusting the investment level for Little Ondine this year as well. For Q2, we believe the growth reflects our change in resource allocation with more focus on skincare brands, adjusting the investment model for Little Ondine and Abby's Choice, and increasing the premiumization of Perfect Diary. This is likely to impact our bottom line. We think such a shift in growth model will ensure a more sustainable and robust growth in the coming quarters. Regarding the DTC customer growth versus ARPU growth, you're right; in Q1, we noted that the average revenue per customer growth was higher than DTC customer growth. We believe that this trend will continue due to resource allocation and investments into premium skincare brands and our Matte Lip Color Cosmetic, Little Ondine and Perfect Diary. We also believe substantial growth opportunities await in the color cosmetics sector. The launch of Pink Bear is designed to capture higher value-for-money product space, and we are pleased with the early results. Going forward, we expect both DTC and ARPU metrics to grow, even as each brand contributes differently to those figures.

Donghao Yang, CFO

Currently, the gross margin in Q1 over last year is more than 7%. The increase in gross margin is driven primarily by the growing revenue share from higher-margin skincare brands. Perfect Diary also contributed to this margin improvement, with the launch of new products that had higher gross margins. However, the increase stems from more disciplined promotions and innovative products enhancing consumer value, rather than a direct price increase of existing products. We continuously invest in R&D, as consumers have high willingness to pay for better and newer products.

Luzi Li, Analyst

Thank you. Just one additional follow-up. So you mentioned that moving forward, we may see a better margin profile, thanks to our strategic shift. Are we looking for a narrower non-GAAP net profit versus last year or will we still see similar levels?

Donghao Yang, CFO

As previously mentioned, we're not in a position to provide guidance on profitability for the rest of the year. However, we believe that as we trade out of existing brands and introduce more luxury skincare brands with higher margins, our confidence in future profitability is increasing.

Jinfeng Huang, Founder, Chairman and CEO

The resource reallocation among our brands and portfolios reflects this change; hence we will allocate resources into the skincare category and continue investing in new color cosmetics brands. This is likely to impact our bottom line. We cannot provide any guidance on this topic at this time. Can we move to the next question? Thank you.

Operator, Operator

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

Christine Cho, Analyst

Thank you, Jinfeng and Donghao. Is it possible to give us a rough sense of the sales contributions from your own organic brands versus the newly acquired brands, both in terms of this quarter as well as the implied in your second-quarter guidance? Also, you mentioned that nontraditional channel sales contributions have increased this quarter, including short videos and experience stores. Should we expect this trend to continue going forward? Would it be possible for you to elaborate on your strategy in these new channels? Lastly, do you have any update on the repurchase rate?

Jinfeng Huang, Founder, Chairman and CEO

Regarding the organic brand revenue, even with the brands we acquired, we still invest heavily in new brands. If you refer to organic growth, it is primarily driven by the existing and the incubated brands, with the newly acquired brands contributing less significantly to total revenue. That said, we have seen substantial growth in Perfect Diary, driven fundamentally by new launches, including lipsticks and expanded categories such as color contact lenses and skincare products. In terms of non-traditional channels, we have observed a growing trend that we expect to continue. For example, during Q1, we focused on testing new traffic acquisition platforms, especially through live broadcasting, and we are very optimistic about the results we are achieving. We see great potential in both existing and emerging platforms for brand-building purposes and customer outreach and we see our resource allocation towards this growing format yielding positive results.

Irene Lyu, Head of Strategic Investment and Capital Markets

For the repurchase rate, we have been seeing similar levels as in the past. Previously, we reported the 12-month repurchase rate at around 40%. In this quarter, we didn’t disclose the exact number, but the level has remained similar.

Operator, Operator

The next question comes from Zhongchao Xu with CICC. Please go ahead.

Zhongchao Xu, Analyst

Hello? Can you hear me?

Operator, Operator

Hello, Zhongchao.

Zhongchao Xu, Analyst

Yeah, this is Zhongchao from CICC. Thanks for taking my questions. I've got two questions. The first one is what's our specific plan on the skincare business this year? And how will we allocate the resources, say, marketing and labor? The second question is, as we test new traffic acquisition channels such as Douyin, could you further elaborate on what we did and how the performance has been so far? Thanks.

Jinfeng Huang, Founder, Chairman and CEO

For skincare growth, we believe the acquisition of Eve Lom is a very important milestone for the company. As we enter the skincare category, it takes time to improve our understanding and assess whether our core capabilities apply. Based on the early results in the past few months, we are very optimistic that our business model works in both color cosmetics and skincare. We see a clear growth path for brands like DR.WU, which we pivoted towards a specific benefit category and strengthened brand equity. We are actively engaging in brand building through various promotions, including live broadcasting. This month, we plan to invest heavily in following up with top KOLs, especially during the June 18 promotion event. Our skincare brands have shown consistent and impressive growth, and our team has been successful in attracting talent that is enhancing our R&D capabilities. The integration of these talents has played an important role, and we are excited about future developments. As for new traffic acquisition, we are testing non-traditional e-commerce platforms and strategies through live broadcasts on Douyin, which have produced significant results. We are learning from our early testing experiences and are adjusting our approach with each iteration.

Operator, Operator

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

Ingrid Zhang, Analyst

Hi. Thanks, management, for taking my question. I have two questions. The first is that Yatsen has been very strong in terms of faster product launches, leveraging our strong consumer insights. With the new cosmetics collaboration coming to effect this May, could you share with us the potential impact on our business? The second question is we started as a very strong company in the mass, masstige segment, particularly in the color category. Now we have acquired new premium to prestige skincare brands. Can you share a bit about our plan to grow these new skincare brands? Many thanks.

Jinfeng Huang, Founder, Chairman and CEO

The implementation of regulations in the beauty industry is not entirely new; we've been discussing this for the past year. We anticipated challenges from the new law and had a solid plan in collaboration with our partners. We will benefit from our established standard operational protocols and strict quality control in product launches. Our flexibility enables us to adapt quickly and maintain compliance. The emerging premium skincare brands, such as the BC serum, are selling well despite higher price points, giving us confidence to continue this strategy. The consumer base is increasingly willing to spend on high-quality and effective products as long as R&D supports the development of superior formulas.

Kevin Xiang, Analyst

Hi. Thank you for taking my questions. I have two quick questions. The first one is about the offline business. Could you please give us more insights into the progress and recovery of our offline experience stores in the first and second quarters? My second question is also about the offline, particularly regarding the distributor model as we've seen brands such as Perfect Diary, Little Ondine, and Abby's Choice collaborating with popular cosmetic chain stores. How should we think about the role of this offline distributor model in the long run? Thank you.

Donghao Yang, CFO

Currently, we have 245 offline stores and plan to open another 104 throughout the year. These stores have performed well and are already profitable on a standalone basis. This profitability can increase further as we expand and optimize our product offerings. We aim to increase revenue per square meter in our offline stores by leveraging skincare category expansion and introducing products tailored for offline consumers, leading to higher repeat purchases and better margins.

Jinfeng Huang, Founder, Chairman and CEO

To add, the decision to collaborate with distributors like H.E.A.T. stems from the need for an effective B2B partner model. For brands such as Perfect Diary, our infrastructure allows us greater control, but for our newer brands, we find it more economically viable to partner with established distributors to maximize their exposure without an extensive direct investment in store expansion. This strategy aids brand equity enhancement and allows us to reach more consumers at lower costs, forming part of our broader strategy. We will continue to evaluate these partnerships' effectiveness moving forward.

Operator, Operator

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.

Irene Lyu, Head of Strategic Investment and Capital Markets

Thank you once again for joining us today. If you have any further questions, please feel free to contact us directly or reach out to TPG investor relations. Our contact information for IR in both China and the U.S. can be found in today's press release. Have a great day.

Operator, Operator