Yatsen Holding Ltd

NYSE:YSG

Earnings Call Transcript 2023-Q1

[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]

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, David.

[Jinfeng Huang, Founder, Chairman and Chief Executive Officer]

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. And 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 expected 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 a 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 7.3% 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 discounting – 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 to our efforts in cost optimization, the net income we recognized for the first quarter of 2023 was primarily 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 greatest 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 a spa level in nourishment, combined with 5 major reparative ingredients to firm and plump the skin. We also hosted a major brand event for Galenic influence to explore the legendary benefit of the brand platinum OG series with international fashion and beauty KOLs. During the quarter, our Color Cosmetic Brands also introduced Valentines Day-themed skin set, this campaign to celebrate the vibrant colors and passionated emotion 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 the 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 chicken acne, we officially launched DR.WU Acne Research Fund and established DR.WU Esper Committee. Together, these organizations will integrate Esper’s resources across multiple medical bills 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 the sustainability practice through Perfect Diary, Little [indiscernible] lipsticks and other Yatsen’s products at event sustainability symposium.

In summary, the first quarter of 2023 was a promising start to 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, Chief Financial Officer]

Thank you, David, 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% and 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 certainly 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 as 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 as 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 as 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 for 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 as 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.

With that, I would now like to open the call to Q&A. Operator?

[Operator]

Thank you. [Operator Instructions] Today’s first question comes from Dustin Wei with Morgan Stanley. Please go ahead.

[Dustin Wei, Morgan Stanley]

Thank for taking my questions. My first question related to the first quarter sales beat versus the prior guidance. So sort of may I know what’s changed for the last beat of the first quarter? Is that because some of the better execution, for instance, like the skincare products or just an industry environment that’s becoming better by 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 second quarter?

[Donghao Yang, Chief Financial Officer]

Well, thank you very much, Dustin for the question. Well, we beat by a pretty big margin our Q1 guidance because of the things that you just mentioned. First of all, the macro environment has improved quite significantly, especially in the off-line business, and we’ve benefited from that trend. And secondly, we – I think we’ve done a good job executing our business strategy in Q1, which is obviously putting more focus on our Skincare Brands and in the meantime, time to execute a strategic transformation for Color Cosmetics Brands. And regarding your second question, we are – as we mentioned in our call script, we are currently cautiously optimistic about the growth of our business. I think that has reflected – has been reflected in our Q2 guidance, which is substantially better than our Q1 and Q4 last year guidance. Basically, we’re now more confident about the such growth of our Skincare Brands and also the success of our strategic transformation of our success diagram. Of course, the success in the upcoming June 18th campaign is one of the factors that we considered in putting out our core guidance.

[Dustin Wei, Morgan Stanley]

Thanks a lot, Donghao. Sort of for the second quarter, are we a little bit counting on the good results for June 18 to perform – to sort of keep up to achieve the guided number? Or we should say this guided number is roughly what we are seeing like from April moving into May?

[Donghao Yang, Chief Financial Officer]

Well, June 18 is obviously a major event for the second quarter, like every year, this year is no different. So the success of the June 18 campaign, obviously, will play a critical role in achieving the guidance. And also, we are putting more efforts in our so-called daily sales, meaning the campaigns are important, but the daily sales are also very critical. So back to your question, April, May – June is an important month. It doesn’t mean that April and May, we can afford to do nothing, which is not the case. We’re going to make real efforts in every opportunity that we can have to drive our sales growth.

[Dustin Wei, Morgan Stanley]

Got it. That’s helpful. And may I follow-up on in terms of the cost you see optimistic, how are we seeing in terms of the industry promotion and the competition? Like year-to-date, are we seeing gradually less competition, the price discount, especially online and in live streaming channel, where we are seeing generally similar level of the competition versus like last year?

[Donghao Yang, Chief Financial Officer]

Well, from our perspective, I think the competition is intensifying. As far as we know, most of the international major brands are actually offering greater than ever discounts in order to drive their sales. So as we mentioned in our call script, the macro environment is improving, meaning the important function, the demand is going up. But in the meantime, the competition is so intensified – is intensifying. So that’s why we say, alright, we’re only cautiously optimistic about the – our business growth in the next couple of quarters.

[Dustin Wei, Morgan Stanley]

Got it. Got it. And just lastly, in terms of the assets on sort of the journey to achieve the full year profitability, I know that each quarter we have some dynamics. Full year sort of being profitable doesn’t mean that every quarter the company will achieve the profitability. But just can we have a little color like are we betting on a little more, for instance, like a major event quarter, such as the second quarter and fourth quarter, to have better profit or a lighter quarter such as the third quarter, we will see better profitability?

[Donghao Yang, Chief Financial Officer]

Well, we are confident that we’re on the right track to turn in profitable in the near to mid-term future. And the seasonality in our business is quite obvious. Q1, Q3 are generally the two low quarters, and Q2 and Q4, generally the high seasons of the year. So as you just mentioned, in Q1, the low quarter, our sales were, compared to the high season, lower. So that’s why in Q1, a non-GAAP. So recorded – we recorded a net loss for non-GAAP measures. But we do expect our profitability to get better in our high seasons, Q2 and Q4.

[Dustin Wei, Morgan Stanley]

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

[Donghao Yang, Chief Financial Officer]

Yes. Thank you, Dustin.

[Operator]

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

[Unidentified Analyst]

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

[Irene Lyu]

Yes, sure. Thank you for your question. In terms of our new product launch, we will share it by category. First, on the skincare category, our May focus still on the existing hero products. So for this June 18, we’re still trying to promote the existing hero products of our three main Skincare Brands, and we think there is still a lot of room for them to grow. At the same time, we did introduce a number of new products for skincare, for example, Galenic, in May, we just launched a new facial cream, the Secret D'Excellence active cream, featuring the finest active ingredient for allergy with antiaging benefits. And also, we mentioned in the call, Eve Lom also launched a Radiance Face Oil. And we think, for the second half of the year, there could be more product launch for the skincare category. And then on Color Cosmetics, as we previously shared, we think the market will gradually recover. So we have a new product pipeline mostly prepared for the second half of the year. But then for Q2, we still have a few new products. For example, there is the [indiscernible], we have a new gift box for Perfect Diary and also Little Ondine to introduce new liner as well. So there are more product to be released in the second half of the year.

[Unidentified Analyst]

Okay. That’s very clear. Thank you. And our second question is that could you give us some more color on the sales growth of the different Skincare Brands this year and with the performance of the major hero products in Q1? And how do we expect the skincare sector’s profitability to evolve this year? Thank you.

[Donghao Yang, Chief Financial Officer]

Yes. Well, thank you very much for your question. Well, you know what, we don’t – we currently do not provide breakdown of the sales growth and profitability for each of our brands. But in general, our Skincare Brands are growing, the growth is very strong and with very good profitability. And if you compare the gross margin level of our Skincare Brands with the Color Cosmetics Brands, it’s like substantially higher. So as I think sales of our Skincare Brands consist a bigger portion of our total sales mix, we do expect our overall profitability to improve over time.

[Unidentified Analyst]

Okay. Okay, that’s very clear. These are all my questions. And thank you again for the very detailed answer. Thank you.

[Donghao Yang, Chief Financial Officer]

Thank you.

[Operator]

[Operator Instructions] Our next question comes from Olivia Tong with Raymond James. Please go ahead.

[Olivia Tong, Raymond James]

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

[Donghao Yang, Chief Financial Officer]

Okay. Well, we feel we’re cautiously optimistic, actually, about our own business. Well, the market has recovered due to the lifting of the pandemic control policies. But again, as I said earlier, the competition has intensified. And if you look at the data from Tmall and Douyin, we can have quite a different picture. So for us, we have been able to grow our Skincare Brands quite fast, but we have also met some challenges in our Color Cosmetics business. So – but in general, I think we’re moving in the right direction, both in terms of sales growth and profitability. So that’s why we said, alright, we are cautiously optimistic about our own business prospects.

[Olivia Tong, Raymond James]

Understood. Maybe just to put that in context relative to your expectation for Q2, you obviously saw a sequential deceleration that narrowed in Q1 by more than you expected. You’re guiding for 2Q 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? In the reopening, you feel cautiously optimistic about your performance. Just trying to understand what you’re seeing in the environment and your own business that what that would – wouldn’t drive even more improvement in Q2 as events return.

[Irene Lyu]

Yes. So actually, for our guidance, if we look at the range, right, it has been sequentially narrowing down because last time we gave a decline of 10 to 20, and the quarter before, it’s 20 to 30, and before that, it’s 30 to 40. So definitely, on a guidance basis, is narrowing down. And from what we see from in the market, in Q1, as I mentioned, the whole makeup for the first time, now show a positive growth of 6% versus single-digit decline over the past three quarters. Yes. But it’s definitely a gradual recovery rather than a very abrupt recovery.

And then secondly, in terms of what’s behind our Q2 guidance we think there is still going to be a decline. There are three major reasons. The first one is the main flagship brand, Perfect Diary, which still contributes to a majority of our revenue still under the brand strategic transformation. And as mentioned, most of the new product launches are planned for the second half of this year. So that’s why for Q2, we don’t think the brand will be back to the growth stage. And then secondly, there is still going to be a high base for comparison compared to the prior-year period, primarily because of the larger scale of the off-line business. If we look at last year, we still have close to 230 stores for Perfect Diary at the end of June 2022. And then by end of March this year, we only have around 150. The off-line business, because of the large number of closure of stores, there is going to be a decline. And then lastly, for our Skincare business that we have a good momentum going at a faster than market average pace, but Q1 is not a – Q2 is a relatively good season for Skincare, but the size is still relatively small compared to our Color business. So those are the key kind of reasons behind our guidance. But again, we do see a sequential narrowing down of our guidance and the year-over decline, which suggests a healthy trend that we are expecting.

[Olivia Tong, Raymond James]

Got it. Thank you. My last question is just around the positioning of your mass brands versus your more prestigious brands and how you’re seeing – if you could compare and contrast the recovery – excuse me, of your larger mass brands versus perhaps a little bit lesser growing in some of the more prestigious brands in your portfolio? Thank you.

[Irene Lyu]

So your question is kind of performance. Just wanted to clarify, the performance kind of comparison between mass versus prestige brands for the industry or for our own brands?

[Olivia Tong, Raymond James]

Honestly, both, but your view on the industry and then also your – specifically your brands. Thank you.

[Irene Lyu]

Yes. Okay. Got it. So we don’t actually see a very clear divergent pattern between mass and prestige segment. But instead, what we see is we are seeing each pricing here in the category. There is – the brands tend to show more clear divergent performance because this Q1, if you look at Tmall and Douyin, the performance really divert, some brands are growing fast, while some of the more established brands are growing at a slow pace or even have a decline. So with the intensifying competition in this industry, we do see increasing divergence of performance, given the brands’ own equity and also their operational excellence. So in our view and also we think for our brands, the long-term performance is definitely driven by more like brand building and R&D investments. So that’s why, for us, we – for – to support a sustainable growth, we want to build long-term success. So the brand building and R&D investment is definitely the most important initiatives that we are undertaking.

[Olivia Tong, Raymond James]

Got it. Thank you. Best of luck.

[Operator]

Thank you. This concludes today’s question-and-answer session. I’d like to turn the conference back over to the management team for any closing remarks.

[Irene Lyu]

Thank you, once 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]

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.