Yatsen Holding Limited

Ladies and gentlemen, good day and welcome to the Yattson Second Quarter 2022 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Irene Liu, Head of Strategic Investment and Capital Markets. Please go ahead.

Thank you, Operator. Please note that 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 Yasen'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 Yasin's senior management team are Mr. Xinfeng 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 Yasen's investor relations website at ir.yasenglobal.com. I'll now turn the call over to Mr. Jinfeng Huang. Please go ahead, David.

Thank you, Irene, and thank you, everyone, for participating in Yasen's second quarter 2022 earnings conference call today. At the start of the year, we embark our next five-year development journey with a simple focus on building strong brands and world-class R&D capabilities while achieving sustainable growth. In the second quarter, we entered into a turbulent stretch of this journey where a confluence of challenges has put our strategies and execution to the test. The main challenge was widespread COVID-19 recurrences, which shut down our numerous cities in China between April and June. According to the latest data from the China National Bureau of Statistics, beauty retail spending was down by 22.3% and 11% in April and May, respectively, before slightly recovering in June. This disproportionately impacted offline retail spending nationwide, including our offline stores. In the online arena, competition intensified as our competitors engaged in aggressive promotions to charge sales amidst sluggish market demand for color cosmetics. The premium skincare category, on the other hand, proved to be highly resilient and, in fact, grew during the second quarter. Against this backdrop, our total net revenue decreased by 37.6% year-over-year to RMB 951.8 million, meeting the high end of our revenue guidance. The year-over-year decline in revenues was mainly due to soft performance of our color cosmetics brands, particularly offset are partially offset by seller growth across our skincare brands. Our non-GAAP net loose margin reached 20.8% in the second quarter, an increase of 9 percentage points compared with the prior year period. Attributable to the higher operating cost ratios of our offline stores due to weak offline store sales, as well as inventory loose and provisions for store closures. Encouragingly, our quarterly net cash generated from operating activities turned positive for the first time since Yasen's IPO at RMB 111.9 million, compared to an outflow of RMB 79 million for the prior year period. Due to our disciplined working capital management practices, While our overall strategy goals remain unchanged, these results demonstrated our ability to accelerate the optimization of our revenue mix and the cut cost in response to the evolving market environment in the second quarter. Let's look at our revenue mix in greater detail. Net revenues from our skincare brands grew by 49.2% year-over-year representing 33.4% of total net revenues for the second quarter, compared with 14% for the prior year period. Total net revenues from Dr. Wu, Yvlon, and Glenit collectively achieved year-over-year growth of 112%, supported by growing brand recognition, strong hero products, and a successful ramp up across multiple e-commerce channels. Our skincare brands also exhibited superior growth margin and net profitability levels compared to our color cosmetic brands and proved highly resilient during this period of economy uncertainty in China. Notably, Dr. Wu became the largest and the most profitable skincare brand in our portfolio. driven by stellar performance of the classic Mandelic Axis series, which topped the anti-acne serum chart on Tmall during the June 18th shopping festival. Furthermore, Dr. Wu's sales through Douyin live streaming grew by more than eight times compared to the prior year period, and the new triple action repair serum became the top-selling skin repair salon on Douyin during the June 18th Shopping Festival. Yiflong ranked number one on Timor during the June 18th Shopping Festival in the premium makeup removal category. On the branding side, following a well-received brand-relaunched media campaign in late April, Yves Long hosted a number of live events in London's Covent Garden and in New York's Soho District to provide an immersive offline experiential touchpoint for our customers. In May, Yves Long launched a new foaming cream cleanser, which improves upon traditional cleansers with an asthmatic-infused surface active formula. representing our latest efforts to expand Yves Long into mainstream skincare categories, beyond its roots in makeup removal. Last but not least, Galanit continued to demonstrate robust growth on the strength of its core vitamin C serum synthesis. During the second quarter, Galanit launched the Secret Excellence Snow Algae Anti-Aging Serum, and a summer limited edition gift set for the Vitamin C series. Accompanied by branding campaigns featuring the Chinese women's cohort, a short-distance speed skating gold medalist, Xu Chunyu, award-winning female surfer, Monica Guo, and a female free diving champion, Vika Li. As you can see, Our skincare business is growing from strength to strength, attachment to our ability to translate our accumulated experience and know-how from color cosmetics into success in the field of luxury and premium skincare. We have sponsored a truly global team to organically develop and grow our skincare brands. Our open lab system and our R&D teams are also building the capability to develop a strong pipeline of new products to support the growth of our clinical and skincare brands. Notable R&D breakthroughs during the quarter include the successful launch of the Triple Action Serum for Dr. Wu and the Anti-Aging Snow Algae Serum for Galanique, which featured active ingredients and formulations developed with significant contribution from our R&D lab. The Triple Action Serum, for example, was developed in partnership with the Huazhou University of Science and Technology, and both are nano-targeting technology, enabling the precise release of active ingredients directed to an acne inflammation spot deep under the skin layers for an increase in efficacy compared with fire product series. The anti-aging snow algae serum featured our work with botanicals, combining a high concentration of inclusive snow algae originating from Swedish permafrost regions with Yassin's blend of hetalpeptide to achieve higher efficacy in anti-wrinkle and anti-aging applications. The successful launch and commercialization of these products shows that our R&D teams can develop new products that suit the needs of our growing brand portfolio in an expenditures and effective manner. Our color cosmetic brands, on the other hand, saw a 50.5% decline in total net revenue. led by a slowdown in our Perfect Diary and Little Ondine brands. Perfect Diary launched several new products in the second quarter, such as the Roll Gemstone Eyeshadow, Lipstick, and Blush series, as well as the new Rimmie Lip Crush Collection and the Love Confession Lipstick Gift Set Collection for the May 20th Chinese Valentine's Day campaign. These new product launches were impacted by the clinical downturn in consumer color cosmetic spending, as well as intense market competition among the mass segment. The resurgence of COVID-19 also adversely impacted ProfitDiary's offline store sales and profitability. necessitating an acceleration of our store optimization plans. As of June 30, 2022, we operated a total of 228 proprietary stores, a net reduction of 58 stores since the beginning of this year. Given the worsening retail environment in China, we plan to close additional underperforming stores in the second half of 2022. We will continue to monitor the offline retail environment on an ongoing basis to determine if further store closures are needed. We are also exploring other ways to serve our offline stores' customers profitably. Both TeamBear and LittleOndine, for example, expanded their distribution with KK Group to more than 300 TKV and colorist stores across the nation in the second quarter, which generated additional incremental revenue and profits for the two brands. Going forward, we will look to replicate this success and further expand collaboration with other distribution partners. Due largely to the elevated levels of promotions during the June 18th period, particularly for the color cosmetics, our overall gross margin declined to 62.9%, a decrease of 2.9 percentage points compared with the prior year period. Our gross margin was also impacted by an inventory loss of RMB 43.9 million, representing 4.6%, of total net revenue. Now let's have a look at our cost. By far, the largest piece of our operating expenses was our selling and marketing expenses, totaling RMB $602.5 million for the second quarter on a non-GAAP basis, which decreased by 34% 5.7% year-over-year, the same rate as our revenue reduction. However, as a percentage of total net revenue, our non-GAAP selling and marketing expenses remain elevated at 53.3% for the second quarter, compared with 61.4% for the prior year period. attributable to higher operating cost ratios of our offline stores, certain store closure related expenses, and the provision of RMD $28.7 million for further store closures in the second half of 2022. This store closure provision represents 3% of our total net revenues. Our elevated Score-related expenses offset the effect from the reduction of our performance-based marketing expenses, which declined substantially as a percentage of total net revenue in the second quarter. Our non-GAAP general and administrative expenses recorded a net reduction of RMB 18.7 million compared with the prior year period. Though as a percentage of total net revenues, they increased by 3.5 percentage points to 12.6% due to the deleveraging effect from the reduction in our revenues. In addition to optimizing our fixed expenses, we have further changed our total headcount in the second quarter our fulfillment expenses remain flat as the percentage of total net revenues, despite operational disruption stemming from COVID-19. Overall, our non-GAAP net loss margin of 21.8% reflects the exceptionally challenging external environment in the second quarter, as well as the numerous initiatives we took to adjust our business with inventory loose and the store closure provisions totaling 7.6% of total net revenues. As we look back at our second quarter, we see it as an arduous chapter in our five-year development journey, a crucible from which a stronger and a more resilient Yasen will emerge. We generated a net cash inflow for operations of RMB 111.9 million, the first positive quarterly net cash flow recorded since our IPO, and ended the second quarter with RMB 3.06 billion of cash and a short-term investment. While we expect the external environment to remain challenging in the near term, we have ample financial flexibility to meet our strategic objectives and continue our journey of evolution. With that, I will now turn the call over to our CFO, Donghao Yang, to discuss our financial performance. Thank you, everyone.

Thank you, David, and hello, everyone. Before I get started, I would like to clarify that all financial numbers presented today are in Lumindi amounts, and all percentage changes refer to year-over-year changes unless otherwise noted. Total net revenues for the second quarter of 2022 decreased by 37.6 percent to 961.8 million RMB from 1.53 billion RMB in the prior year period. The decrease was primarily attributable to a 50.5% decline in net revenues from our color cosmetic brands, partially offset by a 49.2% increase in net revenues from our skincare brands. Growth profits for the second quarter of 2022 decreased by 40.3% to $598.3 million from $1 billion in the prior year period. Growth margins for the second quarter of 2022 decreased to 62.9% from 65.7% in the prior period. The decrease was primarily attributable to elevated levels of promotions during the June 18th shopping festival and an inventory loss of 43.9 million RMB. Total operating expenses for the second quarter of 2022 decreased by 38% to $875.3 million from $1.41 billion in the prior year period. As a percentage of total net revenues, total operating expenses for the second quarter of 2022 were 92% as compared with 92.6% in the prior year period. Fulfillment expenses for the second quarter of 2022 were 69.7 million as compared with 118.1 million in the prior year period. As a percentage of total net revenue, fulfillment expenses for the second quarter of 2022 decreased to 7.3% from 7.7% in the prior year period. The decrease was primarily attributable to a reduction in share-based compensation corresponding to a decrease in fulfillment headcount. Selling and marketing expenses for the second quarter of 2022 were $625.7 million as compared with 972.5 million in the prior year period. As a percentage of total net revenues, selling and marketing expenses for the second quarter of 2022 increased to 65.7% from 63.8% in the prior year period. The increase was primarily attributable to higher operating cost issues of our offline stores responding to our depressed offline store sales. as well as store closure related expenses and the provision of 28.7 million RMB for further store closure in the second half of 2022, partially offset by a reduction of our performance base and brand marketing standards. General and administrative expenses for the second quarter of 2022 were 147.8 million RMB as compared with 286.4 million in the prior year period. As a percentage of total net revenues, general and administrative expenses for the second quarter of 2022 decreased to 15.5% from 18.8% in the prior year period. The decrease was primarily attributable to a reduction in share-based compensation, corresponding to a decrease in general and administrative headcount. Research and development expenses for the second quarter of 2022 were $32 million, as compared with $35.2 million in the prior year period. As a percentage of total net revenues, research and development expenses for the second quarter of 2022 increased to 3.4% from 2.3% in the prior period. The increase was primarily attributable to the deleveraging effect of lower total net revenues. Loss from operations for the second quarter of 2022 decreased by 32.4% to 277 million RMBs from 409.9 million in the prior period. Operating loss margin was 29.1% as compared with 26.9% in the prior year period. Non-gap loss from operations for the second quarter of 2022 increased by 3.2% to 218.2 million RMB from 211.4 million in the prior year period. Non-gap operating loss margin was 22.9%. as compared with 13.9% in the prior year period. Net loss for the second quarter of 2022 decreased by 32.4% to 264.3 million RMB from 391.2 million in the prior year period. Net loss margin was 27.8% as compared with 25.3% 7% in the prior year period. Net loss attributable to Yeltsin's ordinary shareholders for diluted ADS for the second quarter of 2022 was 0.43 RMB as compared with 0.62 RMB in the prior year period. Non-JET net loss for the second quarter of 2022 increased by 6.5% to 207.5 million RMB from 194.9 million in the prior year period. Non-GAAP net loss margin was 21.8% as compared with 12.8% in the prior year period. Non-GAAP net loss attributable to yesterday's ordinary shareholders for diluted ADS for the second quarter of 2022 was 0.34 RMB as compared with 0.31 RMB in the prior year period. As of June 30, 2022, the company had cash, restricted cash, and short-term investments of 3.06 billion RMB as compared with 3.14 billion RMB as of December 31, 2021. Net cash generated from operating activities for the second quarter of 2022 increased by 241.6% to 111.9 million RMB from net cash use in operating activities of 79 million in the prior period. For the third quarter of 2022, the company expects its total net revenues to be between 738.4 million RMB, and 872.7 million. We're presenting a year-over-year decline of approximately 35% to 45%, primarily due to the continued softness in market demand for our color cosmetics. These forecasts reflect the company's current and preliminary views on the market and operational conditions. which are subject to change. With that, I'd now like to open the call to Q&A. Operator?

Thank you. We will now begin the question and answer session. To ask a question, you may press star then 1 on your touch-tone phone. If you are using a speaker phone, we ask that you please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. And for the benefit of all participants on today's call, if you wish to ask your question to management in Chinese, please immediately repeat your question in English. Today's first question comes from Justin Wei of Morgan Stanley. Please go ahead.

Thanks a lot for taking my questions. The first question, I want to start with the guidance. The third quarter guidance in terms of the revenue, the decline magnitude is quite similar to the second quarter. But considering I think the COVID situation is probably is, you know, worse is over. And I think the base will be also lower into the second half and the third quarter. So, you know, understand that. Don't talk about the softness in color cosmetics we're just wondering if there's you know more information behind this guidance and maybe you know management could share some of the near-term trend third quarter today um you know and maybe by channel or by by products or by category you know what kind of softness um or you know that we are talking about and a second question regarding the gp margin So I think this is probably the second quarter that we have this inventory loss or the inventory provision. So I'm not sure if we have this number to share regarding the inventory age structure, like how much sort of a little bit aging inventory that we're still seeing that can potentially still be written off in the coming quarters. And also regarding GP margin, I think it's encouraging to see the revenue contribution from the skin care is increasing. And so I think it's probably on the direction to reach to almost like half of the business coming from skin care. So how should we in the longer term or maybe next year or so think about the GP margin for the company? Thank you.

All right, thanks for the question. First on guidance, the overall cosmetics market in China has experienced a very sharp decline, starting from the beginning of this year. Well, some of that was related to macroeconomy, the global situation, and some of that also was due to the COVID-19 situation, especially in Shanghai and areas around Shanghai. Even today, you may also know that in a lot of the areas, regions in China, the COVID-19 situation is still very serious. For example, today, I think in some of the northwest and southwest provinces in China, people are so restricted from traveling due to the resurgence of of the COVID-19 pandemic. So that's about the overall market softness that we've experienced this year. And if you compare our Q3 guidance versus Q2 that you've mentioned, our Q3 guidance is very similar to the level of Q2. Actually, to us, we view that as a very positive signal. That means the business has stabilized you know, from the trend of a sharp decline starting from, you know, the beginning of this year. And so that's one thing, you know, our overall business is stabilizing. And also, you know, the softness of our color cosmetics business, you know, is to some extent offset by our strong growth in skin care. So that's why, you know, we're giving this guidance level similar to that of Q2. And you talked about our GDP margin and aging of inventory. We're not providing that kind of detail for our inventory, but what we can tell you is we made a provision of 44 million RMB for obsolete inventory in Q2, which is quite a substantial number. And we do have a provision policy as part of our overall accounting policy, and going forward, you know, we'll continue to make provisions as required by our policy. David, Irene, do you have anything else to ask? Irene Aihie, Yeah, sure.

So, yeah, all that guidance, basically, I think it's we're providing this based on our estimation of both the external and internal factors, and then we have to look at it by different product category, right? For example, on the color cosmetic side, Donghao has mentioned external environments. We see a resurgence of the COVID, which continues to impact consumer confidence. And also, the unemployment rate among the young generation these days are also impacted by the COVID situation, which those people are core customers. So that continues to impact the color cosmetic market, which we could also see in the July overall China beauty retail spending is still negative growth year over year. That's on the external side for color. And internally, as we're still going through our strategic evolution, we're still really focusing on high-quality revenue for those color cosmetics brands. So right now, because of this refining of our business model, we could still see, you know, decline in the color cosmetic segment of our business. And on the skin care side, we had a very strong growth in Q2. And for skin care, because it's highly seasonal, normally Q2 and Q4 are the major seasons for skin care, because consumers tend to stock up during large promotions. So for Q3, we think we continue to see growth in skin care. But given it's kind of a quiet period for the e-commerce That's why we are also providing this guidance. That's kind of just some additional points on the guidance side.

One other thing to add. You just asked about the impact of the growth of our skin care business on the growth margin trend. Obviously, our skin care business has a much higher growth margin level than our color cosmetics. The difference could be as big as 10 percentage points. So as we continue to grow our skincare business, as the skincare business continues to take more shares in our total product mix, we believe that we will continue to see improvement on our gross margin.

All right. Got it. Thanks a lot.

And, ladies and gentlemen, our next question comes from Quanye Lin with CICC. Please go ahead.

Thanks for taking my questions. I have two questions. The first one regarding selling and marketing expenses. As industry competition intensifies and some international brands also lower their price, which exerts great pressure to the domestic brands. So could the management give some color on your plan for marketing and promotion in the second half of 2022? And how do you see the trend of the assets selling in the marketing census as the percentage of total revenue in the second half of the year? And the second question regarding organizational structure, as the growth of this brand's portfolio Could you give some color on how you allocate resources and talents among different brands?

Well, thank you very much for your question. First, on the selling and marketing, you know, we compete, of course, with other, you know, overseas brands as well as those domestic brands. not only on selling and marketing, but also we are making very big investments in our R&D capabilities. We wanted to improve the efficacy of our products and to make it one of our biggest competitive advantages going forward. For the second half of this year, I believe the selling and marketing expenses as a percent of revenue will most likely stay at a relatively stable level, meaning you won't be seeing a sharp increase in our selling and marketing expenses to drive sales growth because, you know, we, for the long term, you know, we do believe that product efficacy and our investment in R&D will be, you know, the most important drivers of our future business growth. And organization structure, you know, how do we allocate our talents? Well, it depends. You know, for our skincare brand, I think, you know, we will allocate or we will assign, you know, our talents in marketing and branding most likely to those brands. And R&D, you know, we're going to allocate more, you know, R&D dollars or talents for in our skincare brands. And for color cosmetics, maybe more operational. And also, branding is also very important. So it really depends on the specific brand and market segment and product categories and et cetera.

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

Thank you.

And ladies and gentlemen, as a reminder, please press star then one to ask a question. Today's next question comes from Olivia Tong with Raymond James. Please go ahead.

Hi, this is Devin Weinstein on for Olivia. I appreciate you taking our questions. First, just wanted to ask a little bit more about the competition that you're experiencing. One, how would you compare it to prior quarters and perhaps how are you looking at it going ahead? And then I want to specifically ask about the level of promotional activity that you experience during the 6-18 event and how you're expecting it to evolve for 11-11 and any preparations that you're making for that.

Yeah, sure. So most of the competitors, you know, public listed companies have reported their Q2 as well. we're seeing a soft season for most of the competitors, which is kind of demonstrating our thesis on the overall demand for the beauty industry in China has been impacted by the ongoing COVID and also consumer confidence issue. The competition is still quite intense. Ever since last year, we're actually at the beginning of the COVID, whereas there's more pressure for the international players on there to meet their targets. So their sales and promotions have been strong, which is still the case. Going forward, we think as COVID, if, you know, after this year could become more of what will pass COVID, then such level of promotion we think could ease in future. So that's angle number one. Nowadays, it's not only competition based on promotions, right, and also not only on branding, but more, as Dong Hao mentioned, on efficacy of the product. We're seeing, for example, recently some of international companies reported their financials, some strong, some less strong, and you can see because of the difference of accuracy of the products, right, especially for skin care, if the brand portfolio has brands which are more focusing on efficacy-based products, then the performance tends to be stronger in the Chinese market because these days consumers and QLs are more sophisticated in terms of formulation and gradients. So we think, as we mentioned, the three of the recently acquired skin care brands in the efficacious and also premium category and Dr. Wu, the growth is over 100% for Q2, which we think because of the position are very in trend in China, we'll continue to see a strong growth of those brands.

Thank you. Thank you. I appreciate that. And if I could just sneak in one more. I just wanted to ask, I realize the shutdowns and the lockdowns from COVID impacted you Was there any material impact from Hainan on your business?

What?

So just wanted to clarify, you mean the duty-free of the Hainan sales, right, given the recent lockdown of Hainan?

Correct. I was curious what impact that is having on your business, that area specifically.

Yeah, it's relatively small for us because, you know, only premium and large risk in care only have large distribution in Hainan. We do have distribution of Eve Loam in Hainan right now, but still relatively small contribution to the overall revenue as most of our business are still in the mass and the message segment.

Okay, very helpful. Thank you so much for the answers. Thank you.

And ladies and gentlemen, as a final reminder, if you would like to ask a question, please press star then 1 at this time. And everyone, this concludes our question and answer session. I'd like to turn the conference back over to management for any additional or closing remarks.

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

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.