istyle Inc. (3660) Earnings Call Transcript & Summary

Thank you for joining us despite your busy schedule. I'm Yoshimatsu, President and CEO of istyle. Now I'd like to start the financial results meeting for the second quarter FY 2021. I would like to review the period up to the previous year, and let me explain the present phase. Five years ago, the midterm business plan was presented, and the plan is divided into 4-year phase. After facing the performance deterioration in 2019 during our investment expansion phase, we had to review the strategy and extended investment pace by 1 year. During the period, COVID-19 pandemic hit us. It overlapped with the timing of expansion acceleration when we rolled out stores in November and December 2019 in Hong Kong and opened a large flagship store of @cosme Tokyo, and this is where we are. In the meeting for the previous fiscal year's financial results, we withdrew the midterm plan, and now we have to make a strong company, which can respond to COVID-19 flexibly. And I would like to present the overview of the second quarter financial results at this juncture. First half. As for the cumulative results for the first half, net sales were JPY 15.615 billion. It was 98% of the previous year, coming close to the previous year's level, even in the very tough condition. Operating profit substantially improved from the large loss in the previous year. On Platform sales were down year-on-year to 87% of the previous year. Beauty service sales were 120% of the previous year. It grew due to the contribution by e-commerce, even in the very tough condition. In global, direction changed from investment expansion and through the restructuring and withdrawal from the unprofitable businesses, loss has been contracting drastically. In other business, business condition has been very tough due to COVID-19, but the staffing business turned profitable. Progress against the plan. Indonesia plan, 3-year sales targets were set at JPY 37.2 billion and the progress against that was 42%. As the assumption for the plan, we had expected that COVID impact would be subsiding in the second quarter from October to December. And from the turn of the year in the third quarter, profitability had been expected. This plan was set in July last year, and the situation turned more difficult due to the second and third spike of COVID-19, but still in the first half, losses contracted compared to the initial plan. Cumulative sales in the first half was 98% of the previous year, almost coming back to the previous year. From here, detailed second quarter information will be provided. Sales in the second quarter alone were 100.9% of the previous year. As you can see in this chart, January to March 2020 was the third quarter, and April to June was the fourth quarter of the previous year, and we are recovering from the worst time. Sales by segment. Sales in On Platform was 88.9% of the previous year, and it is still in very tough condition. In the advertisement service, due to the performance deterioration of cosmetics makers, our clients, because of COVID-19, whole cosmetic industry has been hurt, and their budgets turned more conservative. Just the other day, leading domestic cosmetic makers announced financial results, but they secured profitability through cost reduction, including advertising costs. And given that, the tough condition for us continues. But even under such circumstances, profit returned to pre-COVID level through cost reduction. Beauty service business. Sales increased drastically to 125.7% of the previous year, contributed by the strong growth of e-commerce. As you see here, declaration of emergency was issued in the fourth quarter of the previous year, and stores were closed and customers moved to e-commerce, pushing up sales drastically, and the positive contribution remains. When the degradation of emergency was lifted, customer traffic returned to stores and sales recovered sharply from the level of fourth quarter in the previous year. In January, a large flagship store @cosme Tokyo rolled out, and that also pushed up sales much higher than the previous year. Global business, originally, aiming to achieve the midterm business plan target. Active investments in the investment phase have been carried out in many countries, up to the second quarter in the previous year. However, overseas business environment began to change substantially in the last 4 years. For example, regarding the strong growth of Chinese companies and their expansion into Southeast Asia. Due to that, our plan didn't progress as we initially planned. While we were reorganizing unprofitable businesses, COVID-19 pandemic happened last year, prioritizing reduction of losses, we are reorganizing businesses which were still in the growth phase. As a result, with some sales decline, we were able to reduce losses substantially. Other business. Investment in the consolidation business was sluggish, and sales in the staffing business also declined due to COVID-19, but staffing business recovered to post profit through the cost control. SG&A was 88.9% of the previous year. When we compare the fixed cost, excluding product sales-related cost in a part of variable cost, which increased in line with the growth of e-commerce, it fell substantially to 81.9% of the previous year. Operating income by segment. Reorganizing unprofitable businesses to respond to this emergency, some businesses turned to be profitable. But as a whole, operating income was still negative, minus JPY 384 billion. Latest status of operating services. Monthly active users of @cosme recover to JPY 14.5 million. Due to algorithm changes of Google, it vary temporary, but gradually SEO measures began to deliver results. Number of @cosme's members has been growing steadily. Connection, which shows connection between clients and users, has been growing steadily as well. Next, I'd like to review the first half of FY 2021. This slide shows the segments and the services of our group, except a large flagship store and overseas stores, mainly in Hong Kong, in the first half overturned to be profitable. As for On Platform, amid the tough condition were clients' budget grew more conservative due to cost reduction, operating profit ratio returned to the level of the previous year. As for the number of contracts for brand official, it has been increasing up to the third quarter of the previous year. But from the fourth quarter, with the more notable COVID 19 impact, it began to decline slightly due to increasingly conservative budget of cosmetic makers and brand and some brands discontinued contract. But the target for the end of the fiscal year remains unchanged as 300, and we'll continue to pursue this. Sales of stores. Year-on-year growth was achieved due to the rollout of a large flagship store, but existing store sales decreased to 88.5% of the previous year. As for the operating income of stores, existing stores returned to the profitability with 88.5% sales of the previous year. This is due to the operational review and cost reduction, but due to the large scale of our flagship store as a whole, still loss was incurred. E-commerce sales increased substantially. In order to expand the EC market of small-scale cosmetics, we have been organizing e-commerce specialty in December every year. Partly due to the contribution of this event, sales increased 3.5x of 3 years ago, and the current quarter sales have grown to over JPY 2 billion. Sales of global contracted due to reorganizing and withdrawal from the unprofitable businesses, but except overseas stores, basically, businesses returned to profitability. As a part of selection and concentration, though it was hard, we decided to sell Helmo, a Mauritian EC company and 2 pull out stores in Thailand. We are in the process of reducing losses steadily. To summarize, except a large flagship store and overseas stores, even under COVID-19, our services basically returned to profitability, and we acknowledge that the worst phase was over, and we were heading for the recovery in the first half. As for the consolidated operating income in the second quarter, we posted loss of JPY 384 million due to loss of a large flagship store and overseas stores and temporary promotion cost of easy special event, but with some improvement in the situation, profitability will be achievable. Although in the initial plan, we projected that COVID-19 impacts will be over in the second quarter, and from the second half, we will be back to the growth track. But due to the third spike of the COVID-19, business sentiments have been worsening further. Given it will be difficult to achieve the initial target due to these reasons, we decided to withdraw the full year business forecast. And we'd like to announce the revised forecast after careful assessment of COVID-19 impact. Currently, entire cosmetic industry is sluggish. But when they recover, I believe we would make the significant recovery. Major businesses that showed disparity between plan and the result: advertisement, brand official, stores and stores in Hong Kong, by recovering these businesses, we would like to move forward in the second half. I have been through the financial results of the second quarter FY 2020. Next, I'd like to talk about outlook for cosmetic industry and the future direction of istyle. Let me talk about the potential of istyle and the value of the assets istyle has built up with a changing business environment from our perspectives. I talked about that review up to the previous fiscal year, affected by COVID-19, we withdrew the midterm plan, changed the policy from business expansion through investment to reorganization of unprofitable businesses and losses have been contracting substantially now. How do we view the impact of COVID 19? We think that it accelerates the change in cosmetics industry by 10 years. In terms of shift to EC, promotion of digital transformation at stores and integration of off-line and online, despite the past slow progress for a long time, now makers seem to make drastic advancement. And we feel that they are coming closer to what we have envisioned. Now istyle faces major questions. Does off-line business leads to improvements in profitability? Thus, a large flagship store have higher growth potential than the risk. Financial figures shows that the [indiscernible] out from the off-line store would lead to profitability. But we are examining its value once again. Looking back the last 20 years, we enhanced convenience and increased value through the shift from off-line to online. And we have been promoting a business with a belief that integration of off-line and online would create new value in the future. Present state and the outlook of the cosmetics industry. As for the changes in cosmetics industry, as you know, e-commerce has been growing, large makers are promoting digital shift in the marketing and digital-native emerging brands, D2C are increasing. I think you are familiar with all these already happening these things. Then what will happen from now? First, with the growth of EC, business model restructuring in retail business is expected. Second, with digital shift in marketing, budget will be shifted from advertising through mass media to sales promotion cost for retailers which have more selling power. Third, with the rise of digital-native brands, the value of off-line will be reexamined and pursued. E-commerce has been growing substantially. EC business of companies has been expanding as shown in Rakuten and Amazon. The other day, ZOZO cosme announced the business launch, and EC in cosmetics has been expanding as well. This indicates that even when coronavirus is contained, market size of off-line store would not recover to the previous level. In cosmetics, with the growth of the e-commerce market, it is difficult to increase profit in off-line stores. In order to be profitable in such circumstances, digital transformation would be definitely required, but to secure profit to invest there only by off-line stores will be difficult. Given companies with off-line stores would find it difficult to develop business only through off-line stores as before, new business model will be required, can be applied to department stores, drugstores and cosmetic specialty stores. istyle is also compared with drugstores, but the biggest competitor for drugstore is e-commerce. So to compete, they need to increase daily customer traffic. And to this end, they need to enhance daily food stuff supply, competing against supermarket and convenience stores. And I think they will shift investment into digital. We are also aware of the imminent needs to change business structure of off-line stores. Second point is significant, and that is the shift in budget from advertising to sales promotion cost. With the growth that we see, communication with users is now online, and cost effectiveness of advertising in mass media has decreased because of lack of sales in off-line stores. Therefore, advertising budget will shift to retailers with sales capabilities in the form of sales promotion expenses. Pre COVID-19, makers posted large advertisement in mass media to increase sales of retailers, and retailers decided their purchase based on this. But now advertisement-effective mass media weakened, and the digital media is gaining presence, and the budget previously allocated for advertisement shifts to sales promotion cost for retailers. These sales promotion expenses cover not the point or the coupon issuance cost, but wider communication costs through digital media or apps of retail stores. COVID-19 promoted a shift in budget from advertisement to sales promotion cost, in addition to the digital shift from mass media to web media. Third one is emerging brands expansion into off-line store business with their growth. As you know, D2C brands are emerging. We discussed in the company, if we compare the last 10 years and upcoming 10 years, which would see more brands emerging? And we think upcoming 10 years, we'll see much more brands emerging by far. This is because the environment is now prepared for small lot. And marketing, manufacturing and the logistics are available with small cost. And that enabled the digital-native new brands to start business. But only with online business, cost per order would eventually peak out and core user pool to acquire will be limited. Competition only with EC would be difficult. And in terms of new customer acquisition and to communicate value of experience, the value of off-line stores is increasingly appreciated. Some brands, which started as digital and now gaining new customers through selling products off-line. In that sense, for emerging brands, off-line stores, where customers can try products and experience, would be extremely important. And I think M&A by large makers would be accelerated further because it would be increasingly difficult for large maker to start a brand from scratch in terms of cost effectiveness. I think they would rather acquire an emerging brand and leveraging assets and resources of a large manufacturer, they would develop business, including off-line store business. Large manufacturers have been promoting portfolio management through M&A. And I think with this, entire structure of the cosmetics industry began to change substantially. To summarize, retailers need to change their business model substantially due to growth of e-commerce. This a shift in marketing and emerging new brands. Focus should be on sales promotion expenses rather than advertising cost. And with the growth of digital-native brands, new potentials of off-line stores are emerging. Then what will be the requirements for a more competitive company? First, retailers needs to be restructured with dominant sales capability through off-line and e-commerce. Given the shift from advertising cost to sales promotion cost, sales volume only through e-commerce may not be sufficient and dominant sales capability, including off-line, might be required. On the other hand, growth only through off-line will be difficult, but earnings should be gained through e-commerce growth. Secondly, only companies with earnings models, which enables investment in off-line, can gain share in off-line store and market. Walmart growth in the U.S. is notable. In the United States, largest digital investment is spent by Amazon, followed by Google. And the third one is Walmart. Walmart did not open a single store in the previous year but spent for digital investment. It means that they invested in digital heavily to prepare for the investment in off-line stores, and then they would expand off-line store businesses drastically. Without the environment to be able to invest in off-line stores, you cannot grow from now on. Thirdly, seamless user experience, both in online and off-line would be required. Border between online and off-line is disappearing. So having dominant selling power, combining e-commerce and off-line stores and creating seamless experience there will be key requirements to become more competitive. Bearing those in mind, what are istyle's advantages? Do things we have accumulated so far truly have values? Present istyle is strengthening selling power, combining stores and EC. We are #1 cosmetic specialty store and #1 EC in cosmetics, but our sales cannot be described as dominant. Selling power in EC and stores supports our earnings model to invest in off-line stores. And this is our advantage. And we have been exactly developing seamless user experience over years. By identifying the strengths and advantages of our assets @cosme, I think we can find a future direction. How should we position these three assets? So far, we positioned media of @cosme in the center. With this, we gained advertising revenue and sent customers to EC and stores, and we valued them. But at this juncture of COVID-19, we examined the strength of our assets from different perspectives and found out that this service has a platform to connect online and off-line. What we do does remain unchanged, sending customers from media to e-commerce and building seamless link between media and stores. Because of this sales of EC and stores are growing strongly, even under COVID-19, when the entire cosmetics industry has been suffering. In most of cases, where a company of off-line base started e-commerce, EC conversion rates will be single-digit percentage. Then istyle has a great advantage of having 2 pillars of e-commerce and off-line stores, and have created user experience. And in the geographical area of our off-line store, number of e-commerce users tends to be high. Having lots of e-commerce and off-line stores from the early stage, serves as a great advantage under the current environment. Up to now, expansion of media scale was important, and it was prioritized in investment strategy. Of course, the media scale is still important, but it would not push up the advertisement contractor drastically, strengthening selling power in EC and stores will be a key factor to be a partner in cosmetics marketing. And it will be important to focus on this point. Then there will be next questions. How important is media @cosme? Isn't it enough to have social networks? If selling power matters, how can you compete against Amazon, Rakuten and ZOZO eventually? EC market expanded addressed during the last 10 years. If we want something, you can consider off-line and purchase there. And similar things are recommended with the environment, you can buy them immediately. So far, the strength of e-commerce was that without going to stores, you can buy things conveniently and reasonably online. But in the era of COVID-19, social media contributes greatly to the process where user who has not yet decided what he or she wants, goes through to purchase. This process can be divided into two: process of deciding what you want and the process of purchase. If you are not sure what you want, you'd surf around Instagram, YouTube and find something and that leads to purchase. After this, you would read words of mouth and official information of brands and think you'd try one. And without further search, you'd buy right away. This process of deciding what to buy, while your want is not clear, is growing increasingly important in social media. The great value of @cosme is that information of your interest or accurate information is available. Ranking is also useful. Many people who are not sure what to buy, look at ranking often to the decide, and this is an important factor in the process. What matters is not the scale, but the process to decide and its seamless link to purchase platform. Therefore, the scale of @cosme will continue to be important for us. But another important point is reliability in media information, and that importance has been increasing. It is well reflected in this data, a Word of Mouth, the number Word of Mouth in 2020 last year was the second highest in the history of @cosme. The record high was in 2011, the year of the Great East Japan earthquake. You can post Word of Mouth for cosmetics in many places, Instagram, YouTube and Twitter besides @cosme. Then what is important is not the volume, but the quality of information. Brand equity of @cosme has been increasing, and this would be an overwhelming value for us. As for how we view off-line stores, I talked about the process to decide what I want. But the place you'd visit while you're not sure about what you want would be off-line stores, browsing around, touching products and through experience and counseling, you will come to purchase products. The process to decide what you want is realized in our large flagship store, @cosme Tokyo. Unlike department stores and others, product lineup is unbelievably extensive to cover from mass brand to departments towards brand. And you can encounter with the popular brand supported by popular ranking through Word of Mouth. I think online store network has great affinity with off-line stores. Then what are advantages of @cosme? Social network online and experienced stores are beginning to be connected. As for the words of mouth, products widely supported by words of mouth, are readily available at stores, and their product lineup reflects Word of Mouth online. And due to the connection of online and off-line, customer information and data are consolidated and managed, and this connection is of overwhelming strengths. Another strength of @cosme is that everything is specialized in cosmetics. When you come to @cosme, you'll find overwhelming strengths in product lineup and information volume, and they are our strengths. Media of @cosme has a process to decide what you want. EC is a process of purchasing and off-line stores have both of these functions, and they are connected seamlessly, and this is the strength of our business model, not only the sales through e-commerce. We believe that this communication is a pillar of the business and the point we need to pursue. Challenges and action of istyle. What we need to do now is reorganization of unprofitable business and strengthening financial base. After realizing them, the action we need to take is, first, [ broad ] expansion of e-commerce, and we will definitely achieve this. Second is to rebuild the investment policy, along with the store development. Stores were adversely affected by COVID-19. But without closing them, I would like to use them as major fire powers. Of course, we will not make any major investment immediately. But by reorganizing new investment policy, I'd like to think about the future development of stores from now on. And we have sales promotion services, which are combined with advertising and brand official, which enabled us to do analysis on user behaviors, and we are focused on them. And finally, we will make data more openly available through data connections with cosmetics makers and brands. We were not able to work on this sufficiently before, and we like to promote this more actively. What is important for us is not mere profitability, but to move forward further. We have already achieved profitability in businesses, except a large flagship store and overseas stores. Now we'd like to focus on establishing a key position in the future market, leveraging our variable assets. To that end, it is essential to improve profitability so that we can maintain the existing businesses, and we need to prepare environment for the time when COVID-19 will be gradually subsiding to accelerate business promptly. As a first step to that end, previously separate companies of EC and off-line stores will be merged into the new company, istyle retail. When we started the cosmetics sales business initially, some cosmetics companies did not agree for contracts because they were worried that products sold at off-line stores might be sold at online when e-commerce company starts off-line store businesses. To wipe out such concerns, we had separate companies. However, affected by COVID-19, we decided to merge to promote actively that environment for marketing, which entails advertising and the sales promotion, both of them. We established the business model that online and off-line are seamlessly integrated. And today, we believe that this will lead to further value in the future. Finally, istyle's direction. As for future direction, so far, we have been focusing on cosmetics. But under COVID-19, we found that potentials are expanding beyond cosmetics to wider scope of beauty in general. While makeup products were not selling well, skin care product sales increased. In terms of time access, scope expands to Asian care, which extends throughout life. And cosmetics are not only for women but for men and people of diverse genders, genderless products. They indicate the expanding beauty market. Cosmetics companies are not only selling products of cosmetics, but offering beauty services. I describe this as beauty as a service. In the changing environment, future potential of istyle's platform are expanding further. We will overcome current situation and return to profitability promptly, sustaining the current real value. And when the environment recovered, we would like to make a big step forward immediately. This concludes my presentation for the overview of financial results for the second quarter FY 2021 and the outlook for the cosmetics industry and the future direction of istyle. Thank you for your attention.