RLX Technology Inc. Q4 FY2020 Earnings Call

Hello, ladies and gentlemen. Thank you for standing by for RLX Technology Inc.'s Fourth Quarter and Full Year 2020 Earnings Conference Call. Today's conference call is being recorded and is expected to last for about 40 minutes. I will now turn the call over to your host Mr. Sam Tsang, Head of Investor Relations of the company. Please go ahead, Sam.

Thank you very much. Hello, everyone, and welcome to RLX Technology Incorporation Fourth Quarter and Full Year 2020 Earnings Conference Call. The company's financial and operational results were released through PR Newswire services earlier today and have been made available online. You can also view the earnings press release by visiting the IR section of our website at ir.relxtech.com. Participants on today's call will include our Co-Founder, Chairperson of the Board of Directors, and Chief Executive Officer; Ms. Kate Wang; and myself, Sam Tsang, Head of Investor Relations. Before we continue, please note that today's discussion will contain forward-looking statements made under the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. These statements typically contain words such as may, will, expect, targets, estimates, intent, belief, potential, continue, or other similar expressions. Forward-looking statements involve inherent risks and uncertainties. The accuracy of these statements may be impacted by a number of business risks and uncertainties that could cause actual results to differ materially from those projected or anticipated, many of which factors are beyond our control. The company, its affiliated advisers, representatives, and underwriters do not undertake any obligation to update this forward-looking information, except as required under the applicable law. Please note that RLX Technology Incorporation earnings press release and this conference call include discussions of unaudited GAAP financial measures as well as unaudited non-GAAP financial measures. RLX press release contains a reconciliation of the unaudited non-GAAP financial measures to the unaudited GAAP measures. I will now turn the call to Ms. Kate Wang. Please go ahead.

Thank you, Sam. And thank you, everyone, for taking the time to join our earnings conference call today. Just a little over two months ago, on January 27, 2021, we successfully listed our shares on the New York Stock Exchange and began our new journey as a public company. On behalf of the management team, I would like to extend our gratitude to our employees, business partners, and all our shareholders and stakeholders who have been following and supporting us. I believe many of you are joining us today not only to learn about our fourth quarter earnings results and full year achievements but also to hear more about our response to the regulatory developments that occurred earlier this week. We are as attentive to these developments as you are, and we will do our best to answer any questions you have during the Q&A session. Now I will talk you through our operational performance in the last year and then share our strategies going forward. Throughout last year, we remained focused on our mission and strategies, and we achieved solid results despite the challenging macro environment. First of all, looking at the overall e-vapor market in China, user penetration has been growing steadily. According to the CIC report, China's e-vapor user penetration rate grew from 0.4% in 2016 to 1.2% in 2019 and witnessed further growth in 2020. As the industry leader in the e-vapor market in China, we are well-positioned to make RELX an attractive brand for adult smokers, providing better alternatives for them. Secondly, on our commercial front, we pioneered and integrated an offline distribution and branded store plus retail model, tailored to China's e-vapor market. Under this model, we identified and leveraged a variety of distribution and retail channels to allow our products to reach adult smokers more effectively. As of September 30, 2020, we partnered with 110 authorized distributors to supply our products across over 5,000 RELX branded partner stores and over 100,000 other retail locations nationwide, covering over 250 cities in China. We have adopted comprehensive systems and methods to manage, supervise, and empower our distributors and retailers. In this fourth quarter, we achieved significant growth in terms of the number of branded stores and productivity, with an increasing number of branded store partners joining our leading network and crossing the 10,000 mark for the first time. On the other hand, we have been expanding our retail outlet network through multiple forms. More importantly, more retailers have been increasingly recognizing the benefits of selling e-vapor products and partnering with RELX. In addition to our commercial development to continually improve adult smokers' interactions with our products, we have implemented a multi-layer development framework to provide a solid infrastructure for our technology and product development. This framework involves five development layers surrounding our e-vapor products, mainly accessories, interactions, applications, user experience transition, and infrastructure, catering to the diversified needs of adult smokers. In December 2020, we introduced RELX Phantom, which embodies our latest technologies developed to holistically enhance user experience for adult smokers, including newly introduced battery capacity indicators, improved lifetime and charging speed, strengthened structural resistance to e-liquid leakages, refined airway design, and upgraded safety features. In the meantime, we have also received wide recognition for our products globally. In November 2020, RELX Infinity was granted the Golden Pin Design Award 2020. Turning to our corporate social responsibility development, we continued to uphold and practice our ethical principles, including promoting the prevention of underage use of our products. Through our industry pioneering Guardian Program, we introduced effective age verification practices to the industry. This past quarter witnessed the first anniversary of the launch of our Sunflower System, which is a first-of-its-kind technology-driven underage access prevention system in China, according to the CIC Report. The Sunflower System encompasses a comprehensive set of technology-driven best practices designed to prevent underage use through advanced recognition tools to enhance on-site age verification at retail outlets, as well as through geo-fencing technology to identify the appropriate locations for opening RELX Branded Partner Stores. In addition, we have a zero tolerance policy for counterfeit products that could jeopardize adult smokers' health and interests. To that end, we launched the Golden Shield Program to combat sales of counterfeit products in cooperation with public media and local authorities. At RELX, social responsibility is embedded into our everyday actions, operations, and systems throughout our organization. We have been caring for our user communities, partners, and employees since day one and have emphasized helping minorities through initiatives that provide better services and technological solutions to assist them with their unique needs. In this regard, we recently launched three new initiatives: one to empower female entrepreneurs and working mothers, another to assist the elderly in understanding and using technology in their everyday lives, and the third to strengthen our equal opportunity guidelines. We will continue to prioritize social responsibility in our organization because it is part of who we are. Looking ahead, we plan to further solidify our leadership by continuing to invest in scientific research, enhancing our technology and product development, strengthening our distribution and retail network, and bolstering our supply chain and production capabilities. These strategic initiatives are designed to support our growth over the long term. This concludes my part. Thank you, everyone. With that, I'll now turn the call over to Sam, who will discuss our key financial results.

Thank you, Kate. I will now provide a brief overview of our financial results for the fourth quarter and the full year of 2020. Net revenues increased by 44% to RMB 1.62 billion in the fourth quarter of 2020 from RMB 1.12 billion in the first quarter of 2020. The increase was primarily due to an increase in net revenues from sales to offline distributors, which was mainly attributable to the expansion of our distribution and retail network. Gross profit increased by 59% to RMB 694 million in the fourth quarter of 2020 from RMB 438 million in the first quarter of 2020. Gross margin increased to 42.9% in the fourth quarter of 2020 compared to 39.1% in the first quarter of 2020. Operating expenses were RMB 853 million in the fourth quarter of 2020, representing an increase of 124% from RMB 380 million in the third quarter of 2020. Selling expenses increased by 127% to RMB 197 million in the fourth quarter of 2020 from RMB 87 million in the third quarter of 2020. The increase was mainly driven by an increase in share-based compensation expenses and an increase in branding material expenses. General and administrative expenses increased by 75% to RMB 447 million in the fourth quarter of 2020 from RMB 255 million in the third quarter of 2020. The increase was primarily due to an increase in share-based compensation expenses and an increase in professional service fees. Research and development expenses increased by 442% to RMB 209 million in the fourth quarter of 2020 from RMB 39 million in the third quarter of 2020, driven by an increase in share-based compensation expenses and an increase in software and technical service expenses. Share-based compensation expenses recognized in selling expenses, general and administrative expenses, and research and development expenses in total were RMB 656 million in the fourth quarter of 2020 and RMB 238 million in the third quarter of 2020. The increase was primarily due to the increase in fair value of ordinary shares of RELX Inc. Loss from operations was RMB 158 million in the fourth quarter of 2020 compared with income from operations of RMB 58 million in the first quarter of 2020. Income tax expenses were RMB 111 million in the fourth quarter of 2020 compared with income tax expenses of RMB 77 million in the third quarter of 2020, primarily due to an increase in taxable income. Net loss was RMB 237 million in the fourth quarter of 2020 compared to net income of RMB 8 million in the third quarter of 2020. Non-GAAP net income was RMB 419 million in the fourth quarter of 2020. Basic and diluted net loss per American depositary share (ADS) were both RMB 0.165 in the fourth quarter of 2020 compared to basic and diluted net income per ADS of RMB 0.005 in the third quarter of 2020. Non-GAAP basic and diluted net income per ADS were both RMB 0.292 in the fourth quarter of 2020 compared to RMB 0.171 in the third quarter of 2020. Moving to the full year of 2020, net revenues increased by 147% to RMB 3.82 billion in 2020 from RMB 1.55 billion in 2019. The increase was primarily due to an increase in net revenues from sales to offline distributors. Gross profit increased by 163% to RMB 1.53 billion in 2020 from RMB 581 million in 2019. Gross margin was 40% in 2020 compared to 37.5% in 2019. Operating expenses were RMB 1.51 billion in 2020, representing an increase of 189% from RMB 525 million in 2019. Selling expenses increased by 23% to RMB 443 million in 2020 from RMB 359 million in 2019. The increase was primarily due to an increase in share-based compensation expenses and an increase in salaries and welfare benefits to our selling personnel, partially offset by a decrease in e-commerce platform service expenses as we closed our stores on e-commerce platforms. General and administrative expenses increased by 479% to RMB 772 million in 2020 from RMB 133 million in 2019. The increase was primarily attributable to an increase in share-based compensation expenses and an increase in salaries and welfare benefits to our general and administrative personnel. Research and development expenses increased by 837% to RMB 299 million in 2020 from RMB 32 million in 2019. The increase was primarily due to an increase in share-based compensation expenses and an increase in salaries and welfare benefits to our research and development personnel. Share-based compensation expenses recognized in selling expenses, general and administrative expenses, and research and development expenses in total were RMB 929 million in 2020 and RMB 53 million in 2019, primarily due to an increase in fair value of ordinary shares of RELX Inc. Income from operations decreased by 77% to RMB 13 million in 2020 from RMB 56 million in 2019. Income tax expenses were RMB 231 million in 2020, representing an increase of 789% from RMB 26 million in 2019. The increase was primarily due to an increase in taxable income. Net loss was RMB 128 million in 2020 compared with net income of RMB 48 million in 2019. Non-GAAP net income was RMB 801 million in 2020. Basic and diluted net loss per ADS were both RMB 0.089 in 2020 compared to basic and diluted net income per ADS of RMB 0.033 in 2019. Non-GAAP basic and diluted net income per ADS were both RMB 0.557 in 2020 compared to RMB 0.070 per ADS in 2019. Moving to the balance sheet, as of December 31, 2020, the company had cash and cash equivalents, restricted cash, short-term bank deposits, and short-term investments of RMB 3.42 billion compared to RMB 812 million as of December 31, 2019. Now turning to guidance, for the first quarter of 2021, the company currently expects net revenues to exceed RMB 2.3 billion and expects non-GAAP net income to exceed RMB 590 million. The company expects net income will also improve share-based compensation expenses, which depends on the company's share price. The company also expects gross margin to remain steady. The above outlook is based on the current market conditions, including those related to the COVID-19 pandemic, and reflects the company's preliminary estimate of market and operating conditions and user demands, which are all subject to change. Please refer to safe harbor statements in the press release for risks associated with forward-looking statements. The above concludes all of our prepared remarks today. We are now opening the call to questions. Operator, please go ahead.

Our first question today comes from Lydia Ling with Citigroup.

Hello, management. Can you hear me?

Hi, Lydia.

Hello, management. Can you hear me?

Yes. We can hear you.

This is Lydia from Citi. I have three questions. One is on the regulation side. So regarding the monthly announcement, could management share more of your views on this announcement and its implications? What do you think of the future regulatory trends looking forward in China's e-cigarette industry? And how will the company cope with these changes if anything should happen? And my second question is about expansion. The company has achieved very impressive expansion in the first quarter for the branded stores, as just mentioned. Could you also talk about the company's expansion for this year? The competition looks more intense for this year as more players ramp up their store openings at a very aggressive pace. How do you view the competitive landscape and the potential impact on your margins? And my last question is regarding the product. We noticed that the company has introduced a few new products this year and also some entry-level products. How has the feedback been so far? Could you talk about your product strategies for this year?

Sure. So I mean, there are three questions. The first is on regulations, the second is on the store plan, and the third is on our product feedback. I mean, regarding the regulations, on Monday, we are aware that the Department of Industry Policies and Regulation of the MIIT, which is the Ministry of Industry and Information Technology, made an announcement seeking public comments requiring the authority proposal to revise detailed implementation regulations of the tobacco monopoly law of the PRC. Such comments or feedback shall be submitted by April 22, which gives one month for submission of such comments. Two attachments were included in the announcements. The first attachment proposed a new rule in the implementation regulation as rule 65, indicating that the implementation rules for next-generation tobacco products, including e-cigarettes, should reference relevant rules concerning them under the implementation regulations of the tobacco monopoly law. The second attachment provided considerations for making suggestions to add the proposed rule 65. The first consideration is to advance the regulatory development of e-vapor products, and the second consideration is based on the similarities between e-vapor products and cigarettes, referencing international regulations on e-vapor products. The third consideration is to improve the effectiveness of regulating the e-vapor industry, including regulating the operating activities of the e-vapor industry and addressing potential product safety issues, false advertising issues, etc., in order to protect the rights of e-vapor users. So, I generally repeat what happened. For the Chinese reader, it gives a basic understanding of such regulation first. So from a company point of view, in response to the regulation announcement, we plan to submit our feedback regarding the proposed revision of implementation plans by April 22. We are also well aware of the considerations mentioned in the attachment, including regulating the operating activities and tackling potential product safety issues, concerns over the underage issue, which has been our focus in daily operations. However, it is premature to speculate about the potential changes on the commercial front as the regulations or the proposal amendment are still in the process of seeking public feedback. This is our response to your first question. May you repeat your second question again, as I may have missed that?

Yes, sure. The second question is about could you talk about your expansion plan for this year given you already have 10,000 branded stores? The competition looks more intense this year because some small brands are also ramping up their expansion with very aggressive subsidies. We want to hear management's views on the competitive landscape in the China's e-vapor industry and also your potential impact on your margins.

Sure. So we'll talk about the first one. Regarding our costs, as we have mentioned, the number of Branded Partner Stores has been growing steadily. As of the end of September last year, we partnered with over 5,000 stores. At the end of last year, in the opening remarks made by Kate, we had already partnered with 10,000 Branded Partner Stores. We see that the growth momentum on store opening remains strong, as we see that many of our existing Branded Partner Store partners seeking to open more stores, i.e., second, third, fourth stores. We also received applications from potential new store owners. However, from an operational or commercial strategy point of view, the number of stores is not the first parameter, nor is it the paramount important parameter from our view. We always prioritize our Branded Partner Stores owners' productivity. We will closely monitor the latest sales of our Branded Partner Stores to evaluate the number of stores to open and to assess the requests or applications made by these store owners. Under our current understanding, we have beaten our internal projections, and we believe such a trend will continue in the near future regarding the growth trajectory based on our projections. Regarding the margin side, our gross margin has been growing steadily with our cost optimization initiatives and better supply chain management. We have also achieved operating leverage as shown in the fourth quarter or the past few quarters' results. However, we will also still focus on investing in our strategy as mentioned in Kate's opening remarks. Your third question, may you talk about that again?

Sure. The last question is about the products. We noticed that the company also introduced some products early this year, including some entry products, such as the cotton vape. What has the feedback been so far? Could you share your views on your product strategies and technologies moving forward?

Sure. We have always used a user-centric approach to have a diversified product portfolio in order to meet the increasing needs of e-vapor users as we see the penetration increasing. In March, we introduced the affordable version of rechargeable e-vapor products. However, as it is still at an early stage of development, we would like to share more thoughts regarding that when we have more results internally. Thank you very much, Lydia, for the questions.

Our next question is from Charlie Chen with China Renaissance.

This is Charlie Chen from China Renaissance. I have three questions here as well. First, how do you think ceramic atomizers versus cotton atomizers? How do these two different materials fit into your future business strategies in both supply chain and product portfolio management? So that's the first question.

Thanks very much, Charlie. The first question is about ceramic and cotton heating elements. We prioritize user-centric needs as our first priority. As mentioned before, we use a product development framework called AIPI to develop e-vapor products for adult smokers in China. So for the supply chain aspect, it largely depends on user feedback on which products to use, including which elements to include. So far, we have been using both cotton and ceramic heating elements in our supply chain, and currently, products with ceramic heating elements still account for the majority of our rechargeable cartridges. We will continue to monitor user preferences closely and improve our products and technology accordingly, providing the right product mix to adult smokers in China. I hope this answers your question.

Second question is about consumer loyalty. Do you have any data on the average number of e-vapor brands your consumers regularly use or how difficult it is for consumers to switch brands? What are the factors that help them make such decisions? Any consumer insights in this area will be very helpful.

So there are differences between us and other brands, and it includes very strong user loyalty for e-vapor products as more adult smokers increasingly recognize the benefits of using better alternatives. For us, we can share more insights from a couple of perspectives. First, regarding user experience, our internal data indicates that our users continue purchasing our e-vapor products after the second consecutive month of their initial purchases. We have also observed improvement in terms of retention rates of user cohorts over a longer timeframe. Regarding daily e-vapor users, they experience significant differences in product availability, inhalation experience, and issues they might overcome compared to other products. Our in-store experiences at our branded partner stores are critical, and most importantly, our users recognize our unique brand value. Therefore, a majority of them tend not to consider other competitors' products, given our leadership in every aspect of development.

Lastly, on distribution, what kind of indices, such as sales or traffic, do you use to monitor your store density in a city or market? For example, in Beijing, how many stores do you think is enough? What makes you think so? This also relates to what kind of store expansion plans you have in other cities.

Regarding distribution and store density, if I can briefly share the logic behind our store opening plans. The overall model largely depends on whether there are enough potential users of e-vapor products in such areas. User penetration of e-vapor products among adult smokers across China has been relatively low, with single-digit penetration across Tier 1 cities, counties, and villages. We do have requirements for our store opening selection, such as a 500-meter distance requirement for most regions to avoid cannibalization among stores. However, the most important parameter is always about the user penetration of the corresponding city to calculate if the number of stores can be supported in their operational model. In the future, we expect a growing user penetration of our products among adult smokers, and we plan to gradually loosen the 500-meter requirements to maintain our competitiveness, while most importantly, ensuring the productivity of each of these stores.

Due to time constraints, I would now like to turn the call back over to the company for any closing remarks.

Thank you very much. Thanks, everyone, for your time. Feel free to look at further information through our website, ir.relxtech.com, for corporate information or through the TPG Investor Relations team. Thank you very much.

This concludes this conference call. You may now disconnect your lines. Thank you.