RLX Technology Inc. Q4 FY2021 Earnings Call

Hello, ladies and gentlemen. Thank you for standing by for RLX Technology, Inc.'s Fourth Quarter and Full Year 2021 Earnings Conference Call. Today's conference call is being recorded and is expected to last for about 50 minutes. I will now turn the call over to your host, Mr. Sam Tsang, Head of Investor Relations for the company. Please go ahead, Sam.

Thank you very much. Hello, everyone, and welcome to RLX Technology's Fourth Quarter and Full Year 2021 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; Chief Financial Officer, Mr. Chao Lu; 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, expects, targets, estimate, intend, believe, 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 affiliates, advisors, representatives, and underwriters do not undertake any obligations to update this forward-looking information except as required under the applicable law. Please note that RLX Technology's earnings press release and this conference call will 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 measures to the unaudited GAAP measures. I will now turn over the call to Ms. Kate Wang. Please go ahead.

Thank you, Sam. And thanks, everyone, for making time to join our conference call today. As many of you might have become aware, just hours ago, the State Tobacco Monopoly Administration released an updated draft consultation paper regarding national electronic cigarette product standards. At the same time, administrative measures for electronic cigarettes have been made official effective starting on May 1, 2022. While we didn't expect the announcement of these regulatory developments to coincide with our earnings growth, we welcome the finalization of these regulatory measures as it delivers certainty regarding timeline, mode of transaction, product specifics, among others. The removal of these uncertainties and accelerated timeline will provide our organization with more concrete directions in our business operations and planning. We believe the new standards and measures will significantly improve adult smoker populations' positive recognition of our product safety in the nature of harm reduction. We are confident that the likely restriction on flavors will not impact the core needs of our users and millions of traditional cigarette smokers for harm reduction. The experiences from other markets support the same view. Against the backdrop of the evolving regulatory landscape for e-cigarettes and the recurring COVID-19 outbreaks throughout 2021, we remained committed to enhancing our vision and executing our founding strategy, further cementing our industry-leading position as the trusted e-vapor brand for adult smokers. We ended 2021 on a solid note with our core strengths and fundamentals driving our performance, although we faced our share of challenges during the year. Our financial highlights include fourth quarter revenue growth of 17.7% year-over-year, which propelled a year-over-year increase of 123.1% in our full year 2021 net revenue. Our CFO, Chao, will share more details regarding our financial results and underlying drivers later. With that, I'd like to start by outlining the backdrop of the regulatory environment in the fourth quarter. The fourth quarter ushered in meaningful regulatory development for China's vapor industry with the introduction of the draft administrative measures and draft national standards for e-vapor products. The regulators have introduced an electronic filing system to provide a means for all value chain participants and compelling manufacturers, distributors, dealers, and supply chain partners to register their business details. In addition, all e-vapor brands are also required to register each of their products or SKUs, including product characteristics and classifications. We believe that as these new rules and policies take hold, the barriers to entry in China's e-vapor industry will become more difficult to penetrate given the substantial compliance and product development requirements. Moreover, given ongoing regulatory scrutiny of e-vapor product quality, sales of counterfeit products will be further curbed and users' rights will be better protected. In sum, we firmly believe that the new regulatory framework will support the overall e-vapor industry and allow its participants to move forward confidently and embrace healthy, sustainable long-term growth. In response to updated regulations announced in December 2021, in the fourth quarter, we proactively implemented an array of refinements across both the front and back end of our operations. On the product and supply chain, we swiftly adjusted certain features in our product suite and pipeline products based on the draft national standards, drawing on our state-of-the-art product development capabilities to enhance our child-lock design, e-liquid bottlers, and other technical design elements. Although we embraced a more ideal approach to compliant management, prudently managing our key components and material procurement orders according to the draft national standards may impact our inventory preparation. On the sales and channel management front, we adopted a nimble approach to managing active inventory for distributors and retailers to avoid over- or under-supply. In addition, we offer assistance to our distributors and retailers with the required registration on the electronic filing system and maintain active communication with them to understand their needs and track the potential impact of the new policy enforcement on their operations. Now I'd like to provide some updates on our scientific research progress. We worked diligently to improve our scientific research capabilities and are firmly convinced that scientific evidence-based communication is paramount when addressing users' and shareholders' concerns about the harm reduction efficacy of e-cigarettes. One area of particular focus for RLX is fundamental research on the amortization mechanism through which we explore the long-term health effects of vaping. As China's pioneering e-vapor brand, we initiated China's first clinical research on vaping, citing the acute effects of traditional cigarettes and electronic cigarettes on the human respiratory and cardiovascular system. In February 2022, we successfully registered our clinical research on the China Clinical Trial Registry, which is a primary registry in the World Health Organization registry network, further validating the strength of our scientific research capability and underscoring our progress in advancing these studies. As China's national standards for e-cigarettes come into effect, RLX will continue to devote more resources to R&D and support a regulatory framework that recognizes these harm reduction opportunities for the adult smoking population. Our accomplishments in 2021 position us for a good start as we head into the new year of 2022. I'm pleased with our achievements so far in 2022. Our strategic initiatives are designed to capture any growth potential ahead of us within a clearer regulatory regime. As we continue to improve our product performance, advance scientific research, and promote digitalization upgrades, we are poised to further grow and increase the value we bring to all of our stakeholders. With that, I will now turn the call over to our CFO, Chao Lu. He will elaborate on further initiatives and go over our operational and financial results in more detail. Thank you.

Thank you, Kate, and hello everyone. I will start by sharing some major initiatives and developments from the fourth quarter and then walk you through our key financial results. As Kate mentioned earlier, despite the backdrop of regulatory impact, we delivered quarterly net revenues of RMB 1.9 billion, up 13.6% sequentially and by 17.7% year-over-year, reflecting the momentum behind our efforts to optimize our distribution and retail channel network and enhance our diversified product portfolio. Notably, we witnessed that there have been increasingly more fact-based and neutral public voices commenting on the e-vapor industry and e-vapor products in recent months. According to a survey in light of the relief of the proposed draft national standards, 69% of our potential users are aware of the regulatory changes and 87% expressed increased or unchanged willingness to purchase e-vapor products in light of the national standards as they believe that the regulations will positively impact product safety and quality. Since December 2021, orders from our distributors and retailers have remained solid as end users' demand has remained strong. We have been closely monitoring the trade inventory level of our distributors and retailers and cautiously fulfilling their orders to mitigate risks related to any excess inventory in our trade channels. In addition, we continued investing in our Golden Shield Program to combat sales of counterfeit products and made meaningful progress during the fourth quarter. In December 2021, we successfully assisted Shenzhen Police in busting a counterfeit factory site located in the Huaqiangbei electronics market, seizing over 20,000 counterfeit products. Since launching the Golden Shield Program in 2019, we have assisted the police in solving more than 130 administrative and criminal cases of intellectual property rights infringement and helped to seize more than 1.5 million counterfeit products, a testament to our commitment to protecting the rights and interests of consumers as a responsible corporate citizen. We also strove to optimize our supply chain and streamline our operations. Our efforts in cost control and active supply chain management have been effective, further reducing the unit cost of our products. Meanwhile, we have become more agile in managing our supply chain; for example, we have significantly increased the utilization rate of our logistics and warehousing facilities in recent months by closing unused or low usage warehouses. Moreover, our distributor survey showed that in the second half of 2021, our distributor satisfaction level with our supply chain management improved immensely compared with the first half of 2021, validating our relentless efforts to improve our supply chain capabilities and strengthen our relationships with our value chain partners. As we mentioned last quarter, we continue to strategically introduce new products tailored to various user segments with the goal of engaging new users to support our sustainable and quality growth. To that end, we launched several new targeted products during the fourth quarter and have recently seen an upward trend in our new user retention rate, which we believe is partially attributable to our successful product strategy. Our Xiao Jin Zhi product, targeting adult smokers with a long history of smoking, complements our current product portfolio with a unique compelling product design. Meanwhile, we also released a premium device line aimed at fashion-conscious users who are willing to pay a premium for exquisite design. We will continue to expand and enhance our product offering to cater to China's distinct user group's differentiated preferences and price sensitivity. To further increase user engagement and build our brand equity, we also introduced accessories including cartridge cases, device stands, and necklace lanyards, which can be purchased with cash or used loyalty program points. As a user-centric company, RLX always puts our users first. They are the core of our business. During the transitional regulatory period, we will continue to prioritize our users' needs by creating new innovative products that comply with the national standard and can be launched upon regulatory approval. Last, but not least, I'd like to share with you some updates on our corporate social responsibility initiatives. RLX Technology has always been committed to CSR. We believe that prioritizing and fulfilling our social responsibility is essential to corporate growth. As raising its popularity grows, the disposal of used cartridges has become a major concern for both e-vapor companies and users. To solve this problem and create additional economic value, we launched China's first cartridge recycling program in September 2021, covering more than 16 cities in the program's first phase. Users can pick up special recycling bags in selected RLX branded stores in China to collect used cartridges and return them to in-store recycling bins. The program has enjoyed great initial success, with over 200,000 cartridges recycled to date. By enhancing ties between RLX and our users, we believe that this environmentally friendly program will encourage more users to choose our products as we fulfill our corporate social responsibilities and inspire eco-consciousness through our industry. In recognition of these efforts, our 2021 CSR Report recently received a Grade A rating from the Ministry of Industry and Information Technology, which is a powerful endorsement of our work and commitment to advancing CSR initiatives nationwide. MIIT assessed RLX's strong performance across a broad range of CSR metrics and commended our report for its clear guidance on the company's strategic planning and governance with respect to sustainable development concepts. Moving forward, we will continue to increase RLX's positive social impact with substantive work and engaging products to address industry, community, and environmental issues. I will now provide a summary overview of our financial results for the fourth quarter and for the full year of 2021. Net revenues increased by 17.7% to RMB 1.9 billion in the fourth quarter of 2021 from RMB 1.62 billion in the same period of 2020. The increase was primarily due to a rise in net revenue from sales to offline distributors, which was mainly attributable to the expansion of the company's distribution and retail network. Gross profit increased by 10.3% to RMB 765.5 million in the fourth quarter of 2021 from RMB 694.1 million in the same period of 2020. Gross margin was 40.2% in the fourth quarter of 2021 compared with 42.9% in the same period of 2020. The decrease was primarily due to: 1. an increase in direct costs related to promotional activities and 2. an increase in the inventory provision. Operating expenses were RMB 231.5 million in the fourth quarter of 2021, representing a decrease of 72.8% from RMB 852.6 million in the same period of 2020. The decrease in operating expenses was primarily due to the change in share-based compensation expenses, which decreased by 93.6% to RMB 42.1 million in the fourth quarter of 2021 from RMB 656.1 million in the same period of 2020. The decrease in share-based compensation expenses was primarily due to the changes in the fair value of the share incentive awards that the company granted to its employees, as affected by the fluctuation of the share price of the company. Selling expenses decreased by 76.3% to RMB 46.6 million in the fourth quarter of 2021 from RMB 196.7 million in the same period of 2020. The decrease was mainly driven by an increase in share-based compensation expenses and a decrease in salaries and welfare benefits, partially offset by an increase in branding material expenses. General and administrative expenses decreased by 62.6% to RMB 167.1 million in the fourth quarter of 2021 from RMB 447 million in the same period of 2020. The decrease was mainly driven by a decrease in share-based compensation expenses and a decrease in salaries and welfare benefits, partially offset by an increase in software and technical service expenses. Research and development expenses decreased by 91.5% to RMB 17.8 million in the fourth quarter of 2021 from RMB 208.9 million in the same period of 2020. The decrease was mainly driven by a decrease in share-based compensation expenses and a decrease in salaries and welfare benefits, partially offset by an increase in consulting expenses. Income from operations was RMB 534 million in the fourth quarter of 2021 compared with a loss from operations of RMB 158.5 million in the same period of 2020. Income tax expense was RMB 129.5 million in the fourth quarter of 2021 compared with RMB 110.6 million in the same period of 2020. U.S. GAAP net income was RMB 494.4 million in the fourth quarter of 2021 compared with U.S. GAAP net loss of RMB 236.7 million in the same period of 2020. Non-GAAP net income was RMB 536.5 million in the fourth quarter of 2021 compared with RMB 419.3 million in the same period of 2020. U.S. GAAP basic and diluted net income per ADS were RMB 0.367 equivalent to USD 0.058 and RMB 0.363 equivalent to USD 0.057, respectively, in the fourth quarter of 2021 compared with U.S. GAAP basic and diluted net loss per ADS of RMB 0.165 in the same period of 2020. Non-GAAP basic and diluted net income per ADS were RMB 0.398 equivalent to USD 0.062 and RMB 0.394 equivalent to USD 0.062, respectively, in the fourth quarter of 2021 compared with RMB 0.292 in the same period of 2020. Moving to the full year of 2021, net revenues increased by 123.1% to RMB 8.52 billion in 2021 from RMB 3.82 billion in the prior year. The increase was primarily due to an increase in net revenue from sales to offline distributors, which was mainly attributable to the expansion of the company's distribution and retail network. Gross profit increased by 140.4% to RMB 3.67 billion in 2021 from RMB 1.53 billion in the prior year. Gross margin increased to 43.1% in 2021 compared with 40% in the prior year. Operating expenses were RMB 1.37 billion in 2021, representing a decrease of 9.3% from RMB 1.51 billion in the prior year. The decrease in operating expense was primarily due to the change in share-based compensation expenses, which decreased by 76% to RMB 223.3 million in the fiscal year 2021 from RMB 929.1 million in the prior year. The decrease in share-based compensation expenses was primarily due to the changes in the fair value of the share incentive awards that the company granted to its employees as affected by fluctuations in the share price of the company. Selling expenses increased by 17.5% to RMB 520.7 million in 2021 from RMB 443.2 million in the prior year. The increase was mainly driven by an increase in branding material expenses, an increase in shipping expenses, and an increase in salaries and welfare, partially offset by a decrease in share-based compensation expenses. General and administrative expenses decreased by 12.9% to RMB 672.7 million in 2021 from RMB 772 million in the prior year. The decrease was primarily attributable to a decrease in share-based compensation expenses, partially offset by an increase in salaries and welfare benefits and an increase in legal and other consulting fees. Research and development expenses decreased by 39.9% to RMB 179.9 million in 2021 from RMB 299.3 million in the prior year. The decrease was primarily due to a decrease in share-based compensation expenses, partially offset by an increase in salaries and welfare benefits, an increase in software and technical expenses, and an increase in consulting expenses. Income from operations was RMB 2.3 billion in 2021 compared with RMB 13.1 million in the prior year. Income tax expense was RMB 631.4 million in 2021, representing an increase of 173.9% from RMB 230.5 million in the prior year. The increase was primarily due to an increase in taxable income. U.S. GAAP net income was RMB 2.03 billion in 2021 compared with U.S. GAAP net loss of RMB 128.1 million in the prior year. Non-GAAP net income was RMB 2.25 billion in 2021 compared with RMB 801 million in the prior year. U.S. GAAP basic and diluted net income per ADS were RMB 1.445 equivalent to USD 0.227 and RMB 1.436 equivalent to USD 0.225, respectively, in the fiscal year 2021 compared with U.S. GAAP basic and diluted net loss per ADS of RMB 0.089 in the prior year. Non-GAAP basic and diluted net income per ADS were RMB 1.604 equivalent to USD 0.252 and RMB 1.595 equivalent to USD 0.25, respectively, in the fiscal year 2021 compared with RMB 0.557 in the prior year. Moving to the balance sheet, as of December 31, 2021, the company had cash and cash equivalents, restricted cash, short-term bank deposits, net short-term investments, and long-term bank deposits net of RMB 14.86 billion compared with RMB 3.42 billion as of December 31, 2020. As of December 31, 2021, approximately USD 1.62 billion was denominated in U.S. dollars. Lastly, turning to our share repurchase program. On December 8, 2021, the company announced that its Board of Directors authorized a share repurchase program under which the company may repurchase up to USD 500 million of its shares over a period until December 31, 2023. The program, which is integral to our commitment to providing shareholder value, is proceeding smoothly. It demonstrates our continued confidence in our core capabilities: business growth, long-term market potential, and the further development of the e-vapor industry. This concludes our prepared remarks today. We will now open the call to questions.

Today's first question comes from Louise Li of Bank of America.

So my question is, could you share with us the latest year-to-date shipment and sell-through trend? Do you expect to see any significant changes from now to 1st of May and after 1st of May? So just another quick question on the newly released regulation. According to the China National Standard file, we see that only tobacco flavor can be sold. So if this is the case, why do you still put a list of ingredients? Is there any conflict?

Louise, I will talk about more on the year-to-date shipment trends first and then I'll respond to your question regarding the latest regulations. So till December, we have still seen continuous improvement in multiple operating metrics, thus we are confident in our commercial development including the number of potential e-vapor users, which have been driven by the increasing willingness to consider e-vapor products as mentioned by Chao, a retention of new users and the number of cartridges per user, which we think reflects a higher number of potential users together with a higher user lifetime value. We believe the primary reason is that more users have higher confidence in e-vapor products and our products after the release of the first draft of national standards recognizing the benefits of harm reduction tobacco alternatives. Due to the above trends, we have been gradually optimizing our shipment level to respond to the latest developments. And regarding the latest regulations, given that it was released article, it requires more time for us to evaluate it internally and see how it will evolve regarding the commercial results. Thank you for your question.

Ladies and gentlemen, our next question today comes from Lydia Ling at Citi.

I have two questions here. The first one is on the regulatory side regarding today's regulators update, including administrative measures and also the second draft on the national standard. So can management evaluate the potential impact on your business and how to deal with the evolving regulation and increased penetration among the adult smokers, particularly the restrictions on the flavor part? Could you give us more color on that? And my second question is on the product side. In light of the new national standards, could you share any progress on the new product line?

So two questions: one is on the regulations and the other one is on changes to new product launches. For today, the State Tobacco Monopoly Administration announced the administrative measures of e-vapor to further strengthen the supervision of next generation tobacco products to regulate the market order, ensure the health and safety of adult smokers, and promote the legalization and standardization of the industry, which will be effective on the 1st of May. We need to see the key changes when compared with the public consultation paper released in early December. These include having a greater emphasis on underage access prevention, dissuading minors from using e-vapor products, retailers obtaining an integrated retail license to procure products from local licensed e-cigarette wholesalers, and they shall not exclusively distribute listed e-cigarette products. It also prohibits exhibitions and events promoting e-vapor products. The regulators have announced to seek public opinion regarding the second draft of national standards with a commission deadline of March 17. Some key changes include that products should not be marketed to minors and shall not have flavors other than tobacco. However, we do see that key components in the existing product portfolio have been included. We believe such a wide list will continuously evolve based on our research and through effective fact-based communication. We are delighted to see the formalized regulations which significantly improve health makers' positive recognition of e-vapor product safety compared to tobacco products. We believe that these measures could better progress the development of our industry with higher standards, higher entry barriers, and higher clarity with promising prospects for each value chain participant. Regarding product launches, given that it's still a draft national standard, we need to wait until the national standards are formalized to have our products approved. However, we have been diligently modifying products along with potential new product launches. First is on product safety, which includes the change of requirements for raw materials, including ingested and released substances and safety requirements on electronic products, such as factory waterproofing and child-lock prevention. Our product safety standards are much higher than global standards, including the draft national standards. Our prototypes are fully prepared. We see that we have provided greater clarity regarding the allowed ingredients, where non-listed additives will be subject to higher safety assessments. We will continue to modify in response to the second draft of national standards released today. Thank you for your question.

And our next question today comes from Charlie Chan at Sana Renaissance.

I have one question. During this transition period where you cannot extend your sales network or launch new products, what is the main focus of your day-to-day work during this period? Can you share some of your major achievements or progress in your work for the past quarter?

I can share our progress for the last quarter in three aspects. The first is on sales and distribution. We have been closely monitoring our partners' operating and financial performance. We have put great efforts into driving single-store sales by introducing operational efficiencies and training. After the regulations and draft measures were released, we saw that distributors and retailers have high confidence in the e-vapor industry and RLX, driving our robust order book. We launched internal training to equip our sales experts with the right skill set considering the potential changes in our industry. On the product development front, in modifying our portfolio, we have invested resources in developing new technology and products, maintaining several new product pipelines. We expect to obtain approvals after the national standards become effective. Lastly, on organization upgrades, we have heavily invested in digitalization and optimizing work efficiency. We have been building an all-in-one digitalization system that monitors and tracks our operating and financial performance from front to back end, enhancing our decision-making and increasing our operating efficiency.

And the next question comes from Peihang Lyu with CICC.

I have two questions here. The first one is we've noted a shortage of certain flavors in your stores, could you provide some color on that? The second question is how will the second draft of national standards affect your existing portfolio?

On the first question regarding the shortage of flavors in stores, after the administrative measures were released in December, we cautiously lowered our trade inventory considering multiple factors, including restrictions on product launches and new store openings during the transitional period. We required time to evaluate distributor and retailer order sentiments, along with our sufficient production capacity to be increased promptly. Since December, we have seen continued improvement in operating metrics, including user-related metrics and store inventory metrics for single store sales. As a result, the order book from distributors has been solid, and our trade channel inventory has stood at a low level since the first quarter of last year. Concerning the second question about flavor, the primary reason for adult smokers to use e-vapor products mainly lies in the harm reduction effects compared to other tobacco products. Our internal user surveys indicate that flavors contained in cartridges are not the main reason for adult smokers switching from cigarettes to e-vapor products. Insights from overseas markets show that when there is a restriction on flavor, it causes short-term turbulence in the trade channel, especially in existing inventory management, but has limited impacts on the long-term trend for adult smokers switching from cigarettes to e-vapor products. We are confident that Chinese e-vapor users will continue choosing RLX after the draft national standards become effective. Those affected are likely to switch from their best-preferred flavor to tobacco flavor. Thank you for your question.

Ladies and gentlemen, this concludes the question-and-answer session. I'd like to turn the conference back over to management for closing remarks.

Thank you again for joining us today. If you have further questions, please feel free to contact RLX Technology's Investor Relations team through the contact information provided on our website.

Ladies and gentlemen, this concludes today's conference call. We thank you for attending today's presentation. You may now disconnect your lines and have a wonderful day.