RLX Technology Inc

NYSE:RLX

Earnings Call Transcript 2020-Q4

[Operator]

Hello, ladies and gentlemen. Thank you for standing by for RLX Technology Inc.'s Fourth Quarter and Full Year 2020 Earnings Conference Call. [Operator Instructions] 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.

[Sam Tsang, executive]

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 the 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.

[Wang Ying, executive]

Thank you, Sam. And thank you, everyone, for making your time to join our earnings conference call today. Just a little over 2 months ago, on [ January 27, 2021 ], we successfully listed our shares on our New York Stock Exchange and started 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 result 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'll best 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 sharing our strategies going forward. Throughout last year, we remain focused on our mission and strategies and we have achieved a solid that of 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 of the e-vapor market in China, we are well positioned to make RELX attractive brand for adult smokers providing better alternatives for them.

Secondly, on our commercial front, we pioneered and integrated offline distribution and branded store plus retail model, tailored to China's e-vapor market. Under this model, we identified and the leveraged a rarity of distribution and retail channels that allow us our products to reach adult smokers in a more effective manner.

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 ones nationwide, covering over 250 cities in China as we adopt comprehensive systems and methods to manage, supervise and empower our distributors and retailers.

In this fourth quarter, we achieved significant growth in terms of number of branded stores and productivity. And increasing number of branded store partners have been joining our leading network and crossed the 10,000 mark for the first time in the fourth quarter. On the other hand, we have been expanding our retail outlet network with multiple forms. More importantly, more and more retailers have been increasingly recognizing the benefits of retailing e-vapor products and partnering with RELX.

In addition to commercial development to continually improve adult smokers' turns with our products, we have implemented a multiple layer development framework to provide a solid infrastructure for our technology and product development. This framework involves 5 development layers surrounding our e-vapor products. Mainly accessories, interactions, applications, face transition and infrastructure, catering to 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 a 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 consistently uphold and practice our ethical principles, including promoting the prevention of underage use of our products. Through our industry pioneering Guardian Program, introducing 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 is kind technology-driven underage access prevention system in China, according to CIC Report.

The Sunflower System encompasses comprehensive set of technology-driven best practices. It's designed to prevent underage use through and area of advanced recognition tools, to enhance on-site age verification at the retail outlets. As well as through geo-fencing technology to identify the appropriate locations for opening with RELX Branded Partner Stores.

In addition, we have zero tolerance for counterfeit products that could jeopardize adult smokers health and interest. To that end, we launched the Golden Shield Program to combat sales of counterfeit products in cooperation with the public media and the local authorities.

At RLX, social responsibility is not something we do on the site. It's part of our DNA and embedded into our everyday actions, operations, systems throughout our organization. We have been caring for our user communities, our partners and our employees since day 1. We have always placed substantial emphasis on helping minorities and this is the [ vantage tool ] through initiatives that provide better services and technological solutions to help them with their unique needs.

In this regard, we recently launched 3 new initiatives: One to empower female entrepreneurs and working mothers. In order to assist to the elders -- elderly 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's part of who you 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, bolstering, supply chain and production capabilities. These strategic initiatives are designed to support our growth over the long term.

Here's to the end of my part, thank you, everyone. With that, I'll now turn the call over to Sam, who will discuss our key financial results.

[Sam Tsang, executive]

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 through 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. The increase was primarily 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 was 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 and ceased collaboration with e-commerce platform distributors in response to the October 2019 announcement.

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 was RMB 231 million in 2020, representing an increase of 789% from CNY 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 '20 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 equivalent, 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 expect 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 and are not available without unreasonable efforts. The company also expects gross margin to remain steady.

The above outlook is based on the current market conditions, including those related to COVID-19 pandemic and reflect 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 risk 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.

[Operator]

[Operator Instructions] Our first question today comes from Lydia Ling with Citigroup.

[Lydia Ling, analyst]

Hello, management can you hear me?

[Sam Tsang, executive]

Hi, Lydia.

[Lydia Ling, analyst]

Hello, management, can you hear me?

[Sam Tsang, executive]

Yes. We can hear you.

[Lydia Ling, analyst]

This is Lydia from Citi. I have three questions, one is on the regulation side. So as for the monthly announcement, so could management just share a bit more of your views on this announcement and also its implication. So what do you think of the future regulation trends looking forward in China's e-cigarette industry? And also, how will the company cope with these changes anything should happen?

And my second question is about expansion. And the company has achieved very impressive expansion in the first quarter for the branded stores, as just mentioned. So could you also talk about the company's expansion for this year. The competition looks more intense for this year as more players also ramp up our store openings with very aggressive pace. So how do you view the competitive landscape and the potential impact on your margin?

And my last question is regarding the product. We noticed that the company has introduced a few new product here in this year and also some entry level products. So how about the feedback so far? And could you talk about your product strategies for this year?

[Sam Tsang, executive]

Sure. So I mean, there are 3 questions. First is on regulations, and the second is on the store plan, and the third 1 is on our product feedback. So it's like a lengthy questions and we'll go 1 by one. So I mean, 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, they made an announcement seeking for public comments requiring the authority proposal to revise detailed implementation regulations of the tobacco monopoly law of the PRC. So such comments or feedback shall be submitted by April 22, i.e., they give 1 month for submission of such comments.

So there are also like 2 attachments were included in the announcements. So the first attachment proposed new rule under the implementation regulation as rule 65 (sic) [Article 65] indicating that the implementation rules for next-generation tobacco products, including e-cigarettes shall take reference to the relevant rules in respect to see with under the implementation recreation of the tobacco monopoly law. And there are also the second attachment they have provided free considerations for making suggestion of adding the proposed rule 65 (sic) [Article 65].

So the first consideration is to make progress in the regulatory development of e-vapor products and the second consideration is to -- due to the similarities between e-vapor products and cigarettes, which is also taking reference to the regulation on e-vapor products internationally.

And the first consideration is to enhance the effectiveness of regulating the e-vapor industry, including effectively regulating the operating activities of the e-vapor industry and tackling potential product safety issues of e-vapor products, false advertisement issue, et cetera, in order to protect the rights of e-vapor users.

So I generally repeat what happened for [ unknown ] Chinese reader has a basic understanding of such regulation first. So as a company point of view, in response to the regulation, the announcement, we plan to submit our feedback regarding the proposed revision of implementation plans by April 22. So we are also well aware of the considerations mentioned in the attachment, including regulating the operating activities, tackling potential product safety issues, concerns over the [ underage ] issue, which has been our focus in daily operations.

So I think your last bit of your question is mainly about how we adjust our operations. Given that the regulations or the proposal amendment is still in the process of seeking public feedback, it's premature to speculate about the potential change on the commercial front. So this is our response on your first question.

So may you repeat your second question again, as I may have missed that?

[Lydia Ling, analyst]

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

[Sam Tsang, executive]

Sure. So we'll talk about -- the other first one first, regarding our costs. So as we have mentioned, so the number of Branded Partner Stores have been growing steadily. So as of end of September last year, we have partnered with over 5,000 stores. And as of end of last year, in the opening remarks made by Kate, we have already partnered with 10,000 Branded Partner Stores, yes. So we do see that the growth momentum on store opening remains strong, as we see that many of our existing Branded Partner Stores partners seeking to open more stores, i.e., second store, third stores, fourth stores. And definitely, we also received applications from potential new store owners as well.

However, from an operational or a commercial strategy point of view, number of stores is not the first parameter or the paramount important parameter from our view. We always prioritized our Branded Partner Stores owners' productivity. So we will always closely monitor the latest sales of our Branded Partner Stores to evaluate the number of stores to be opened and then to determine and assess the number of requests or applications made by these store owners.

So under our current understanding, as you can see, we have beat our internal projections. So we believe such trend will continue in the near future regarding the growth trajectory based on our projections.

And I think your second question -- second sub-question is mainly on the margin side. So I mean, on the margin side, our gross margin has been growing steadily with our cost optimization initiatives and better supply chain management. And we also have achieved operating leverage as shown in the fourth quarter or the past few quarter results. However, we will also still focus on investing in our strategy as mentioned in Kate's opening remarks.

So you have your third question. May you talk about that again?

[Lydia Ling, analyst]

Sure. The last question is about the products. And so we noticed that the company also introduced some products in early this year, like some entry products, including the [ cotton vape ]. And so about the feedback so far? And also could you share about your views on your product strategies and also some technologies looking forward?

[Sam Tsang, executive]

Sure. So we have been always using the 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 has been increasing. So in March, so we have introduced the affordable version of rechargeable e-vapor products. But given that is still at the early stage of development, we would like to share more thoughts requiring that when we have more results internally. So thank you very much, Lydia, for the questions.

[Operator]

Our next question is from Charlie Chen with China Renaissance.

[Charlie Chen, analyst]

This is Charlie Chen from China Renaissance. I guess 3 questions here as well. First, how do you think ceramic atomizers versus cotton atomizers? I mean, how did these 2 different materials fit into your future business strategies in both supply chain and product portfolio management? So that's the first question.

Second question is about consumer loyalty. Do you have any data in terms of average number of e-vapor brands your consumers regularly uses or how often or how difficult for consumer to switch brands? And how -- what are the factors to help them to make these kind of decisions? Any consumer insights in this area will be very helpful.

And lastly, on distribution, what kind of index such as like sales or traffic et cetera, if you have -- do you use to monitor your store density in a city or in the market like in Beijing, how many stores do you think is enough? And what makes you to think so? And also that relates to what kind of store expansion plan you have in other cities. So that's my 3 questions.

[Sam Tsang, executive]

Thanks very much, Charlie. So I mean, for the first question is about the ceramic and also the cotton heating elements that you mentioned. So for us, we always prioritize user-centric needs, that's our first priority. So as mentioned before, so we used a product development framework called [AIPI ] to develop the e-vapor product for adult smokers in China. So I mean for the supply chain [ 1 side ] it largely depends on user feedback. On which products are used from time to time, which includes -- which elements to use as mentioned in your question.

So far as we have been using both cotton and ceramic heating elements in our supply chain, to currently products with ceramic heating elements still account for the majority of our rechargeable cartridge. So for us, we will continue to monitor user preferences closely. And the improvement of the product and technology, providing the right product mix to adult smokers in China. So I mean, I hope this answers your question.

So your question -- your second question is on the -- like the brand loyalty and the user preference side. So for us, there are differences between us and also other brands. So it includes very strong user loyalty for e-vapor products as more and more adult smokers and our users have been increasingly recognized the benefits of using better alternatives. So I think for us, we can share about like more insight in the following perspective.

So I mean for the first perspective I can share is about the user experience side. So according to our internal data, we observed that our users have continued to purchase our e-vapor products after the second consecutive month of their initial purchases, i.e., after M1. We can also see improvement in terms of retention rate of user cohorts with a longer time frame as well.

And I think the second perspective I can share is about the user experience. So far, a more daily e-vapor users, they can have a significant difference in terms of product availability, like the inhalation experience, like the issues that they may overcome and other products like [indiscernible], in-store experience and our Branded Partner Stores, and most importantly is to recognize our unique brand value. And therefore, I mean, a majority of them, they tend not to consider other competitors' products, given our leadership in every aspect of development.

So I mean for that part, we do have seen that, it's [ mentioned ] this number of competitor users, becoming our users as indicated by competitors, a significant increase in rechargeable device, but with a lower or like low increase in cartridge volume.

And your third question is the distribution, yes. Distribution and also the store density. So if I can briefly share the logic of our store opening plan or the logic behind like we're not talking about like we set certain limits of goal for each city or region. So the overall logic of the operation model for like cities or like regions which largely depend on whether there are sufficient potential users of e-vapor products in such area.

So as we know that user penetration of e-vapor products among adult smokers across China has been relatively low, with a single-digit penetration across Tier 1 cities to counties, villages, et cetera. I mean, of course, we do have requirements for our store opening selection. Like we said, the 500-meter distance requirement for most of the region to avoid the cannibalization amongst us. But if you're talking about the most important parameter, it's always about the user penetration of the corresponding city in order to calculate whether the number of stores can support -- can be supported in their operational model.

So in future, as we can see, there will be growing user penetration of our products among adult smokers. We expect to gradually [ loosen ] the requirements like a 500-meter requirements to maintain our competitiveness, having an increasing number of Branded Partner Stores while most importantly, to ensure the productivity of each of these stores. So thank you very much for your questions.

[Operator]

Due to the time constraint, now I'd like to turn the call back over to the company for any closing remarks.

[Sam Tsang, executive]

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

[Operator]

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