Sam Tsang - Head of Capital Markets Chao Lu - CFO

Hello, ladies and gentlemen, thank you for standing by for RLX Technology Inc.'s Fourth Quarter and Full Year 2023 Earnings Conference Call. At this time, all participants are in listen-only mode. After management's remarks, there will be a question and answer session. 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 Capital Markets for the Company. Please go ahead, Sam.

Thank you very much. Hello, everyone, and welcome to the RLX Technologies Incorporation's fourth quarter and full year 2023 earnings conference call. The company's financial and operational results were released through PR Newswire 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 CFO, Mr. Chao Lu, and myself. Before we continue, please note that today's discussions will contain forward-looking statements made under the safe harbor provisions of the US Private Securities Litigation Reform Act of 1995. These statements typically contains 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 affiliates, advisors, and representatives do not undertake any obligation to update this forward information except as required under the applicable law. Please note that, RLX Technology's 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 measures to the unaudited GAAP measures. I will now turn the call over to our CFO, Mr. Chao Lu. Please go ahead.

Thank you, Sam, and thanks, everyone, for making time to join our earnings conference call today. 2023 was a transformative year for RLX. Despite external challenges, our outstanding product portfolio and strong strategic execution propelled an impressive recovery throughout the year, setting the stage for new ventures. I will begin with an update on our domestic operations before devolving into our international endeavors, followed by a review of our financial performance. For our domestic business, 2023 was the first full year under the e-vapor industry's new regulatory framework in Mainland China. The regulations necessitate prior approvals for e-vapor products, restrict flavors to tobacco only, and impose a 36% exercise tax on sales to distributors. As a compliant player, we have strictly adhered to the new rules since day one, continuously innovating to offer premium-compliant products amid competition from unauthorized flavored products. Leveraging our strong R&D capabilities and deep industry insights, we more than doubled our selection of approved cartridges this year, from 15 in January to 32 by December. Additionally, we broadened our cartridge series to four compared with three one year ago, enhancing our offerings to meet the diverse needs of adult smokers with more value-driven options. With a growing product portfolio, we believe we are well positioned to seize opportunities in China's legal e-vapor market, especially once enforcement against illicit products becomes more effective. While we have made meaningful progress in 2023, the adverse impact of illegal products is still lingering. Given the broad availability of popular flavors through unauthorized products, their sales still account for a significant portion of domestic sales -- sales volumes, weighing heavily on compliant product sales. Unauthorized products are also often cheaper than compliant products, as their manufacturers typically do not pay excise tax and duties. More importantly, they are manufactured without oversight…

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Peihang Lyu with CICC. Please go ahead.

Thank you, management. This is Peihang from CICC. I have two questions here. The first one is regarding your overseas disposable products, WAKA, which have sold very well. And how do you view the growth trend of disposable products overseas given the intensifying competition and changing regulations in some countries? And my second question is that in the domestic market, has there been an enhancement in the enforcement and has the approval process for new products accelerated compared to the past? Those are my questions. Thank you.

Thank you very much, Peihang. So in the last 10 years, the subcategory of e-vapor has evolved from time to time, from open system to closed system, from pod system to disposables. One thing that hasn't changed is the overall penetration of e-vapor has been growing among adult smokers. The evolving regulatory landscape and intensified competition presents challenges and opportunities in specific markets, such as proposed ban on disposable vaping products in countries like the UK and France. For markets that may have banned disposable products, this won't affect the overall demand of e-vapor category over a longer time frame. Users can move from one product subcategory to another and we are a global leader in the pod system and have a significant presence in disposable products. Suppose the ban on disposable products is effective in some markets, in that case, we will encourage users using disposables to use our pod products as we can provide a similar or even better user experience. For countries that have yet to announce regulatory changes, we will continue to offer and launch various products in various forms, including disposables, pod systems, and e-vapor solutions that may fit different user groups to capture the growth of the overall category. And regarding your second question about the domestic market, enforcement as well as the product approval, regulators have been continuously cracking down on illegal sales of flavored e-vapor products, and we have long assisted and supported their enforcement. Multiple enforcement actions have been recently carried out nationwide among manufacturers and distributors. One example is Zhejiang province, where regulators have been working with the police force. They have arrested 23 suspects, closed seven warehouses, and one production facility, and seized illegal e-vapor products valued at RMB15 million. We continue to assist regulators in cracking down on illicit sales of e-vapor products. We have continuously applied for new approvals for cartridges and devices as new products must undergo several rounds of reviews to ensure they meet the national standard requirements, including the packaging inspection and technical review of quality and ingredients. Obtaining approvals take time, especially since the Chinese New Year holiday just passed a few weeks ago. We can bring you more exciting new products soon once approved. Thank you for your question.

That's very comprehensive. Thank you.

And once again, just in case, for the benefit of all participants on today's call, if you wish to ask your question to management in Chinese, please immediately repeat your question in English. The next question comes from Lydia Ling with Citi. Please go ahead.

Hi management, thanks for all the presentation. So, here I have two questions related to the overseas expansion. And the first one is, right, the overseas expansion, like kicked off in the first quarter last year. And so looking into this year and also beyond, so can you actually detail like the more of your like overseas expansion plan, and also such as which countries and also regions that you plan to expand for this year and also any other acquisition plan looking forward? And the second question is on the profitability of your overseas business. And so, could you share like a little bit more color on like how is the profitability of your existing overseas business you entered and also how to further drive the profitability looking forward? And so what kind of the normalized margins that you would target looking forward for overseas business versus like the domestic business? Thank you.

Thank you very much, Lydia. So regarding the international expansion, our two strategic priorities is to increase our product accessibility and enhance our profitability in international markets. So we periodically examine different markets and decide whether to expand to that market. We expanded to North and Southeast Asia in late 2023 and plan to expand to more Asian markets in 2024. We are confident in many Asian markets and have built a strong presence. We have been and will expand to more markets and we hope Asian markets can contribute significantly to our Company in 2024. For European markets, we are still evaluating the regulatory changes in certain markets and it will take some time for us to expand and decide. Regarding acquisition plans, we do have discussions with potential partners occasionally. We will share more details once we have any meaningful progress. And regarding the profitability of our overseas business, it is still in the early stages of development and we have been expanding to certain markets. And the profitability of each market depends on the volume, the competitive landscape, taxation, and pricing across the value chain. Expanding to a new market could change our overall profitability. Even as we are in the process of expanding, the profitability varies across different time periods. Our strategic focus is to optimize product portfolios and expand international sales channels, which could contribute to our top and bottom lines. Looking at our non-GAAP operating profit this quarter, our efforts to optimize domestic operations' operating efficiency and generate additional earnings from our international franchise have benefited us. As we are still expanding to many international markets, it is premature to share specific margin targets. However, our directional-wise sales volume, which could have economies of scale, is the most crucial factor for profitability. Thank you for your question.

Thank you.

The next question comes from Eileen Lin with China Renaissance. Please go ahead.

Thanks, management, for taking my questions. I have two questions. The first one is on domestic market. Can management share some comments on the momentum of domestic sales by month? Is there any changes in the trend? In particular, I also want to get the sense of where are non-JV products now and what's the latest trends onto this product from the regulator's perspective. My second question is on the overseas market. UK government recently made some changes in the policies on the e-cigarettes, including restrictions on some disposable and flavored products. And there's a new potential tax on e-cigarettes starting on 2026. Have you seen any changes in the market after this announcement and how do you think it might impact RELX? Thank you.

Thank you very much, Eileen. So regarding our domestic business, the sales trend in the domestic market are influenced by seasonality, with stable monthly averages observed over longer periods. For instance, in February this year, the Chinese New Year holiday lasted for eight days with minimal sales a few days before and after the holiday. We also had relatively strong sales in January before the CNY. We remain vigilant in monitoring the illicit markets and assist regulators in combating these challenges. Our commitment to compliance and market integrity supports regulatory efforts to secure consumption tax and can position us as leaders in promoting responsible market practices. Our proactive stance on compliance and collaboration with authorities will foster a healthier market environment and support sustainable growth. So regarding your second question about the recent proposed policy in the UK. I think the UK regulatory changes could present a nuanced landscape, opportunities to adapt and capture new consumer segments. We can share our view on these three topics that you mentioned. First is the proposed disposable ban. As you have mentioned, the prohibition of disposables will not -- as we have mentioned earlier, the prohibition of disposables will not change the overall demand in the long run as most users who migrates from disposables to other forms back to the pod system. There has been early signs that some distributors and retailers have started encouraging users to convert from disposables to pod system, which allow us to expand to the market and acquire new users in the medium term. The ban may create short-term chaos in the market, just like what happened in the US and China, but we are well prepared for the changes. Second, regarding proposed vapor restrictions. British regulators have been encouraging adult smokers to switch from cigarettes to reduced-risk products like e-vapors. Regulators are concerned about appealing packaging, use of appealing flavor, and advertising, but at the same time, they also understand flavor's role in adult smokers' transition. In other words, products with plain flavors and packaging that are not marketed and appealing to minors shall not be restricted. We are confident that such restrictions should be reasonable and might have minimal impact on adult smokers. Finally, excise tax could level the playing field. We have seen this introduced in many countries and regions, including the countries where we are currently operating. The current suggested tax rate is moderate compared to other countries globally. This would foster a healthier industry ecosystem and provide incremental incentives for regulators to combat illegal products. Thank you for your question.

Very clear. Thank you.

At this time, there are no further questions. I would like to turn the call back over to the company for closing remarks.

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

This concludes the conference call. You may now disconnect your line. Thank you.