Management Review and Sharing:
During the first quarter, we continued to optimize our GB-compliant e-cigarette products under the new regulatory framework and made steady progress, thanks to our effective product strategy and growing R&D capabilities. However, the prevalence of illegal products continues to pose short-term challenges to our business in the broader industry as we work to develop new GB e-cigarette products to meet the diverse needs of our users.
First, let me shed some light on recent market conditions impacted by illegal products. The biggest hurdle we face in the first quarter of 2023 is competition from illegal products. This includes illegal and counterfeit e-cigarette products manufactured by companies that have not yet been licensed. The presence of these illegal products not only affects our e-cigarette product sales, but also reduces consumers’ willingness to switch to the new national standard e-cigarette products and disrupts the pace of recovery for the industry as a whole.
On the bright side, however, the government has stepped up its efforts to crack down on illegal products, and they have recently launched special operations focused on 2 types of offenders: e-cigarette manufacturers who continue to illegally produce flavored products and retailers who conduct sales of e-cigarette products. These policies are working well and we are now seeing more and more unlicensed producers removing products from their business licenses. Sales of our e-cigarette products have gradually recovered following the implementation of these special actions, which our CFO will describe in more detail later. We are confident that the government will continue to crack down on illegal e-cigarette products and hope that it will effectively support the creation of fair and orderly market conditions that will allow law-abiding companies to resume sustainable growth. At the same time, we remain alert to any potential backlash from these illegal activities.
All in all, the first quarter was a mixed bag. While we made solid progress in improving our new national standard products, we also encountered significant resistance from illegal products. However, we firmly believe that the worst times seem to be over as the government’s efforts to maintain order and fairness in the market take effect and users gradually adapt to the national standard products, and illegal products will eventually be pushed out of the mainstream market. As a trusted boutique brand, we are confident in our core competence. As we explore growth opportunities in an evolving industry, we will fulfill our commitment to provide quality e-cigarette products that meet the standards and satisfy the needs of our users.
Financial Data Sharing:
We experienced a very challenging first quarter, particularly in January and February, given the severe impact of illegal condiments. These tantalizingly flavored but unsafe illegal e-cigarette products caused users to shift to our new national standard products more slowly than expected, resulting in a significant decline in our net income to RMB 189 million in the first quarter, but our sales have recently shown significant signs of recovery, due in part to the government’s massive sales campaign against illegal products. Specifically, our monthly sales experienced year-over-year improvement, particularly following the government’s special action in March. In fact, monthly sales almost doubled in March compared to January. However, the negative impact of sales of illegal e-cigarette products continues to linger, and the market will take some time to digest inventory, as it did in the fourth quarter of last year, when users took several months to consume our older products. The near-term challenges from illegal products will gradually ease and become more manageable, and users will gradually rely on the new national standard products.
In terms of gross margin, the first quarter was our first full quarter under the new excise tax policy on e-cigarette products that took effect in November. As a result, our gross margin declined to 24.2% from 38.3% in the same quarter last year. If we exclude the impact of the excise tax on an adjusted basis, using adjusted net income, our adjusted gross margin declined by only 1.6%. This result reflects our ongoing efforts to improve supply chain efficiencies and product design to mitigate the deleveraging effects of lower sales of our e-cigarette products. In addition, fixed costs, including the rent and depreciation we pay for our exclusive manufacturing facilities, put pressure on our gross margin in the low single-digit percentages in the first quarter. As the deleveraging effects I mentioned earlier narrow, our gross margin will gradually improve as revenues recover over the next few quarters. In addition to these cost optimization efforts, we continue to focus on improving operational efficiencies. As a result, excluding equity-based compensation expense (share-based compensation), our non-weighted operating expenses declined 15.1 percent year-over-year in the first quarter. However, due to our lower sales, we reported a non-weighted operating loss of RMB133.0 million and a net loss of RMB56.3 million in the first quarter. Excluding share-based compensation, our non-weighted net income was RMB 184 million and non-weighted basic and diluted net income per share was RMB 0.139 and RMB 0.136, respectively.
Our cash position remains solid. As of March 31, our cash and cash equivalents, limited to RMB15,369 million including cash short-term bank deposits, long-term and short-term investments, long-term bank deposits and long-term debt investments, and we have been working to maximize interest and investment income since the second half of the year