RLX Technology Inc

NYSE:RLX

Earnings Call Transcript 2021-Q2

[Operator]

Hello, ladies and gentlemen. Thank you for standing by for RLX Technology Inc.'s Second Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After management's remarks, there will be a question-and-answer session. Today's conference 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, Head of Investor Relations]

Thanks very much. Hello, everyone, and welcome to RLX Technology's Second Quarter 2021 Earnings Conference Call. The Company's financial and operational results were released through PR Newswire press release 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 expect our guess, estimate, depend [Indiscernible] 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 as of release [Indiscernible] advisors, representatives, and underwriters do not undertake any obligation to update this forward-looking information, except as required under the applicable law. Please note that the RLX Technology earnings press release and this conference call include discussions of unaudited GAAP financial measures, as well as unaudited non-GAAP financial measures.

Our RLX Technologies press release contains a reconciliation of the unaudited non - GAAP measures to the unaudited GAAP measures. I will now turn the call over to Ms. Kate Wang, please go ahead.

[Kate Wang]

Thank you, Sam. Hello, everyone. Thank you for joining our earnings conference call today. As most of you are aware, two major regulatory developments took place around the second quarter of 2021. The first was on March 22nd when the authorities made an announcement, speaking public comments on a proposal to revise relevant regulations to strengthen the supervision of the e-cigarettes and solve the quality and safety risks, enforce advertising problems, among others.

We believe that such a regulatory framework is both necessary and beneficial for the long-term healthy development of the industry. It has served to eliminate the risks associated with uncertainties regarding the legitimacy of this product category. It can also help [Indiscernible] incidents and setbacks that have occurred in some other overseas markets and ensure the long-term vitality of the industry in China. As of today, no details under the regulatory framework have been released yet. and we will closely monitor and follow up on any further announcements.

The second development took place in May and June when the Chinese National Health Commission published the China report on health hazards of smoking, 2020. Mentioning vaping products. The media and public, and some adult smokers and adult users of vaping products were confused by certain context, historical information in the report about the harm reduction benefits of using vaping products.

Next to the public has sustained since the release of the report. We have been working closely on the relevant scientific research and consumer communication to provide better information in unbiased knowledge on related topics. RELX was founded to serve adult smokers with state-of-the-art products and an unwavering pursuit of scientific advances to deliver harm reduction benefits to our users in the Second Quarter, we continued devoting resources to key operational areas, including science research and development, product innovation, quality assurance and control, and brand building.

Moreover, as a public Company, we have further strengthened our operational and financial internal controls to better protect our shareholders ' value. In the Second Quarter, we maintained our momentum in attracting and developing higher caliber talent and grew our workforce by 27%. These highly skilled individuals joined us from leading companies across the FMCG technology and pharmaceutical industries. We are pleased to see like-minded talents joining our course. And together, we have achieved satisfactory net revenue growth of 6% from 2.4 billion RMB in the first quarter to 2.54 billion RMB in the second quarter. With that, I will now turn the call over to our CFO, Lu Chao.

He will elaborate further on some initiatives taken during the last quarter and go over our operational and financial results in more detail. Chao, please go ahead.

[Chao Lu, Chief Financial Officer]

Thank you Kate, and hello, everyone. It has been my pleasure and privilege to have worked at the RLX for over a quarter by now. To quote Steve Jobs, the only way to be truly satisfied is to do what you believe is great work. At RLX, we're doing great work by providing products of the highest quality and safety standards to adult smokers. For harm reduction for themselves and for their loved ones around them.

I'm glad that I have joined this call. Now, let me share some specifics regarding the initiative we have taken in the second quarter. Following that, I will walk you through our financial results. In the past quarter, we continued the expansion of our offline distribution network and retail channels.

While we saw some weakness in product procurement by branded stores in the second half of the quarter, most likely due to negative publicity on the e-vapor industry and the absence of clarity on the regulation front, we firmly believe that the steady expansion of our distribution network and the retail channel is key to our long-term growth and competitiveness. We hope that with the passing of time and fading out of publicity effects, the first procurement of branded stores will soon regain momentum.

On the product front, we have focused on both device and flavor innovation. We are working on a rich pipeline of product offerings to cater to distinct user groups with differentiated preferences and price sensitivity. We expect these product offerings to be launched in stages to further drive penetration and enhance user retention.

We also take pride in our reputation, consistently delivering high-quality products, and investing heavily to improve quality control measures as we seek to further elevate user experience and inspire deeper user loyalty. We conduct rigorous quality assurance and control throughout our entire production cycles, and have [Indiscernible] 3 production plans to further strengthen our QA and QC capability.

Our QA and QC systems consist of 5 laboratories with 197 quality control checks to ensure that every intake of our aerosol represents the safest and finest of vaping experience. Currently, we have over 110 professionals managing our entire quality control process, which includes raw materials, production, and finished products.

In terms of scientific research, on July 3rd, 2021, we jointly published a research paper in The XCI Journal, Nico -toxicology and environmental safety with Sung Yunghse University, titled Comparison of Biological and Transcript Comics, Effects of Conventional Cigarette and Electronic Cigarette Smoke Exposure at Toxicological Dose in BEAS -2B Cell.

The research paper revealed that based on equivalent nicotine content and acute exposure in cigarette smoke condensates have a significantly larger impact on cell defect and gene expression profile compared to e-cigarette smoke contents, further demonstrating the harm reduction effects of e-vapor products versus cigarettes.

On August 4th, 2021, our e-vapor clinical trial was successfully registered with the China Clinical Trial Registration Center and the WHO International Clinical Trial Registration Platform. Our trial is the first e-vapor clinical research project in China to have passed both ethical and expert reviews and to be approved for implementation.

Filling the void in domestic e-vapor clinical research. It is also a pioneering study -- a scientific study in the China e-vapor industry. Looking forward, we will keep investing in in-house lab research related to product quality and safety, physiochemistry, pathological and clinical elements, and the evaluation of long-term use of e-vapor products. In keeping with our commitment to [Indiscernible] corporate responsibility, we remained dedicated to building and strengthening our trusted brand by consistently adhering to our strong ethical principles.

On June 1st, immediately after the enactment of the law on the protection of minors, RLX was the first among all our peers to call on all industry participants to thoroughly study the regulations and strictly abide by all of them. In July, several provinces in China were affected by extreme weather and natural disaster, resulting in hundreds of casualties. We once again acted swiftly by donating millions to China [Indiscernible] Foundation for Poverty Alleviation for emergency [Indiscernible] In addition, we were also deeply concerned about our partners' losses and decided to set up [Indiscernible] RELX Stores Relief Fund to help them recover those businesses.

Now, turning to financial performance. Our top-line quarter-on-quarter growth slowed down in Q2 due to external factors as mentioned by Kate previously. The impact of these factors is difficult to predict and may linger after the second quarter as well. However, we remain devoted to continuing driving user penetration among adult smokers as we firmly believe that the science and the benefits of harm reduction will prevail over misconception and false information.

I will now provide a summary overview of our financial results for the second quarter of 2021. Net revenues increased by 6% to RMB 2.54 billion in the second quarter of 2021 from RMB 2.4 billion in the first quarter of 2021. The increase was primarily due to an increase in net revenue from sales to the offline distributor, which was mainly attributable to the expansion of the Company's distribution and retail network.

Gross profit increased by 3.8% to RMB 1.15 billion in the second quarter of 2021, from RMB 1.1 billion in the first quarter of 2021. The gross margin was stable at 45.1% in the second quarter of 2021 compared to 46% in the first quarter of 2021. Operating expenses were RMB 167.2 million in the second quarter of 2021, representing a decrease of 86.3% from RMB 1.22 billion in the first quarter of 2021.

The significant decrease in operating expenses was primarily due to the recognition of share-based compensation expenses of positive RMB 172.5 million, representing: one, share-based compensation expenses of positive RMB 51.5 million recognized in selling expenses; two, share-based compensation expenses of positive RMB 41.4 million recognized in general and administrative expenses; and three, share-based compensation expenses of positive RMB 79.7 million recognized in research and development expenses.

The significant fluctuations in share-based compensation expenses were primarily due to the changes in the fair value of the share incentive awards that the Company granted to its employee as affected by the significant fluctuations of the share price of the Company. Selling expenses decreased by 66.8% to RMB 126 million in the second quarter of 2021 from RMB 291.5 million in the first quarter of 2021.

The decrease was primarily driven by: one, the fluctuations of share-based compensation expenses; and two, a decrease in salaries and welfare benefits, partially offset by an increase in branding material expenses. General and administrative expenses decreased by 93.5% to RMB 46.1 million in the second quarter of 2021 to RMB 712.8% -- million in the first quarter of 2021. The decrease was primarily driven by first, the fluctuation of the share-based compensation expenses.

And second, a decrease in salaries and welfare benefits, partially offset by an increase in legal and other consulting fees. Research and development expenses decreased by 102.3% to positive RMB 4.9 million in the second quarter of 2021 from RMB 211.6 million in the first quarter of 2021. The decrease was primarily driven by first, the fluctuation of the share-based compensation expenses.

And second, a decrease in salaries and welfare benefits, partially offset by an increase in depreciation and amortization expenses. Income from operations was RMB 979.3 million in the second quarter of 2021, compared with a loss from operations of RMB 111.9 million in the first quarter of 2021. Income tax expense was RMB 204.2 million in the second quarter of 2021 compared with RMB 176.3 million in the first quarter of 2021.

The increase was primarily due to an increase in taxable income. U.S. GAAP net income was RMB 824.3 million in the second quarter of 2021 compared with US GAAP net loss of RMB 267 million in the first quarter of 2021. Non - GAAP net income was RMB 651.8 million in the second quarter of 2021, representing an increase of 6.8% from RMB 610.5 million in the first quarter of 2021. U.S. GAAP basic and diluted net income per American depository share were RMB 0.595 and RMB 0.591 respectively, in the second quarter of 2021.

Compared to U.S. GAAP basic and diluted net loss per ADS of both RMB 0.174 in the first quarter of 2021. Non - GAAP basic and diluted net income per ADS was RMB 0.47 and RMB 0.467 respectively in the second quarter of 2021. Compared to non-GAAP basic and diluted net income per ADS of both RMB 0.398 in the first quarter of 2021.

As of June 30th, 2021, the Company had cash and cash equivalents, restricted cash, short-term bank deposits, short-term investments, and long-term bank deposits of RMB 14.88 billion compared to RMB 14.44 billion as of March 31st, 2021. As of June 30th, 2021, approximately $1.64 billion was denominated in U.S. dollars. This concludes our prepared remarks today. We will now open the call to questions. Operator, please go ahead.

[Operator]

We will now begin the question-and-answer session. [ Operator Instructions ] 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. [Operator Instructions] The first question comes from Lydia Ling with Citi. Please go ahead.

[Lydia Ling, Citi]

Hi management this is Lydia from Citi, and thanks for the presentation and taking my questions. I have 2 questions. The first one is given the slowdown in the Second Quarter, could you elaborate more on the Third Quarter to date trends and also your outlook on the Second Half, given currently like the frequent negative publicity and also the regulatory environment.

And my second question is on the expansion. Could you actually tell us about how many stores did open in the Second Quarter and also what's your opening plan in the Second Half given current market conditions? And also, how is your distributor sentiment on the new opening? Thank you.

[Chao Lu, Chief Financial Officer]

Sure. Thanks very much, Lidia. So regarding the first question, it's mainly regarding the first-quarter trend and also the second-half outlook. As of the amount, e-vapor products remain under-penetrated among [Indiscernible] in China.

Though our Company believes that harm reduction products, including e-vapor products, are better alternatives for adult smokers in China. We remain committed to the trend of adult smokers converting from cigarettes to e-vapor products.

And we are competent in the medium and long-term prospects of the industry, as well as our future performance. So to directly answer your question regarding our third quarter to date trends, specifically, we have cleanups the decrystallization of operating and financial metrics in recent weeks as we continue to engage and retain our users. So we are very confident about the future outlook of the Company.

So regarding your second question, it's mainly on these store numbers, opening plan, distributor sentiments, etc. So I mean, for our overall store open logic, we believe that our current model is very sound. Our model lastly, depends on where there are enough users using our products in order to support a brand upon a store in the given area or a district. For our newly open [Indiscernible] stores, we monitor and evaluate the store productivity in combination with other macro and micro factors.

For example, if the store productivity after nearly open stores is better than the expected productivity curve, we will allow some new stores to be opened and vice versa. We do have various color label packs in different districts or areas based on the existing store's productivity, in order to micro-manage and witness or manage any cannibalization between existing and new stores. We indeed closely monitor the single-store economic model of our current brand department stores. Thanks very much for your question.

[Operator]

The next question comes from Charlie Chen with China Renaissance. Please go ahead.

[Charlie Chen, China Renaissance]

Thank you, management, for taking my question. I got two questions here. First of all, I want to ask about the performance of your products in different categories, like the premium products versus the mainstream products which we launched about a quarter ago. So how's that developed so far?

And my second question is regarding the retail price. As we observed, some of the competition in certain areas are quite intense. So do you see any retail price softness, or rather volatility in some of the markets? And also, is there any special situation where distributors may do parallel trading, which means they're selling their products at a lower price to -- outside of their authorized areas. Does that situation are -- things happening in your market? Thank you.

[Chao Lu, Chief Financial Officer]

Sure. So thank you very much, Charlie. Regarding the first question is it on a product [Indiscernible] We have been providing a diversified product portfolio, with various price points from [Indiscernible] We do see that more and more users have smokers, with different sets of user groups trying to use our products as their harm reduction alternatives.

Still, regarding our new products, we do see that there has been positive feedback and contribution from both our users and retailers. Still, we will continuously, cautiously monitor our user behavior and trends, trying to optimize our product mix, while further launching new product lines.

The second question is on pricing actually [Indiscernible] having price, and where there is an unauthorized sale by distributors to unauthorized areas. So the first one is on pricing. So we have been closely monitoring the pricing across the value chain, especially the actual selling price and discounts of our products from retailers' point of view. So we indeed initiated a program to monitor the actual selling price of each layer of our value chain in the second quarter of 2021.

We do see that most of our retailers, especially [Indiscernible] have been following suggested retail selling price in the actual sales to adult smokers. Regarding any unauthorized sales or distribution to unauthorized areas. We have been implementing effective measures in technology and control. We have a unique QR code system for each of our product lines. If we found any of our distributors or retailers, report any cases that they see unauthorized products being appeared. We could reveal the identity of distributors selling such products and solve the issue accordingly. Thanks very much for your questions.

[Operator]

The next question comes from Stephanie Lam with Haitong International. Please go ahead.

[Stephanie Lam, Haitong International]

Hi, management. Thank you for taking my questions. I have two questions from my end. My first question is regarding on store opening subsidy. We noticed that some of our peers have offered more store opening subsidies in the past couple of months. May we know what is the management's views on that, as well as all approaches to store opening subsidy.

The second question is regarding the raw material cost pressures and gross margin. Given the cost hike of raw materials, may we know if we have split up the wholesale prices to franchisees and distributors in order to pass the cost on? And how should we estimate the trend of the margin going forward? Thank you.

[Chao Lu, Chief Financial Officer]

Sure. Thanks very much, Stephanie. The first one is on subsidies. Given our competitive landscape, you do see that our store [Indiscernible] have remained consistent and now subsidies per store have decreased consistently since we have introduced our branded partner stores model back in early 2019.

We have been assessing and grants stores of these largely based on the macro environment and single-store economics of our branded partner stores. So, I mean, for the past 2 years, peers have offered far more subsidies to potential store owners driven by their intention to penetrate the market and make a presence.

However, these larger subsidies frequently do not translate into the market share growth of their brands. Given the current developments of the industry, we have recently seen our peers start to decrease their subsidies to potential brands [Indiscernible]. In the medium and long term, we believe that store subsidies will be more rational and will become more dependent on the single-store economics of each brand [Indiscernible]. So regarding the second question is on the increase of the raw material and whether it increased our pricing and margins.

Though given the macro situation, the price of raw materials, for example, chips, batteries, have been on an upward trend since the beginning of the year. As a result, some of our suppliers have experienced an increase in procurement costs throughout the supply chain. However, so far, we didn't really experience a significant increase in unit cost due to the price of raw materials so far.

And therefore, we have not increased the wholesale price of our products being sold to our distributors. But of course, we will closely monitor the latest supply-chain developments, as well as our suppliers' operating issues. Given the cost optimization in each [Indiscernible] of our entire industry value chain. For example, automated production, cost-saving product design. We believe the long-term unique cost of the industry, including ours, would be further optimized. Thanks very much for your question.

[Operator]

The next question comes from [Indiscernible] with CICC. Please go ahead.

[Jung Hao, CICC]

Hi. Thanks, management for taking my question. I'm Jung Hao (ph) from CICC. I also have two questions. The first one is, we know that there are many -- there are more and more e-cigarettes in the market. How would the management estimate their future competitive landscape among Chinese e-cigarette brands? And my second question is since many similar vapes [Indiscernible] are eyeing the market. Which can also be [Indiscernible] our devices, like [Indiscernible] What actions would our -- what would they do to solve this problem? That's my two questions. Thank you.

[Chao Lu, Chief Financial Officer]

Frankly [Indiscernible] I mean, the first one is on the competitive landscape of China's e-vapor markets. I believe the competitive landscape of the markets will be increasingly complex. Requesting each brand or market participant to put more effort and further innovate in FS such as commercial strategy, product innovation, and efforts in scientific research.

We believe that's with our leading position, strong brand equity, expensive retail network, and product innovation capabilities, we can remain or expand our market leadership in the China markets. Regarding the second question, I'm not sure if I hear correctly is on the compatible parts that you have mentioned. I mean, for unauthorized compatible parts, we do see that they pose a greater risk to e-vapor user's health, given that the product quality and safety may not be guaranteed.

These compatible parts are also largely sold in illegal retail channels, which may be accessible to underage users. As a brand, we have been collaborating with various partners and parties to prohibit illegal sales of unauthorized, compatible parts and have filed patent claims and lawsuits against brands that may have used our patents or brands without our permission.

Commercial-wise, we also have expanded our product portfolio to cater to the diversifying needs of the e-vapor users in China in multiple aspects, including the availability of flavors, price points, and functionality. We still believe that these commercial strategies have been, and will continue to be effective in combating unauthorized compatible cottage that currently exists in the markets. Thank you very much for your questions.

[Operator]

The next question comes from Louise Lee with Bank of America Securities. Please go ahead.

[Louise Lee, Bank of America Securities]

Hi. Thank you, management, for taking my question. I have two questions here. Firstly, I know that we actually set up our electronic cigarette clinical [Indiscernible] several weeks ago. So what is the major [Indiscernible] the potential benefit of this. And secondly, about the regulation on the potential impact. But what will happen if the whole industry is under the regulation on China tobacco? Thank you.

[Sam Tsang, Head of Investor Relations]

Sure. Thank you very much, Louise. It's nice to have you. For your first question is on the last facts Chao mentioned in the open remarks. Our trial is actually the first e-vapor clinical trial project in China for e-vapor products that have passed both ethical and expert reviews and have been approved for implementation.

So we believe that this laboratory and research can showcase our [Indiscernible] of our abilities in scientific research and clinical trials. As a Company, we believe that facts speak louder than words. We hope more and more clinical trials on e-vapor products to be carried out in upcoming years. With increasing fact-based science-based communication across various parties. And more and more adult smokers can use e-vapor products as their harm reduction tobacco alternatives. Regarding the second point on the regulations front.

On March 22, the MIIT released the draft rules regarding e-vapor products. As mentioned in the last earnings call, we have already submitted our feedback regarding the proposed revision of the implementation plan. Currently, decimal updates on the regulations and no new implementation details have been rebuilt.

These are parts of regulatory measures mentioned in announcements, including the proposal to regulate the operating activities of the e-vapor industry and tackle potential product safety issues of e-vapor products across an advertisement, etc. Thanks very much for the questions.

[Operator]

As there are no further questions now, I would like to turn the call back over to the Company for closing remarks.

[Sam Tsang, Head of Investor Relations]

Thank you once again, for joining us today. If you have any further questions, please feel free to contact our RLX Technology Investor Relations team through the contact information provided on our website or at TPG Investor Relations. Thanks very much.

[Operator]

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