RLX Technology Inc.

Hello, ladies and gentlemen. Thank you for standing by for RLX Technology Incorporated's second quarter 2022 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 Tesang, head of investor relations for the company. Please go ahead, Sam.

Thank you very much. Hello, everyone, and welcome to iRX Technologies' 7th Quarter 2022 Earnings Conference Call. The company's financial and operational results were released through Peonys wire 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 irr.redactedtech.com. Participants on today's call will include our CEO, Ms. Kate Wang, CFO Chow Wu, and myself, Sam Tsang. Before we continue, please note that today's discussions will contain four working 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, target, estimate, intend, release, potential, continue, or other similar expressions. Four working 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 obligations to update these for the pin information except as required under the applicable law. Please note that ILS Technologies earnings press release and this conference call include discussions of unaudited gap financial measures as well as unaudited non-gap financial measures. Our ILS press release contains a reconciliation of the unaudited non-gap measures to the unaudited gap measures. I will now turn the call over to Kate. Please go ahead.

Thank you, Sam, and thanks to everyone for making time to join our earnings conference call today. I'm pleased with the healthy financial performance we delivered in the second quarter as we proactively continued to adapt to the new regulatory framework. We remain focused on enhancing the full range of our capabilities, from scientific research, product development, to manufacturing advancements and operation optimization, all of which empowered us to navigate the highly dynamic market and the evolving regulatory landscape. Amid strong macro headwinds and weak consumer sentiment, our solid second quarter results, underscored the resilience of our defensive business model and our commitment to building and strengthening our brand's trustworthiness. Before taking a closer look at business updates, I would like to start with a brief recap of the milestone regulatory development in our industry. Beginning in the first quarter of 2022, the relevant government authorities in China have issued a series of implementation rules and guiding opinions to strengthen oversight of e-cigarette products and regulate the e-cigarette industry. including the administrative measures for e-cigarettes that's coming to effect in May, and the new national standards that will become effective on October 1st, 2022. Now let me share our progress on our relevant license applications as required by the administration measures. To date, two of our subsidiaries have obtained the license for manufacturing enterprise from the State Tobacco Monopoly Administration, SPMA, to conduct manufacturing activities under the regulatory guidance. Specifically, one is approved to manufacture e-liquid and the other is approved to own the RELAX brand and the manufacturer RELAX brand eVapor rechargeable devices, cartridge products, and other relevant products. Obtaining the license marks an important milestone in our strategic roadmap as we actively embrace the new paradigm with top regulatory compliance. We believe our solid, fundamental, industry-leading research and development capabilities and seasoned teams will assist further in our mission to achieve full regulatory compliance for our operation according to schedule. To build on this progress, we have redoubled our efforts to develop new products that meet the applicable requirements while fulfilling users' demands. Some of our new products will amount to the first batch of products in the industry to obtain approvals under the new national standards, a powerful validation of our industry-leading R&D capabilities. We look forward to bringing the approved product to market very soon and are confident that our product's quality, performance, and safety will continue to resonate well with our users. Currently, we have several additional newly developed products in the process of technical review and many more in the application pipeline. In the future, we will remain committed to fulfilling our users' demand for safe, high-quality products in strict compliance with regulations while exploring new growth opportunities in the industry. In particular, we firmly believe that R&D is the key to our success and sustainable future growth. It is R&D that has enabled us to quickly roll out compliant new products and maintain our brand's competitive edge. Here are a set of metrics tracking our R&D standing. Our non-GAAP R&D stands ratio has increased from 1.5% in 2018 to 3.6% in the first half of 2022. and is expected to further increase in the coming years. Beyond product R&D, we are also dedicated to fundamental scientific research to protect our users' health, working relentlessly to better understand and minimize the health risks associated with EVA products. To that end, in addition to running our own scientific labs, we have partnered with various leading research institutions, including 10 universities, two hospitals, and several independent academic research houses to conduct related research and development, building a firm foundation for ongoing product development and innovation. Furthermore, in the second quarter, we collaborated with Shenzhen institutions of the Wang Technology Chinese Academy of Sciences on an evapour cooling agent inhalation study, which concludes that evapour products containing WS23 have lower rewarding effects than pure nicotine products. A breakthrough, we believe, will support us to deliver a better, safer appearance for adult smokers. Turning now to our operations, alongside our efforts to comply with applicable regulations, we continue to streamline our business structure and operational workflow during the second quarter to enhance our agility and flexibility. Our approach has yield good initial results, with non-GAAP expense ratio decreasing quarter over quarter. Chow will elaborate on this further a bit later. We believe this comprehensive operational enhancement will enable us to neatly tackle critical changes and swiftly adapt to the market evolution, boosting both our immediate and long-term efficiency. In conclusion, we remain confident in the inherent potential of China's evapomarket. We believe that as a trusted evapobrand for adult smokers, our leading technologies and scientific advancements high-quality user base, resilient business model, and strong overall execution are our fundamental assets that will empower us to drive sustainable quality growth in the long run and further strengthen our leadership position in the industry. More importantly, we will continue to seek regulatory approvals to meet all applicable requirements on schedule while developing qualified products to deliver superior performance for the enhancing operational efficiency and capturing the industry's growth opportunities ahead of us. With that, I will now turn the call over to our CFO, Chao Lu. He will elaborate for some of our last quarter's initiatives and go over our official and financial results in more detail. Charles, please go ahead.

Thank you, Kate, and hello, everyone. I will now provide a summary overview of our financial results for the second quarter of 2022. In the context of a challenging macro environment and COVID restrictions, consumer sentiment slumped to a record low in the second quarter. According to the National Bureau of Statistics of China, the overall consumer confidence index fell from 121.5 in January 2022 to 88.9 in June 2022. Also, overall retail sales in China decreased by 0.7% year-over-year in the first half of 2022. By actively adapting our business to the market and diligently improving our operational efficiency, we deliver solid and healthy results for the second quarter, recording net revenue of RMB 2.2 billion. However, we believe this elevated level of revenue in the second quarter was primarily due to front-loading of sales in the downstream value chain in anticipation of the discontinuation of our older products as the industry transition period nears its end in the third quarter. Revenue decreased year over year. However, this was mainly due to the expansion of store expansion and new product launches during the regulatory transition period, as we work to strictly comply with the relevant requirements. Our growth profit was approximately RMB 1 billion in the second quarter, with growth margin of 43.8% for the second quarter, compared with 45.1% in the same quarter of 2021. The decrease in growth margin was primarily due to an unfavorable product mix shift, an increase in inventory provision, and the impairment loss recognized for PP&E to comply with the recent regulatory developments. Due to a significant increase in share-based compensation expenses to RMB 193.2 million from a positive RMB 172.5 million in the same quarter of last year, our operating expenses reached RMB 530.9 million in the second quarter of 2022. Compared with RMB 176.2, by $167.2 million in the same period of last year. Specifically, our setting expenses decreased by 2.7% to RMB $122.6 million in the second quarter of 2022 from RMB $126 million in the same period of 2021, mainly driven by a decrease in salaries, welfare benefits, and branding material expenses while partially offset by an increase in share-based compensation expenses. General and administrative expenses increased to RMB 290.7 million in the second quarter of 2022, and RMB 46.1 million in the same quarter of 2021, mainly driven by the increases in share-based compensation, salaries, and welfare benefits. As we remain focused on strengthening our RMB capabilities, our research and development expenses were RMB 117.6 million in the second quarter of 2022, compared with a positive RMB 4.9 million in the same period of 2021. This increase was mainly driven by increases in share-based compensation expenses, salaries, and welfare benefits and consulting expenses. To echo what Kate mentioned about our business structure enhancement, our proactive cost optimization initiatives also continue to bear fruit this quarter. If we exclude share-based compensation, our non-GAAP expense ratio decreased to 15.1% in the second quarter, from 20.9% in the prior quarter. Notably, non-GAAP selling expense ratio decreased to 4.7% in the second quarter from 6.9% in the preceding quarter. If we exclude the impact of one-off items, such as impairment loss, our adjusted expense ratio was similar to that of the same similar to the level of the same period of last year. We believe the adjusted metrics may better reflect our efforts and achievements with respect to operational improvement during the quarter. As a result, our non-GAAP net income increased to RMB $634.7 million from RMB $361.8 million in the prior quarter. Non-GAAP basic and diluted net income for ADS were RMB 0.494 and RMB 0.492 respectively in the second quarter of 2022. Moving on to our balance sheet, we have a solid balance sheet. In particular, our cash position remains strong with cash and cash equivalent, restricted cash, short-term bank deposits, short-term investments and long-term bank deposits net of RMB 16.8 billion as of the end of June 2022, compared with RMB 14.9 billion a year ago. In addition, we generated a positive operating cash flow of RMB 1.4 billion with an increase in the operating cash flow over non-GAAP net income ratio to 228% in the second quarter of 2022 from 100% in the same period of last year. Our strong cash position and sufficient operating cash inflow enable us to agilely adjust our business when facing challenges and support our efforts to capture potential growth opportunities in the industry. In light of the regulatory changes, we are off to a slow but steady start of the sales of our new products that are compliant with the national standards through the new transaction system mandated by the regulators. In closing, we believe that e-vapor products will continue playing a vital part in harm reduction for adult smokers in the new industry, new regulatory areas. With our product's superior quality and safety, our brand will continue to resonate well with adult smokers. Moving forward, we will focus on cost optimization while continuing to reinforce our product competitiveness to create sustainable long-term growth for our shareholders. This concludes our prepared remarks today. We will now open the call to questions.

Operator, please go ahead. Thank you. We'll now begin the question and answer session. To ask a question, you may press star, then 1 on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. 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. We will now pause momentarily to assemble our roster. Our first question comes from Lydia Ling from Citi. Please go ahead.

Hi, everyone. Sex Management. And this is Lydia from Citibank and associate for the presentation. And so here I have three questions. And the first one is, actually, we saw some of the new products have been introduced in selected regions. So we want to know what's the user feedback so far and also as transition period ends a few days later. And so what's your thoughts on your favorite impact on the sales volume in the foreign quarters? So this is the first question. And the second question is, actually, we saw that the retailers now may have over three brands at their store level. So we want to know your view on the competitive landscape looking forward. And the last question is, actually, we are now in September. So could you share with us the quarter-to-date performance and also your outlook for the fourth quarter and 2023? Thank you.

Thanks very much, Lydia. So the first question is mainly on the sales volume of the paper band, and the second one is mainly on how the competitive landscape goes, and the final one is on the outlook for the third quarter and so. So regarding the first one is how will be the impact after we launch products that comply with the national standards. As we just launched these products a few weeks ago, To be honest, I think the vast majority of our users haven't had the chance to try our products. Given that we are still in the transition period, which will last until September 13, it's difficult for us to give a quantitative guidance regarding future projects, given that some products are still being approved at the moment. When we look at the lessons and data learned from the in the United States back in 2020, it took few quarters for users in the US market to adapt to the new places and recover the industry volume. So there have been more and more products being approved in the past few weeks, which we believe could be launched very soon and could cater more existing users' needs. So we have a more clear picture of our user demand change in the late 4Q after users have digested their flavor infantries on hand. And regarding the second question that there could be multiple brands selling in one single store going forward, so in our view, the ultimate goal for retailers is to maximize their store productivity and their own profitability. Instead of selling only one brand in a single store, so retailers have to sell multiple brands under the new regime. We don't expect any material impact on the competitive landscape as retailers have always had the choice to select their designated brand to collaborate. We believe the brand share of the store should be determined by product quality, brand equity, and user base. Based on our observations, our brand share remains steady in the past few months. In the future, we will continue to invest in strengthening our R&D capabilities and our non-GAAP R&D expense has been steadily increasing in the past quarter. We expect it to further increase in the coming quarters. With our increased efforts in R&D, we will continue to offer a better, safer experience for islanders. The last question is on the first quarter outlook. As prepared in our opening remarks, our third quarter revenue benefited from the firm's of sales in the downstream value chain in anticipation of the discontinuation of our older products as the industry transition period nears its end in the third quarter. The resulting high rates for comparison will impact our sequential third quarter results. Meanwhile, we gradually decrease our shipments of old products throughout the third quarter to better translate into the new regime. which will affect our first quarter number. So given that the transition period will end on the September 30, it will take more time for us to better project the future outlook, especially for the fourth quarter. Thank you for your question.

Thank you.

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

Thank you, management, for taking my questions. I got two questions. The first one is regarding your product pipeline, especially the new product, which should abide with the new regulations or new national standard. So what I want to ask is, what is the status of your new product application? In particular, how many have been approved? How many are still pending and also how many have been rejected, if there is any? And what is your product portfolio plan for the coming year, for the next 12 months or so? So that's my first question. And my second question is about the schedule of your product recycling or reshuffling. I remember last time you said you plan to phase out your old products. In the second quarter or third quarter, so I just want to know when exactly have you phased out or stopped producing old products, which is not provided by the national standard? And when is the time when you have new products started production or started to sell to the market? So that's my two questions. Thank you.

Thanks, Charlie. So the first one is mainly on the product approvals and the second one is on the old product results. So I mean for the new regime, every new product must get approval before it launches and the application itself will be an ongoing process. So we will continue diversifying our product portfolio under the new regime and offer quality products for our customers. As of today, we have received product proposals for low teams of devices and low teams of hardware products. And some of our applications are still under review, and we expect the number of our approved products will keep growing. And regarding the segment about the old product phase-outs, we gradually saw our pace in production throughout the first quarter with the majority of our production occurring in the first half of the first quarter. For the sales of products that comply with national standards, we began to participate in the testing of the construction platform this month. We have received more approvals in the past few weeks, and therefore we are still in the early stage of rolling out these new products. Our current sales of these new products may not be accurately reflect our real-use demand, as our users still have access to our old products, and these new products are just being approved very recently. So we'll be able to provide more updates after the transition period. Thank you. Thank you.

The next question comes from Pihang Liv from CICC. Please go ahead.

Hi there, management. This is Pei Hong at CICC, and thank you for the opportunity to take my questions. I have three questions, actually. The first one is, could you please introduce a bit about the current inventory level of your original products, and will there be any further inventory impairment? The second question is, I would love to know what are your recent adjustments after stores cannot be operated exclusively? And my last one is since the national e-cigarette online trading platform has been launched and I would like to know what is your latest progress with regard to the cooperation with tobacco administration and other entities? Thank you.

Thank you, Peihan. So the first one is on the inventory level and also our inventory impairment practice. The second one is on the exclusivity terms that we previously have with our store owners. The final one is the latest developments regarding the transaction platform. Regarding the inventory level for our new products and regarding the inventory impairment, there has been a gradual but steady start with our sales of our new products comply with national standards. Also, our users will need more time to digest the inventory and adjust their user behavior. The inventory level for new products is relatively low compared with the level that we have for older series before the transition period. Regarding the inventory provisions, we have been incurring inventory provisions for products that do not comply with new national standards and raw materials that are no longer applicable since the fourth quarter of 2021. We don't expect to incur more significant infantry provisions regarding processing compliance with national standards in the funding process. And the second question is on the exclusivity term that we have for store owners previously. After the SPMA announced the rule that the exclusive distribution agreements are not allowed for branded products stores in March 2022, we began terminating our agreements with store owners and returning their deposits. So as of the end of second quarter, most of this work has been completed. In our view, the non-exclusivity will enable us to effort to source that previously carried out only other brands. In the future, brands with substantial brand equity and user mind share, i.e. relax, will still be favored by store owners, as such products will help them to improve their store productivity. Based on our own observation, Since the termination of the exclusivity, many additional store owners have started selling relaxed branded products. And finally, regarding the process that we have for the trading platform, since this month's beginning, several regions across the country have begun to test the national transaction platform. As a leader in China's e-waper industry, we were pleased to be among the first few brands selected to participate. The transition process has been smooth, and we are grateful for the support provided by the SMA. For instance, our staff has been offered trainings from research institutes, quality supervision, test standards, and the clinical testing cooperation by the SMA on the national standards. Thanks to their help and assistance, Our new products were among the first batch of products in the industry to obtain approvals under the new regime. Thank you. That's very clear.

Thank you very much.

Due to time constraints now, 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 our technologies and investor relations team through the contact information provided on our website or TVG Investor Relations.

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