RLX Technology Inc.

Hello, ladies and gentlemen, and thank you for standing by for the RLX Technologies third 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 expected to last for about 40 minutes. I'll now turn the call over to your host, Mr. Sam Tsang, head of investor relations for the company. Please go ahead, Sam.

Thank you very much. Hello, everyone, and welcome to IRX Technologies' first quarter 2022 earnings conference call. The company's financial and operational results were released through GL 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.redactech.com. Participants on today's call will include our CFO, Mr. Chao Lu, and myself, Sam Tseng, 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, target, estimate, intend, believe, 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's authorized advisors and representatives do not undertake any obligation to update forward-looking information except as required under the applicable law. Please note that our technology earnings press release and this conference call include discussions of unaudited gap financial measures as well as unaudited non-gap financial measures. Our RX press release contains a reconciliation of the unaudited non-gap measures to the unaudited gap measures. I will now turn the call over to Charles. Please go ahead.

Thank you, Sam, and thanks, everyone, for making time to join our earnings conference call today. During the third quarter, we remain dedicated to preparing for a smooth transition to the new operating environment created by China's new national standards, which came into effect on October 1, 2022. Specifically, We concentrated on developing new products in compliance with the national standard, which we call GuoBiao or GB products, and finished moving ourselves to the national transaction platform. We started this transition in late August during the national transaction platform trial phase in selected regions and have now achieved full geographic coverage nationwide. putting us on track to steadily roll out our new products to customers across China. Before I delve further into the details of our endeavors during the transition period, I'd like to talk first about the recent industry regulatory developments. On October 26, the Ministry of Finance, General Administration of Customs, and State Taxation Administration jointly issued the announcement on imposing consumption tax on e-cigarettes, which came into effect on November 1st, 2022. The new law imposes a consumption tax on manufacturers, importers, and or distributors of e-cigarettes in China, representing another landmark event in the legalization and standardization of China's e-cigarette industry, following the adoption of the e-cigarette mandatory national standard and measures for the administration of e-cigarettes earlier this year. With the implementation of new taxation policy, alongside the relevant laws and regulations on e-cigarettes that have been rolled out over the past two years, we can see that China's regulatory framework is becoming clearer, guiding the industry to a new era of healthier development with better oversight and management. We firmly believe that the new regulatory framework will benefit all industry participants' long-term development, and as always, we will strictly comply with all applicable regulations. At the same time, the new fast-evolving operating environment creates some challenges for industry participants, as well as a short-term adverse impact on our performance as we actively adjust our products and operations. Despite these near-term obstacles, we remain confident in our business's resilience and the growth potential of eVapor industry. We believe RLX will ultimately benefit from the more structured regulatory environment and emerge stronger after we adjust our business and adapt our products and strategies for success in this new era. Now, let me provide some more details on our efforts and achievements during the transition period. Since the formal rollout of the new rules and regulations earlier this year, we have proactively responded through public channels, adjusted our business, and conducted our operations in accordance with all applicable requirements. For instance, under the guidance of the competent authorities, we increased communication and strengthened our internal training on the regulations and the new standards. In addition to deepening our team's understanding of the regulation, we also actively provided timely support for store owners and distributors during the transition period to ensure a smooth transition for the whole value chain. At the same time, we accelerated our research and development of the new GB product and actively applied for technical reviews and relevant licenses. These efforts continue to bear fruit. As we reported last quarter, several of our GB products were among the first batch in the industry to achieve approval. These products have now been brought to market and are achieving steady sales. We have a healthy pipeline of products in the development and are carefully monitoring user feedback on newly released products to ensure that our future products meet their needs. As of the end of last week, we have obtained approval for 14 devices and 14 cartridges, expanding the number of our GB products in our ready-for-market pipeline. Just as we did in the pre-regulation era, we are striving to provide products catering to distinct user groups with differentiated preferences and price sensitivity. For instance, we have TeamView, an affordable device for value-conscious users, and Phantom Device, our classic device product that features a new compliant child lock. Also, we have released an upgraded Phantom Pro device equipped with adjustable power. Lastly, Zeus, our ultra-premium device, boasting adjustable power and resistance levels, is perfect for experienced adult smokers. Consequently, despite the external environment continuing to evolve rapidly and the uncertainty persisting, we believe there is a growth potential in the evapour industry still awaiting to be unleashed. We are convinced that evapour products will continue to play a vital role in harm reduction for adult smokers, and that with our team's hard work and innovation, we will create and deliver satisfying GB products for adult smokers across China in the new regulatory era. Supported by our industry-leading technology and research capability, we plan to introduce our new TB products on a rolling basis as we assess the impact of the new tax regulations on sales, as well as user feedback regarding our product innovations. Aligned with our strong commitment to user satisfaction and regulatory compliance, We also focused on fulfilling our social responsibilities, which we see as one of our core competitive advantages. We recently published our third annual corporate social responsibility report, summarizing our achievements with respect to market responsibility, R&D investment, environmental protection, employee career development, and corporate governance over the past year. Let me go through some of the report highlights. Since the company's inception, R&D investment has always been one of our strategic priorities. To keep RLX at the forefront of innovation, we have developed a one-plus-four science research chain covering product quality, physiochemical research, toxicology research, long-term impact assessment, and clinical research. In March 2021, we launched the first e-cigarette clinical research project in China. And in February 2022, we commenced the first clinical study on the safety of e-cigarettes in China. Both projects were successfully registered with the Chinese Clinical Trial Registry. Additionally, various research projects led by RILX in collaboration with renowned research institutions were published in prominent academic journals, such as the Chinese Journal of Drug Abuse Prevention and Treatment. These achievements, among others, have firmly cemented our industry-leading position in eVapor R&D. Environmental protection is another area where RLX shines. We strongly advocate for sustainable consumption and encourage our users to participate in our POTS Reborn Program, which we started in September 2021. Through the consistent efforts showcased in our CSR report as of June 2022, The program had been implemented in 188 cities in China, with over 16,000 stores boasting used parts recycling bins. We are very pleased to report that, based on SMP's global most recent annual corporate sustainability assessment, Our S&P Global ESG score ranks ahead of 67% of our global peers. Also, our MSCI ESG rating has been upgraded from CCC to A, ranked in the top five in the tobacco industry globally, representing a powerful of our commitment to sustainability and ESG best practices. In more than four years of entrepreneurship, our dedication to fulfilling our social responsibility is one of RLX attributes of which we are most proud. It is not only our duty as good corporate citizens, it is an integral part of the company's ethos and the role we play in the world we all share. Looking ahead, we will continue to uphold our commitment to social responsibility while driving sustainable development along our entire value chain. I will now provide a summary overview of our financial results for the third quarter of 2022. The first quarter was a transitional period for RLX as we actively adapted our business to the new regulations and strictly conducted our operations in accordance with applicable requirements. Amid the complex macro environment, we delivered net revenues of RMB 1.0 billion in the third quarter, recording a sequential decrease, mainly due to the discontinuation of older products during the transition to national standard, as well as the second quarter's high rates resulting from the front-loading of sales in anticipation of the discontinuation of older products. Also, our shift to the national transaction platform was conducted on a regional basis meaning that we also have to roll out our GB products gradually and region by region, limiting the pace of availability in some areas. Although we are experiencing short-term headwinds with respect to our sales performance, we believe our diverse and growing product portfolio will continue to satisfy adult smokers' needs and drive a gradual recovery in sales as users consume their inventories of older products. Moving to our growth process, we delivered profits of approximately RMB 522 million with a growth margin of 50 percent in the third quarter, compared with 39.1 percent in the same quarter of 2021. The increase was primarily due to a favorable change in the channel mix. During the transition period, we gradually terminated our partnerships with distributors who could not obtain a wholesale license, which led to an increased sales contribution from direct supply to stores. An increase in direct costs related to promotional activities was also a factor. Against the backdrop of macroeconomic headwinds and the pandemic's resurgence, we continue to focus on factors within our control, strengthening our execution and getting our house in the best shape possible to move forward in the new regulatory era. Operational excellence is always a good business practice, and it becomes more critical in times of economic turbulence. Since the beginning of the year, improving operating efficiency has been a key focus for our management as we seek to navigate uncertainty with certainty. Our ongoing efforts to enhance cost management once again proved effective in the third quarter, evidenced by a decrease of 23.4 percent in the absolute amount of our non-GAAP operating expenses compared with the second quarter. representing our second consecutive quarter of reduction. We believe non-GAAP metrics may better reflect our efforts and achievements with respect to operational improvement during the quarter. Our GAAP operating expenses increased to RMB 66.8 million from positive RMB 241.3 million in the same quarter of 2021, primarily due to the change in share-based compensation expenses. Specifically, our selling expenses were RMB 52.5 million in the third quarter of 2022, from RMB 56.5 million in the same period of 2021, primarily due to the fluctuation of share-based compensation expenses while offset by the decrease in branding materials and shipping expenses. General and administrative expenses were positive RMB 41.7 million in the third quarter of 2022, compared with positive RMB 253.2 million in the same period of 2021. The change was primarily driven by the fluctuation of share-based compensation expenses. Research and development expenses were RMB 46 million in the third quarter of 2022, compared with positive RMB 44.6 million in the same quarter of 2021. The change was primarily driven by the fluctuation of share-based compensation expenses. Our non-GAAP net income was RMB $328.6 million in the third quarter of 2022, compared with RMB $462.7 million in the same period of 2021. Non-GAAP basic and diluted net income per ADS were RMB 0.247 and RMB 0.246, respectively, in the third quarter of 2022, compared with non-GAAP basic and diluted net income per ADS of RMB 0.334 and RMB 0.332, respectively, in the same quarter of 2021. Moving to our balance sheet, we maintained a solid cash position in the third quarter. Our cash position remained strong with cash and cash equivalents, restricted cash, short-term bank deposits, net short-term investment, and long-term bank deposits, net of RMB 16.4 billion as of the end of September 2022. compared with RMB 14.7 billion a year ago. In conclusion, in the face of challenges in the operating environment, as well as the macro headwinds, we will remain committed to mitigating the effects of external forces by controlling factors we can control. With the application of a 36% consumption tax to e-cigarette manufacturers, since November 1, 2022, we expect that the steady rollout of new products and the price hike necessitated by the consumption tax will impact both sales and profitability in the future, and that end demand will take time to recover as customers acclimate to the new flavors and form new habits. Therefore, Effective cost control measures will remain our priority in the short term as we continue to stimulate sales with enticing new GB products for adult smokers. We remain confident that our business's resilience and operational excellence will empower us to navigate the challenges as we explore new opportunities for growth and development. Meanwhile, we believe all industry participants across the value chain will work jointly to overcome this challenging time and adapt to the paradigm of the new era. Although all industry players, including IOX, will experience short-term fluctuations as a result, we believe this regulation will ultimately facilitate the sector's long-term sustainable development. This concludes our prepared remarks today. We will now open the call to questions. Operator, please go ahead.

Thank you. And ladies and gentlemen, at this time, we will conduct a question and answer session. If you would like to ask a question, please press star then one on your telephone keypad. You may need to pick up your handset before pressing the keys. To withdraw your question, please press star then two. And for the benefit of all participants on the call today, if you wish to ask your question, management in Chinese, please immediately repeat your question in English. One moment, please, for the first question. And our first question today will come from Lydia Ling with Citi. Please go ahead.

Hi, management. Thanks for the presentation. So this is Lydia from Citi. So I have two questions. The first one is on the tax impact. As the CFO just mentioned, actually we have the tax impact. Maybe could you actually quantify like what could be the potential financial impact ourselves and also the profitability after the tax imposition? We noticed that you have the price adjustment at the channel trend. And so how does the margin will look like to the company and also your channel partners? And also we would like to hear your views on your normalized margin outlook in the mid to long term. And so this is on the text part. And my second question is on your new product. And as the national centers can inspect since October and also new products into the market for some time, so could you share with us some user feedback on your new products and also any color on the sales through? That would be very helpful. Thank you.

Thank you very much, Lydia. So the first question is mainly on the market outlook and also the pricing after the test regime. And the second one is mainly on the new product feedback. So I mean on the first one, as an eBay footprint manufacturer, so we subject to a 36% consumption tax. And therefore, the additional consumption tax inflates our cost of goods sold. As we have highlighted in our prepared remarks, we expect the consumption tax will negatively affect our profitability in the coming quarters. On the other hand, with the implementation of the consumption tax, we have adjusted our pricing of our products accordingly, which we could help to mitigate the impact of the consumption tax. So for our channel partners, taking our cartridges as an example, we expect that after the price adjustment, the absolute amount of gross profit per cartridge will still be higher than that of our competitors' products. And regarding a more medium or normalized margin outlook, it's difficult to give a quantitative guidance at the moment. It will affect by several factors. For example, how our consumer behaves and also our efforts to improve our supply chain efficiency. So what we could share now is that even though our gross margin will face some pressure from our consumption tax, which will be put with cost, We are still committed to improving our cost structure, and we'll do our best to mitigate the impact on our bottom line as much as possible. So regarding our second question on the new product feedback, as these national standard products gradually launch with different SKUs on a regional basis, province by province, for consumers in some of our regions or province, may not have the access to our food product portfolio. As we expected, it will take some time for consumers to adapt to some of these news later. Our recent consumer survey suggested that the NPS, i.e. Net Promoter Score, of our new products is improving every month. So, regarding your last bit about the child food, so we are seeing a similar trend as well. and also with more products and SKUs being launched on the market, the portion of consumers who would like to try and use our products continue to grow as well. Thank you very much for your question.

Thank you.

And our next question will come from Charlie Chen with China Renaissance. Go ahead.

Hi, management. Thanks for taking my questions. I have two questions here. The first one is regarding the channel inventory. I remember last time you mentioned that you expect the channel inventory of old products on distributor or consumer's level should be exhausted by somewhere around December. So how do you think the progress right now? Do you still think December will be a month that the old China inventory will be completely depleted? How does that compare with your original expectation? My second question is on your company's sales, monthly sales, actually. Do you see a month-on-month sales recovery since October when the new regulations started to be implemented? Thank you.

Thanks, Charlie. So the first one is mainly on whether the actual results of our channel infant-free meet our expectations. And also the second one is about how the sales trend in recent months. So I mean regarding the infant-free of our channels. So for our last earning call, we expect that the channel infant-free will be digested in six to eight weeks. So as we continue these older products during the third quarter, we expect that the current channel inventory is extremely low, and currently consumers are consuming their products on-channel. So we expect that the majority of channel inventory of older products will be consumed by our users by the end of fourth quarter. So at that point, we will have a clear picture of the consumer demand for next year. And so regarding the recent month's sales, we understand that investors and research analysts are concerned about how consumer demand has changed since we adjusted the pricing of our products to accommodate the change of consumption tax, together with the change of our products from older generations to new products. But honestly speaking, at least through the 16th of November, together with the first week of October is the Golden Week holiday. It's difficult for us to provide an apple-to-apple comparison at the moment. Thank you for your question.

Thank you.

And our next question will come from with CICC. Please go ahead.

Hi there, management. This is Pei Hang at CICC. Thank you very much for taking my questions. My first question is, what are the differences between the Phantom Pro zoos and original products with regard to target customers and positioning strategies? And my second one is recently we have noticed that the retail purchase rate of new national standout products might not be very optimistic. So could you please share some causes for this? And also some e-cigarette users might change back to use e-cigarettes. So how would be the turn rate from your perspective?

Thank you. Thanks, Taehan. So the first one is about our new product launch, what's the difference between our product portfolio. And the second one is about our user retention and also what's the churn and also how users evolve after the GV products being launched or introduced. So far the first one is about the difference of products. So the key difference between the Phantom Pro and Phantom device is that the Phantom Pro features an adjustable power. So, for example, the fixed power level for the original Phantom cartridge is 6.5 watts. And with the Phantom Pro cartridge and device together being used, consumers can select or arrange the power level that best suits them, whether they need stronger or less strong, from 5 to 5 watts to 8 watts. This is our ultra-premium device. both adjustable power and also resistance level. And in our view, it is perfect for adult smokers with a long history of smoking. So as we did in the past, so we plan to have a more diversified product portfolio, covering various consumer segments, offering best-in-class products to various user groups, price and capacity, and also other preferences. So the second question is about our consumer behavior, how the retention goes, and also what the churn rates, whether these users have changed to use Seegers again. So I think we are still in the process of gradually rolling out our entire product portfolio, problem by problem. So therefore, I think the accessibility and availability of products are factors that affect our consumers' purchase journey and also their retention ratio. And also, as said before, we believe that a significant portion of our consumers are still consuming their remaining infantries of our older generations of products, and some haven't tried our new GE products yet. And therefore, I think the current phase of users for calculating retention rates may be distorted. And also, we like to keep in mind for both investors and research analysts that the performance of one to two or three stores may not be representative of the company's overall product performances. And second question is regarding the shift from eBay per pack to cigarettes. And we think that this portion would be extremely limited. We believe that harm reduction and also convenience are two major factors that Adam Smoker tries to give vapor products according to our internal consumer survey. So while our product experience may have changed, these two factors, i.e., the convenience and also harm reduction, will continue to play an important role in our user retention. So thank you very much for your questions.

These were helpful. Thank you. And this will conclude our question and answer session. I'd like to turn the conference back over to management for any closing remarks.

Thank you once again for joining us today. If you have further questions, please feel free to contact IRS Technology's Investor Relations team through the contact information provided on our website or TPT Investor Relations.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your line at this time.