RLX Technology Inc. (NYSE:RLX) Q3 2022 Earnings Conference Call November 16, 2022 7:00 AM ET
Company Participants
Sam Tsang – Head, Investor Relations
Chao Lu – Chief Financial Officer
Conference Call Participants
Lydia Ling – Citi
Charlie Chen – China Renaissance
Peihang Lyu – CICC
Operator
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 a 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 will now turn the call over to your host Mr. Sam Tsang, Head of Investor Relations for the company. Please go ahead, Sam.
Sam Tsang
Thank you, very much. Hello, everyone, and welcome to RLX Technology’s Third Quarter 2022 Earnings Conference Call. The company’s financial and operational results were released through PR 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.rh.com.
Participants on today’s call will include our CFO, 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 US 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 risk 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 forward-looking information except as required by 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 over the call over to Chao. Please go ahead.
Chao Lu
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 gradual or GD products and finished moving our sales 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 endeavor during the transition period, I’d like to talk first about the recent industry regulatory developments. On October 25, the Ministry of Finance, General Administration of Customs and State Taxation Administration jointly issued the announcement of imposing consumption tax on e-cigarettes, which came into effect on November 1, 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 industries, following the adoption of the e-cigarette mandatory national standards and measures for the administration of e-cigarette 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 e-vapor industry. We believe RLX well-automated 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 standard.
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 apply 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 GD products and 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 teamed 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 is our ultra-premium device both in 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 e-vapor industry still are waiting to be unleashed.
We are convinced that e-vapor 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 GD products for adult smokers across China in the new regulatory area. Hence supported by our industry-leading technology and research capability, we plan to introduce our new GD products on a rolling basis, as we assess the impact of the new tax regulation on sales, as well as user feedback regarding our product innovation.
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. This — 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 1+4 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 projects 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 RLX 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 e-vapor R&D.
Environmental protection is another area where RLX shine. We strongly advocate for sustainable consumption and encourage our users to participate in our top reborn program, which we started in September 2021. Through the consistent efforts showcased in our CSR report as of June 2022. The program has been implemented in 188 cities in China with over 15,000 stores both in used at recycling bin.
We are very pleased to report that based on S&P’s global most recent annual corporate sustainability assessment. Our S&P Global ESG report score ranked ahead of 67% of our global peers. Also our MSCI ESG rating has been upgraded from CCC to A rank in the top five in the tobacco industry globally, representing a powerful commendation 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. This 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 third 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 a complex macro environment, we delivered net revenues of RMB1.0 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 base resulting from the truck loading of sales in anticipation of that discontinuation of older products.
Also our shift to the national transaction platform was conducted on a regional basis, meaning that we also had to roll out our GD 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 adopt smoker’s needs and drive a gradual recovery in sales as users consume their inventories of older products.
Moving to our gross profit. We delivered profit of approximately RMB522 million with a gross margin of 50% in the third quarter compared with 39.1% 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 partnership with distributors who could not obtain a wholesale license which led to an increased sales contribution from direct supply to stores. A decrease in direct costs related to promotional activity was also a factor.
Against the backdrop of macroeconomic headwinds and the pandemic 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% 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 RMB66.8 million from positive RMB241.3 million in the same quarter of 2021, primarily due to the change in share-based compensation expenses. Specifically, our selling expenses were RMB52.5 million in the third quarter of 2022 from RMB56.5 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 RMB41.7 million in the third quarter of 2022 compared with positive RMB253.2 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 RMB44.6 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 RMB328.6 million in the third quarter of 2022 compared with RMB452.7 million in the same period of 2021. Non-GAAP basic and diluted net income per ADS were RMB0.247 and RMB0.246 respectively in the third quarter of 2022 compared with non-GAAP basic and diluted net income per ADS of RMB0.334 and RMB0.332 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 remains strong with cash and cash equivalents, restricted cash, short-term bank deposits, net, short-term investments, and long-term bank deposits, net of RMB16.4 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 effect of external forces 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 estimate to the new flavors and form new tablets. Therefore, expected 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 RLX, 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.
Question-and-Answer Session
Operator
Thank you. And ladies and gentlemen, at this time we will conduct the question-and-answer session. [Operator Instructions] And our first question today will come from Lydia Ling with Citi. Please go ahead.
Lydia Ling
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 you — the CFO just mentioned actually we expected the tax impact and so maybe could you actually quantify like what could be the potential financial impact on our sales and also the profitability after the tax imposition. We noticed that you have the price adjustment through 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 tax part.
And my second question is on your new products. And as like the national standards can impact 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 group? That would be very helpful. Thank you.
Sam Tsang
Thank you very much Lydia. So the first question is mainly on the margin outlook and also the pricing after the tax regime. And the second one is mainly on the new product feedback. So I mean on the first one as a feedback for current manufacturer.
So to e-cigarettes 36% consumption tax and therefore the additional consumption tax to e-cigarettes are our cost of goods sold. As we have highlighted in our prepared remarks, we expect the consumption tax is 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 partnership as an example, we expect that after the price adjustments, the absolute amount of gross profit per cartage will still be higher than that of our competitors’ products.
And regarding a more medium or normalized margin outlook is difficult to give a quantitative price at the moment. And 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 costs, we are still committed to improving our cost structure. And we do our best to manifest impact on our bottom-line as much as possible.
So regarding your second question on, the new product feedback as these national products for our national standard products, gradually launch with different SKUs on a regional basis profits by province.
For consumers in some of our regions or province may not have the access to our full product portfolio. As we expected it will take some time for consumers to access to some of these new flavors. Our recent consumer service gets that the NPS i.e. Net Promoter Score of our new products is improving every month.
So regarding your last question is around about the sell group. So we are selling a similar brand as well and also with more products and SKUs being launched in the market. The portion of consumers who would like to try and use our products continues to grow as well. Now thank you very much for your question.
Lydia Ling
Thank you.
Sam Tsang
Sure.
Operator
And our next question will come from Charlie Chen with China Renaissance. Please go ahead.
Charlie Chen
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 China inventory of old products on distributor or consumers’ level should be exhausted by somewhere around December.
So how do you think the progress right now, or do you still think December will be amounts that the older China inventory will be completely depleted. How is that compared 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 regulation started to be implemented? Thank you.
Sam Tsang
Thanks, Charles. The first one is, mainly on better the actual results of our channel inventory meet our expectation. And also the second one is about, how the sales trend in recent months. So I mean regarding the inventory of our channels, so for our last earnings call, we expect that this channel inventories will be digested in six to eight weeks. So as we discontinue 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 them.
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 would have a clear picture of the consumer demand for next year. And so regarding the recent months sales, we understand that investors and research analysts are concerned about, how consumer demand has changed since we adjust the pricing of our products, to accommodate the change of consumption tax together with the change of our products from older generations to GB [ph] products.
But honestly speaking, till 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.
Charlie Chen
Thank you.
Operator
Our next question will come from Peihang Lyu with CICC. Please go ahead.
Peihang Lyu
Hi, there, management, this is Peihang at CICC. Thank you very much for taking my questions My first question is what are the differences between the Phantom Pro’s use 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 national standard 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 cigarettes. So how will be the churn rate from your perspective?
Sam Tsang
Thanks, Peihang. So the first one is, about our new product launch, what’s the difference we see in our portfolio. And the second one is about our user retention and also what’s the churn and also how you sort well GB products being launched or tools. So far the first one is about the difference of products. So the key difference between the Phantom Pro and Phantom devices that – the Phantom Pro features and addressable power.
So for example the fixed power level for the original phantom cartage is 6.5 watts. And with the Phantom Pro and device together being used consumer can select or range the power level that bases where betas stronger or less on from five to five watts to eight watts. This is our ultra-premium device boosting both adjustable power and also resistance level. And in our view, it is perfect for adult smokers with a longer history of smoking. So as we did in the past so it lands a more diversified product portfolio offering various consumer segments, offering best-in-class products to various user groups pricing opacity [ph] and also other passengers.
So your second question is about our consumer behavior, how the retention goes and also what the churn rates whether these users have changed to use cigarettes again. So, I think, we are still in the process of gradually rolling out our entire product portfolio problem by province.
So therefore, I think, the asset severity and availability of products are factors that will 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 inventories of our older generation of products and some haven’t tried on new GB products yet.
And therefore, I think, the current phase of users for calculating retention rates may be distorted. And also we would like to keep in mind for both investors and research analysts that the performance of one to two or three stores may not be resulting of the company’s overall product performances.
And second question is regarding the shift from e-vapor back 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 adult smokers try to the 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 question.
Peihang Lyu
That’s very helpful. Take care.
Operator
And this will conclude the question-and-answer session. I’d like to turn the conference back over to management for any closing remarks.
Sam Tsang
Thank you once again for joining us today. If you have further questions please feel free to contact RLX Technology’s Investor Relations team through the contact information provided on our website or TPG Investor Relations. .
Operator
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect your lines at this time.
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