RLX Technology Inc. (RLX) Q2 2021 Earnings Call Transcript

RLX Technology Inc. (RLX -1.07%)
Q2 2021 Earnings Call
Aug 20, 2021, 8:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Hello, ladies and gentlemen. Thank you for standing by for RLX Technology, Inc.'s second-quarter 2021 earnings conference call. [Operator instructions] 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 services earlier today and have been made available online. You can also build the earnings press release by visiting the IR section of our website at ihos.relanseac.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 contains words such as may, will, expect targets, estimate, beliefs, potential, continues or other similar expressions. Forward-looking statements involve inherent risks and uncertainties. The accuracy of these statement 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, representatives and underwriters do not undertake any obligation to update this forward-looking information, except as required under the 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 Technology's press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited GAAP measures. I will now turn the call over to Mr.

Kate Wang. Please go ahead.

Kate Wang -- Co-Founder, Chairperson of the Board of Directors and Chief Executive Officer

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 27 where the authorities made an announcement seeking public comment on our proposal to revise relevant regulations to strengthen the probation of e-cigarettes and solve the quality and safety risks and force advertising problems among others. We believe that such regulatory framework is both necessary and beneficial for the long-term healthy development of the industry. It serves to eliminate the risk associated with uncertainties regarding the legitimacy of this product category. It can also help avoid 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 on 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 about vaping products. The media and public and some adult smokers and adult users of vaping products will continue by certain out-of-contract historical information in the report about the harm reduction benefits of using vaping products.

Negative publicity 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 and unbiased knowledge on related topics. RLX was founded to serve adult smokers with state-of-the-art product and unwavering pursuit of scientifical advances to deliver harm reduction benefits to our users. To that end, in the second quarter, we continued devoting resources to key operational areas, including science, research and development, product innovation, quality of firms 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 high-caliber talent, improved our workforce by 27%. These highly skilled individuals joined us from leading companies across FMCG, technology and pharmaceutical industries. We are pleased to see like-minded talent joining our course.

And together, we have achieved a satisfactory net revenue growth of 6% from RMB 2.4 billion in the first quarter to RMB 2.54 billion 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 past quarters 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 RLX for over a quarter by now. To quote Steve Jobs, "The only way to be truly satisfied is to do what we believe is great work." At RLX, we are 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 initiatives 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 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 per-store 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 developed three production plants to further strengthen our QA and QC capabilities. Our QA and QC systems consist of five laboratories with 197 quality control checks to ensure that every intake of our aerosol represents the safest and finest 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 3, 2021, we jointly published a research paper in the HCI Journal ecotoxicology and environmental safety with Suning University titled Comparison of Biological and Transcriptomic effects of conventional cigarettes and electronic cigarette smoke exposure at toxicological dose in BA2 cells. The research table revealed that based on equivalent nicotine content and acute exposure in cigarette smoke condensate have significantly larger impact on cell and gene expression profile compared to e-cigarettes more content, further demonstrating the harm reduction effects of e-vapor products versus combustible cigarettes. On August 4, 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 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 social corporate responsibility, we remain dedicated to building and strengthening our trusted brands by consistently adhering to our strong ethical principles.

On June 1, immediately after the enactment of law on the protection of minors, RLX was the first among all our peers to call on all industry participants to thoroughly study the regulation and strictly abide by all of them. In July, several provinces in China were affected by extreme weather and natural disasters, resulting in hundreds of charities. We once again acted swiftly by donating millions to China foundation for poverty alleviation from emergency file. In addition, we were also deeply concerned about our partners' losses and decided to set up Hunan RLX stores relief fund to help them recover their 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 are difficult to predict and may linger after the second quarter as well. However, we remain devoted to continuously 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 revenues from sales to offline distributors, 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.

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 employees as affected by the significant fluctuations of the share price of the company.

Selling expenses decreased by 56.8% 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 from 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 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 U.S. 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 deposit 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 were 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 RMB 0.398 in the first quarter of 2021. As of June 30, 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 31, 2021. As of June 30, 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.

Questions & Answers:

Operator

[Operator instructions] The first question comes from Lydia Ling with Citi. Please go ahead.

Lydia Ling -- Citi -- Analyst

Hi, management. This is Lydia from Citi. And thanks for the presentation and taking my questions. I have two 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 regulation environment? And then my second question is on the expansion. So could you actually tell us about how many stores do you 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?

Sam Tsang -- Head of Investor Relations

Sure. Thank you very much, Lydia. So regarding the first question, it's mainly regarding third quarter trend and also the second half outlook. So as of now, e-vapor products remain underpenetrated among adults in China.

So 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 confident in the medium and long-term prospects of the inventory 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 witnessed the securization of operating and financial metrics in recent weeks as we continue to engage and retain our users. So we are very confident on the future outlook of the company.

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

So for example, if the store productivity of the newly opened stores is better than the expected primacy curve, so we will allow some new stores to be open and vice versa. So we do have like various power label packs in different districts or areas based on the existing store's productivity in order to micromanage and witness or manage any cannibalization between existing and new stores. So we indeed closely monitor the single store economic model of our current brand partner stores. So thanks very much for your question.

Operator

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

Charlie Chen -- China Renaissance -- Analyst

Thank you, management, for taking my questions. 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 you launched about a quarter ago. So how does that develop so far? And my second question is regarding the retail price.

As we observed some of the competition in certain areas, 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 are selling their products at a lower price to outside of their authorized areas? Does that situation or things happen in your market?

Sam Tsang -- Head of Investor Relations

Sure. So thank you very much, Charlie. So regarding the first question is on our product front. So we have been providing diversified product portfolio with various price points from generic and features.

So you do see that more and more users adult smokers with different sets of user group, trying to use our products as their harm reduction alternatives. So regarding our new products, so we do see that there have been positive feedback and contribution from both our users and retailers. So we will continuously cautiously to monitor our user behavior and trends, trying to optimize our product mix while further launching new product lines. So on the second question is on pricing, actual retail selling price and where they are like an authorized sale by distributors to unauthorized areas.

So first one is on pricing. So we have been closely monitoring the pricing across the value chain, especially the actual selling price and discount 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 brand partner stores, have been following suggested retail selling price in their actual sales to adult smokers.

So regarding any unauthorized sales of distributors to unauthorized areas, so we have been actually implementing effective measures in technology and control. We have a unique monitor system for each of our product lines. So if we found any of our distributors or retailers report any cases that they see unauthorized products being appeared, we could rebuild the identity of distributors, search products and software issue accordingly. So thank you very much for your questions.

Operator

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

Stephanie Lam -- Haitong International -- Analyst

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 subsidy in the past couple of months. Maybe now what is the management view on that as well as our approaches on store opening subsidy? Second question is regarding on the raw material cost pressures and gross margin. Given the cost rise of raw materials, maybe if we have mixed up the wholesale prices to franchisees and distributors in order to pass the cost on? And how should we estimate the margin's trend going forward?

Sam Tsang -- Head of Investor Relations

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

We have been assessing and grand store of these largely based on the macro environment and single store economics of our branded partner stores. So I mean, for the past two years, our peers have offered far more subsidies to potential store owners, driven by their intention to penetrate the market and make a presence. However, these large subsidies frequency did not translate into 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 branded partner stores.

In the medium and long term, we believe that stores will be more rational and will become more dependent on the single store economics of each brand's branded partner stores. So regarding the second question is on the raw materials increase and whether it increased our pricing and margins. So given the macro situation, so the price of raw materials, for example, like 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 material 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 development as well as our suppliers' operating issues. Given the cost optimization initiatives of our entire industry value chain, for example, like automated production, cost saving product design, we believe the long-term unit cost of the industry, including ours, would be further optimized.

Thank you very much for your question.

Operator

The next question comes from Jun Hao Fan with CICC. Please go ahead.

Jun Hao Fan

Hi, and thanks, management, for taking my questions. I'm Junhao 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 the future competitive landscape among Chinese e-cigarette brands? And my second question is, since many similar vape captures are in the market, which can also be used in our devices like wick, what actions would RLX will do to solve this problem? That's my two questions.

Sam Tsang -- Head of Investor Relations

Thank you very much, Junhao. So I mean, on the first one is on the competitive landscape of the Chinese e-vapor markets. So we believe the competitive landscape of the market will be increasingly complex, requesting each brand or market participants to put more efforts and further innovate in aspects such as commercial strategy, product innovation and efforts in scientific research. So we believe that with our leading position, strong brand equity, expansive retail network and product innovation capabilities, we can remain or expand our market leadership in the China markets.

So regarding the second question, I'm not sure if I hear correctly, it's on the compatible parts that you have mentioned. So I mean, for unauthorized compatible parts, we do see that they post a greater risk to e-vapor users health, given that the product quality and safety may not be guaranteed. These compatible parts are also largely sold in other retail channels, which may be accessible to underage users. So as a brand, we have been collaborating with various partners and parties to prohibit illegal sales of unauthorized compatible parts and have filed paying claims and losses against brands that may have used our patents, our brands without our permission.

So I mean, on commercial-wise, we also have expanded our product portfolio to cater 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 cartridge that currently exist in the market. So thanks very much for your questions.

Operator

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

Unknown speaker

Hi. Thank you, management, for taking my questions. I have two questions here. So firstly, I know that we actually set up an electronic cigarette clinical trial lab several weeks ago.

So what is the major purpose or the potential benefit of this? And secondly is about the regulation of the potential impact, so what will happen is the whole industry is under the regulation of China tobacco?

Sam Tsang -- Head of Investor Relations

Sure. Thank you very much, Louise. So for your first question is on the lab and trial mentioned in the opening remarks. So 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 leading authorities in scientific research and clinical trials. So 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 sign-based communication across various parties. And more and more adult smokers can use e-vapor products as their harm reduction tobacco alternatives.

So regarding the second point on the regulations front, so on March 22, so the MIIT released the draft rules regarding e-vapor products. So as mentioned in the last earnings call, we have already submitted our feedback regarding the proposed revision of the implementation plan. So currently, there's no updates on the regulations and no new implementation details have been rebuilt. We support the regulatory measures mentioned in the announcement, including the proposal to regulate the operating activities of the e-vapor industry and tackle potential product safety issues of e-vapor products, advertisement, etc.

So thank you very much for your 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

So thank you once again for joining us today. So if you have any 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. Thank you very much.

Operator

[Operator signoff]

Duration: 42 minutes

Call participants:

Sam Tsang -- Head of Investor Relations

Kate Wang -- Co-Founder, Chairperson of the Board of Directors and Chief Executive Officer

Chao Lu -- Chief Financial Officer

Lydia Ling -- Citi -- Analyst

Charlie Chen -- China Renaissance -- Analyst

Stephanie Lam -- Haitong International -- Analyst

Jun Hao Fan

Unknown speaker

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