RLX Technology Inc. (RLX) Q3 2021 Earnings Call Transcript

RLX Technology Inc. (RLX 1.14%)
Q3 2021 Earnings Call
Dec 03, 2021, 7:00 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 third quarter 2021 earnings conference call. [Operator instructions] 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 third 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 view the earnings press release by visiting the IR section of our website at ir.relxtech.com.

Participants on today's call will include our co-founder, chairperson of the board of directors, and chief executive officer, Ms. Kate Wang; chief financial officer, Mr. Chao Lu; and myself, Sam Tsang, head of investor relations. Before we continue, please note that today's discussion will contain forward-looking statements made under the safe harbor provisions of the U.S.

Before we continue, please note that today's discussions will contain forward-looking statements made under the safe harbor provisions of the new at 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, 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'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 Ms.

Kate Wang. Please go ahead.

Kate Wang -- Co-Founder, Chairperson, and Chief Executive Officer

Thank you, Sam, and thanks, everyone, for making time to join our conference call today. In the second half of the third quarter, there have been proactive regulatory developments through the global e-vapor space, including in China. Last Friday, November 26, 2021, the State Council announced its decision to amend the detailed implication regulations of the Tobacco Monopoly Law of the People's Republic of China by adding Rule 65, which states that implementation rules for next-generation tobacco products, including e-cigarettes, shall refer to as relevant rules with respect to cigarettes under the implementation regulation of the Tobacco Monopoly Law. On Tuesday, November 30, 2021, the State Tobacco Monopoly Administration released a consultation paper entitled Electronic Cigarettes, a national public service platform for standards information under the State Administration for Market Regulation, seeking public comment regarding national electronic cigarette products standards.

Yesterday, December 2, 2021, the State Tobacco Monopoly Administration released a consultation paper entitled Administrative Measures for Electronic Cigarettes, seeking public comment regarding national electronic cigarettes, covering various aspects, including production, distribution, and retail sales, import and export, and inspections. We firmly support this amendment to the detailed implementation regulations and have begun making any required attempts to fully comply with the new regulations and administrative measures. We believe the amendment will pave the way for long-term and sustainable growth in this sector. We are also aware of meaningful worldwide regulatory developments, which reflect similar trends globally.

In the United States, the FDA has made substantial progress reviewing PMTA applications and granted its first e-vapor product authorization in October, demonstrating its recognition of certain e-vapor product harm-reduction effects. We closely follow global regulatory developments and user regulation of e-vapor production as a global trend and will grow as countries worldwide recognize e-vapor products harm-reduction benefits for adult smokers. With these regulatory developments, especially in China, we believe the sector will enter a new area of development, an era market -- mocked by enhanced product safety and quality, augmenting social responsibilities, and improved electro property protection. As some of you may be aware, the third quarter was challenging on the commercial front for the entire industry value chain, which had been reflected in our key value chain partner financial results previously.

Misinformation from temporary negative publicity on the e-vapor sector and the walling COVID-19 restrictions in response to outbreaks in China, which we discussed during last quarter's earnings call, has had a significant adverse impact on the retail sales and product procurement in our branded stores since the latter half of the second quarter. As a result, we have record 34% quarter-over-quarter decline in our net revenue. But we believe this revenue decline to be temporary and have a clean plan -- clear plan to achieve long-term, healthy growth, which Chao will explain in detail later. Despite those industry headwinds, we continued to focus on building a solid foundation for sustainable success.

In the third quarter, we redoubled our scientific research efforts and continued to attract and recruit top talent to strengthen our sales supply chain and R&D capabilities. We are committed to providing adult smokers with innovative harm-reduction products of the highest quality. Also, at RLX, we also plan and act for long term. Corporate social responsibility has been an integral part of our values since day one.

In the third quarter, we unveiled our 2020 to 2021 corporate social responsibility report, wherein we shared our progress with respect to our CSR initiatives. Some highlights include our industry-leading age verification system, Sunflower System 3.0, with enhanced features to prevent underage use, our RELX Care community service program to promote rural revitalization and common prosperity. These accomplishments are testament to our dedication to preserving our social responsibilities. We strive to positively impact our users, empower youth and communities in which we live.

With that, I will now turn the call over to our CFO, Chao Lu. He will elaborate further on some of our last quarter's initiative 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. I will start by sharing some of this quarter's major initiatives and developments, and then walk you through our key financial metrics. We believe that offering the right products to the right user segments through the optimal route-to-market will be the key to our sustainable high-quality growth. To this end, we continue to expand our product offerings to meet the needs of diverse user segments and optimize our distribution and retail networks to ensure quality growth.

With respect to products, we are focused on offering better and more tailored vaping products for various user groups to help engage new users with the right products. This quarter, we introduced [Inaudible], a new brand targeting adult smokers with a long history of smoking. Our goal is to recreate an authentic smoking experience for adult smokers by launching eight tobacco-flavored cartridges in our initial stage. At the same time, we further upgraded [Inaudible], a more accessible product line catering to price-sensitive users' need.

We also recently relaunched [Inaudible], or [Foreign language] in Chinese, a premium device line with upscale styling, including leather, lace, and other fashionable material. We will continue to monitor user experiences very closely and launch innovative targeted products at the right time. We also made several advancements in user retention and engagement during the quarter. We've successfully upgraded our membership system, enabling members to enjoy more benefits as they accumulate reward points.

A growing number of users are scanning the QR code on their cartridges to collect reward points which will allow us to empower users with instant product authentication. Separately, we have established more effective communication channels to provide unbiased fact-based scientific e-vape product information to our users and the community. Finally, we are concentrating on distribution and retail channel optimization. Instead of engaging more distributors and expanding the number of our RELX-branded stores, this quarter we prioritized our existing distributors' organizational upgrade.

We encouraged our distributors to hire exceptional talents and refine their team structure within each department. We optimized existing RELX-branded partner stores locations by identifying areas with high retail sales potential and encouraging store owners to adjust their operations accordingly. In addition, we provided online and offline trainings for store owners and sales personnel to enhance their communication skills and enrich their product knowledge in order to counter the adverse effects from misinformation, resulting from periodic negative publicity on all categories. We have also upgraded our digitalization system for branded partner stores, providing improved functionality and additional use of portals to a thrift store owner and sales personnel in their daily operations.

For our other retail outlets, our focus in the third quarter was to identify prime outlets for expansion through trials in various channels. These trials resulted in several initial successes, including strong momentum in lifestyle channels and other key accounts. In addition to our emphasis on high-quality growth, we are deeply committed to fulfilling our corporate social responsibilities. We believe the healthy relationship between our products, users, shareholders, and the community has been essential to the growth we have achieved over RELX's four-year history.

With this in mind, we'll work tirelessly to introduce new technologies to tackle industry pain points. For example, minor protection is one of RELX's highest priorities. We spare no effort in our minor protection initiative, from product labels to trade channels and technology innovation. In June 2021, we began upgrading Sunflower System, our technology-driven minor protection system to version 3.0 and currently equipped all of our branded store with the upgraded software.

On the Sunflower System 3.0, all users are required to complete name plus ID number plus face recognition, three-step verification before purchasing. After the amendments to China national standards become effective, we will strictly comply with any upgraded product requirements. For example, we are prepared to include minor protection features, such as child safety locks, similar to the feature which we have incorporated into our RELX product line back in 2019. As a company that values long-term, high-quality growth, our commitment to social corporate responsibility is at the core of our daily operation.

To echo what Kate has pointed out previously, our game has entered the second half with the State Council's decision to amend the detailed implementation regulations of the Tobacco Monopoly Law and the subsequent release of a consultation paper regarding national electronic cigarette products standards by the State Tobacco Monopoly Administration, as well as last night's release of a consultation paper regarding administrative measures on electronic cigarettes, covering various aspects, including production, distribution, and retail sales, import and export, and the inspection. Different from the first half of the game when the sector lacked clear regulatory guidelines, the second half is marked by an enhanced product's safety and quality, augmented social responsibilities, and improved intellectual property protection. The investments we made in product, talent, research, and compliance in the third quarter and beyond will place us in advantageous positions on the new regulatory paradigm. We expect these investments to yield steady and sustainable growth soon and to reward us and our shareholders in the long term.

Turning into our financial results for the third quarter of 2021, net revenues decreased by 34% to RMB 1.68 billion, equivalent to $260.2 million, in the third quarter of 2021 from RMB 2.54 billion in the second quarter of 2021. The decrease was the result of volatile market conditions including: one, negative e-vapor industry publicity since the latter half of the second quarter; two, the fact that the draft new rules announced on March 22, 2021, had not been formerly confirmed and no new implementation details had been revealed during the quarter; and three, evolving restrictions in response to COVID-19 outbreaks in China, which had an adverse impact on our sales and channel inventory management. Gross profit decreased by 42.8% to RMB 656 million, equivalent to $101.8 million, in the third quarter of 2021 from RMB 1.15 billion in the second quarter of 2021. Gross margin was 39.1% in the third quarter of 2021 compared to 54 -- sorry, 45.1% in the second quarter of 2021.

The decrease was primarily due to: one, an increase in direct costs related to promotional activities; and two, an increase in inventory provisions. Operating expenses were positive RMB 241.3 million, equivalent to $37.5 million, in the third quarter of 2021, representing a decrease of 244.4% from RMB 167.2 million in the second quarter of 2021. This significant decrease in operating expenses was primarily due to a recognition of share-based compensation expenses of positive RMB 523.7 million, equivalent to $81.3 million, consisting of: one, share-based compensation expenses of positive RMB 90.8 million, equivalent to $14.1 million, recognized in selling expenses; two, share-based compensation expenses of positive RMB 320.1 million, equivalents to $49.7 million, recognized in general and administrative expenses; and three, share-based compensation expenses of positive RMB 112.8 million, equivalent to $17.5 million, recognized in research and development expenses. The significant fluctuations in share-based compensation expenses were primarily due to the changes in fair value of the share incentive award that the company granted to its employees as affected by significant fluctuations of the company's share price.

Selling expenses decreased by 55.1% to RMB 56.5 million, equivalent to $8.8 million in the third quarter of 2021, from RMB 126 million in the second quarter of 2021. The decrease was primarily driven by: first, the fluctuation of share-based compensation expenses; and second, a decrease in salaries and welfare benefits, partially offset by an increase in branding material expenses. General and administrative expenses decreased by 649.8% to positive RMB 253.2 million, equivalent to $39.3 million, in the third quarter of 2021 from RMB 46.1 million in the second quarter of 2021. The decrease was primarily driven by the fluctuation of share-based compensation expenses and the decrease in salaries and welfare benefits.

Research & development expenses decreased by 808.3% to positive RMB 44.6 million, equivalent to $6.9 million, in the third quarter of 2021 from positive RMB 4.9 million in the second quarter of 2021. The decrease was mainly driven by the fluctuation of the share-based compensation expenses and a decrease in salaries and welfare benefit, partially offset by an increase in software and technical expenses, and second, an increase in consulting expenses. Income from operations was RMB 897.3 million, equivalent to $139.3 million, in the third quarter of 2021 compared with RMB 979.3 million, in the second quarter of 2021. Income tax expenses was RMB 121.4 million, equivalent to $18.8 million, in the third quarter of 2021 compared to RMB 204.2 million in the second quarter of 2021.

The decrease was primarily due to a decrease in taxable income. U.S. GAAP net income was RMB 976.4 million, equivalent to $151.5 million, in the third quarter of 2021 compared to RMB 824.3 million in the second quarter of 2021. Non-GAAP net income was RMB 452.7 million, equivalent to $70.3 million, in the third quarter of 2021, representing a decrease of 30.5% from RMB 651.8 million in the second quarter 2021.

U.S. GAAP basic and diluted net income per ADS were RMB 0.724, equivalent to $0.112, and RMB 0.717, which was equivalent to $0.111, respectively, in the third quarter of 2021 compared to U.S. GAAP basic and diluted net income per ADS of RMB 0.595 and RMB 0.591, respectively, in the second quarter of 2021. Non-GAAP basic and diluted net income per ADS were RMB 0.336, equivalent to $0.052, and RMB 0.333, equivalent to $0.052, respectively, in the third quarter of 2021 compared to non-GAAP basic and diluted net income per ADS of RMB 0.470 and RMB 0.467, respectively, in the third quarter of 2021.

As of September 30, 2021, the company had cash and cash equivalents, restricted cash, short-term bank deposits, short-term investments, and short-term bank deposits of RMB 14.72 billion, equivalent to $2.28 billion, compared to RMB 14.88 billion as of June 30, 2021. As of September 30, 2021, approximately $1.64 billion, equivalent to RMB 10.59 billion, was denominated in U.S. dollars. For the third quarter ended September 30, 2021, net cash used in operating activities was RMB 142.9 million, equivalent to $22.2 million.

This concludes our prepared remarks today. We will now open the call to questions. Operator, please go ahead.

Questions & Answers:

Operator

[Operator instructions] Today's first question comes from Lydia Ling in Citi. Please go ahead.

Lydia Ling -- Citi -- Analyst

Hi, everyone. Hi, management. Thank you for the presentation. And this is Lydia Ling from Citi.

I have two questions. My first question is, given the recent regulation update developments, would you like to share with us, how are your products portfolio involved going forward, and what changes can we expect to see in your existing product portfolio? And then, my second question is, so we saw further slowdown in the third quarter. So could you actually share more color on your fourth quarter-to-date operations trend and also your outlook for next year, given the current regulation update and also the COVID situation? Thank you.

Sam Tsang -- Head of Investor Relations

Thanks very much, Lydia. So, regarding your first question regarding our product portfolio. We do have already clear our current development strategy. As mentioned in the opening remarks, we try to offer device products to the right future settlements for the optimal route-to-market channel.

So, we, too, are aware of the press conference held by the State Tobacco Monopoly Administration yesterday and also the announced product consultation of the national electronic cigarettes product standards. So, within the transition period of our new quality requirements to become effective, we will strictly comply with the regulatory guidelines. So, regarding what would we change to our current product offerings, if and or when the draft national electronic cigarettes product standards become effective, we anticipate we may need to monetize some of our current offerings. However, we are very confident that such changes won't be complex for our company technically, and we believe our smokers will still continue to seek out and use our products as harm-reduction alternatives.

So, regarding your second question about our 4Q outlook in 2020, so we currently do not have any guidance for the quarter together with next year. So, we hope to share more when we have better clarity. Thank you very much.

Operator

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

Charlie Chen -- China Renaissance -- Analyst

Thank you, management, to taking my questions. I have two questions here. The first one is could you please share your observations on the current competitive landscape for this industry? Are there any challenges compared to the first half of this year? And also, what are your thoughts on the retail pricing for [Technical Difficulty] environments? So that's the first question. And my second question is regarding single-store sales.

So, what are the single-store sales of RELX-branded partner stores for now? From your perspective, where do you consider to be a healthy single-store sales level? Thank you very much.

Sam Tsang -- Head of Investor Relations

Thanks very much, Charlie. So, I mean, there are 2 questions. One is on the competitive landscape and the other one is on our RELX-branded partner stores. So, I mean, on the first one, as mentioned before during the latter half of the second quarter, we do see that the industry development did not progress as expected.

So, indeed, this has carried into the third quarter where we do see that there are external factors affecting the entire industries, including our company and also our peers to varying degrees. But indeed, regarding competitive landscape, we have observed reduced industry combination as compared to the first half of 2021. So, regarding retail price that you have mentioned, so we do have increased our promotional assets in the third quarter, trying to drive our retail sales, and reduced inventory pressure of our chain. And we have also seen that given the third quarter decline, in general consumer spending in China, many other companies similarly implement subtleties or other sales incentives.

For the overall magnitude of our subsidies or promotional efforts is relatively insignificant compared to other consumer goods company in China. And we have started already reducing this further. So, going forward, we will continue to monitor our inventory level together with user demand and adjust our promotional efforts promptly to maintain reasonable retail price for our end users. So, regarding your second question about the single-store sales and also how we mentioned healthy as the indicator, so, indeed, single store sales together with their profitability and every operating metrics has been a really core focus in our day-to-day operations.

Actually, we're also aware of the industrywide beat in retail sales starting in the second half of 2021. But, however, we also see there has been a recovery for many of our stores in recent months. As our stores are operating in a wide variety of location, some of them is in shopping malls and some of them is on the streets, and they also place different working environments, we believe each store situation is very unique. So, indeed, the entire thing will not have a healthy parameter for single-store sales as we look at it one by one.

So, for a branded e-vapor company, we have been devoting resources and tools to update star owners and sales personnel in their data operations, including providing branded materials, POSM, training resources, digitalization tools, and enhanced store site selection assistance. So, indeed, for this quarter, we have also launched several new products and also upgraded our membership system to drive user engagement and retention better. So, with these initiatives, we believe we can and we will continue to drive single-store sales of RELX-branded partner stores. Thank you very much.

Charlie Chen -- China Renaissance -- Analyst

Thank you.

Operator

Our next question comes from Louise Li at Bank of America. Please go ahead.

Louise Li -- Bank of America Merrill Lynch -- Analyst

Hi, management. Thank you for taking my questions. So, my question is only for the -- also for the Q4 outlook. So, I understand that you don't have the guidance, but you just mentioned that you have seen some recovery during the past months.

So, could you share with us more color on the recovery in terms of the single-store sales? And what is the store count as for now and what is our target for the year end? And also, what is the biggest driver for the recovery? Thank you.

Sam Tsang -- Head of Investor Relations

Thanks very much, Louise. So, based on our preliminary, across today's data, we do see sequential improvements in retail sales and also channel inventory management. So, we could share more about our strategies in the following aspects. So, for RELX brand-stores, for quarter-to-date, we have been focusing on increasing single-store sales throughout initiatives being mentioned, and up till now is -- we do see that initial success.

And for our retailers, we do see strong growth momentum in store counts in multiple channels, and our retail channel has become more diversified from call-to-dates. But of course, we are also keenly aware of the recent developments in the regulatory events, especially yesterday's press release held by the State Tobacco Monopoly Administration. So, it was gratefully followed to any new regulations and administrative measures. Thank you very much.

Operator

Thank you. Our next question today comes from [Inaudible] with CICC. Please go ahead.

Unknown Speaker

Hi, dear management. I'm [Inaudible] at CICC. I have one question. Is the -- what is the outlook for purchase development under the nicotine limit of 2%? Thank you very much.

Sam Tsang -- Head of Investor Relations

Thanks very much, Jun Hao. So, I believe you are actually referring to the Tuesday draft in the current cigarette product standards. So, indeed, as a global -- as a U.S.-listed China company, we have been long been aware of product requirements globally, including in the European Union and also the initial draft of national cross vendors. So, looking at the well-developed markets penetration, we believe lowering nicotine concentration will affect some user settlement satisfaction.

However, most of the other smokers could still satisfy with such nicotine content or limits in the long run. But from the perspective of product development or technology development, we have picked up process rate up to low nicotine concentration, better satisfaction since 2019. And we do have the technical know-how and product research. So, currently, as you may know, most of our cartridge nicotine concentration is 3%.

If such national standards become effective, we'll strictly comply with other requirements listed on the national product standards, including on nicotine contents. Thank you very much.

Operator

Thank you. And ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to the company for final remarks.

Sam Tsang -- Head of Investor Relations

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 content information provided on our website or TPG investor relations.

Operator

[Operator signoff]

Duration: 41 minutes

Call participants:

Sam Tsang -- Head of Investor Relations

Kate Wang -- Co-Founder, Chairperson, and Chief Executive Officer

Chao Lu -- Chief Financial Officer

Lydia Ling -- Citi -- Analyst

Charlie Chen -- China Renaissance -- Analyst

Louise Li -- Bank of America Merrill Lynch -- Analyst

Unknown Speaker

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