Q3 2023 RLX Technology Inc Earnings Call

Participants

Chao Lu; CFO; RLX Technology Inc.

Sam Tsang; Head of IR; RLX Technology Inc.

Wang Ying; Co-founder, Chairperson of the Board of Directors & CEO; RLX Technology Inc.

Peihang Lyu; Analyst; China International Capital Corporation Limited, Research Division

Wei Ling; VP; Citigroup Inc., Research Division

Y. Chen; Analyst; China Renaissance Securities (US) Inc., Research Division

Presentation

Operator

Hello, ladies and gentlemen, thank you for standing by for RLX Technology, Inc. Third Quarter 2023 Earnings Conference Call. (Operator Instructions) Today's conference call is being recorded and is expected to last about 40 minutes.
I will now turn the call over to your host, Mr. Sam Tsang, Head of Capital Markets for the company. Please go ahead, Sam.

Sam Tsang

Thank you very much. Hello, everyone, and welcome to RLX Technology's third quarter 2023 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 CEO, Ms. Kate Wang; our CFO, Chao Lu; and myself. 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 maybe 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, advisers and representatives do not undertake any obligations to update this forward-looking information except as required under the applicable law.
Please note that our 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.

Wang Ying

Thank you, Sam, and thanks, everyone, for making time to join our earnings conference call today. Before I get into our third quarter results, I would like to briefly update you on our industry's macro and regulatory involvement. As most of you know, it has been a year since the new regulation framework came into effect, bringing a number of tenders to the industry.
On the supply side, the new rules have pushed the industry participants across the value chain to adjust their businesses and standardize their operations under the authorities supervision. This no longer concerns some strong players, including us, who have already adapted to the new regulations and proactively develop new compliant products to meet users' needs.
However, persistent regulatories among other industry participants continue to disturb the market order and adversely effect the industry's recovery with the negative impact of illegal flavored products lingering. On the demand side, the new regulations seem to have less impact on users and consumption that have shown that most e-vapor users are still unaware of the changes brought about by the new regulations.
But some survey concept by Shanghai, Jiao Tong University reviewed that 40% of users now mainly use National Standard of compliance products, but 17% have not even tried compliant products. Furthermore, only 40% of the users share the new, that legitimate retailers, are only allowed to sell tobacco flavored product. Users lack of awareness of the new regulations has slowed the transition to compliant products that has the easy availability of legal flavored products. Advocating users above the new regulations, compliant products for the (inaudible) and the vendors of related products is pivotal to the industry's recovery, but this will take time and effort.
Amid this challenging environment, we continue to refine and broaden our product portfolio, while improving operational efficiency during the third quarter. I'm pleased to say that these efforts paid off, reflecting our strong execution of our effective cost strategy. We narrowed our operating loss and boosted cash flow during this quarter.
We are also seeing signs of equivalent, recovery in our top line, our CFO, will provide the details of those results in just a moment.
Now let me share a bit more about our strategic efforts and the progress of our product portfolio improvement. In terms of cartridges, we now offer 5 distinctive series of compliant devices at various price points versus just 2 series, Phantom and Phantom Pro a year ago.
Last month, we launched RELX, our fifth compliant series, featuring an addressable power at more affordable price than Phantom Pro and Zeus. We have also quickly expanded our flavor offerings with 17 distinct tobacco flavors now available versus 2 back in October 2022. Our wide selection of compliant products is designed to sell diverse demand across every user's taste and budget.
We will continue to closely monitor market demand and the collect users feedback to inform our product refinements for the -- while leveraging our leading R&D capabilities and deep industry knowledge to develop our portfolio accordingly. Our product value proposition to users extended far beyond our broad production -- product selection. First, RLX has prioritized quality control and product safety since our inception, supported by our strong research, quality control and safety assessment capabilities, we can guarantee higher product quality and system.
All of our products and ingredients must meet international standards and obtain regulatory approval before hitting the market. Furthermore, as a fully compliant participant, we greatly value this consumption period and provide outstanding after sales services. If users have problems with our products, they can call our [Holland] or visit our stores for assistance. Our excellent customer service team can resolve and address users issues in a timely manner with professional service and with patient solutions.
We also offer a 1-year warranty on all of our devices and cartridges. The unique advantages at immense value to our product and create peace of mind for users. In contrast, legal products are manufactured by unlicensed factories, leading to poor quality, a lack of quality control and potential health effects and issues. Illegal products may have dangerously high nicotine concentration levels, or contained levels of nickel or chromium, exceeding the standards as well as other banned ingredients. Illicit cartridges also frequently have oversized tanks, which can create serious safety hazard when using in conjunction with many compliant working devices.
We remain confident that our growing line of quality product will continue to earn more users recognition and ultimately, their loyalty as adult smokers realized our product security and about new habits. Meanwhile, we are trying to enhance users noises of new regulations and collaborating with regulators to combat legal products to create a healthy environment in the market.
Before I conclude, I would like to share that our RELX Quality and Safe-Lab recently received Customer Testing Facilities certificate approval from Eurofins Technology, becoming the first e-vapor brand in China to gain this certification. The recognition by the industry-leading authority indicates that our lab capabilities of testing electrochemical and time needs a global standard, qualifying our test results for acceptance by 54 IECEE member countries and regions worldwide.
Through our ongoing efforts in scientific research and development, we continue to enhance our product safety assessment capabilities and quality control. In conclusion, we continue to forge ahead during the quarter made a challenging environment. We have made meaningful progress in our recovery over the past year with an intense focus on our core strategy to develop our portfolio and enhance the efficiencies.
Looking ahead, we see external headwinds persisting, especially the lingering active impact of the illegal products and the uncertainty in the consumption environment. As such, we will deepen our commitment to offering compliance high-quality products to adult smokers and educating users on the various benefit. Meanwhile, to catch potential growth opportunities in the international market, on November 10, 2023, we terminated an existing non-competition agreement with Relx Inc., which had been entered into December 16, 2020. Terminating this agreement gives us the flexibility to build an international presence in the future by conducting tobacco harm reduction product business outside China.
As we move into 2024, we believe our expansion to international markets, effective products strategy and resilience in this model will propel our recovery, positioning RLX for long-term growth and sustainable value creation.
With that, I will now turn the call over to our CFO, Chao Lu, who will elaborate further on some of our last quarter's initiatives and go over our operational and financial results in more detail.

Chao Lu

Thank you, Kate, and hello, everyone. Before we start the detailed discussion of our financials, please note, unless otherwise stated, all the financials will present today are in RMB terms. I will now provide an overview of our operational and financial results for the third quarter of 2023.
Against the challenging backdrop, Kate just described, our total revenue was down 59% year-over-year. However, this represents a significant narrowing from last quarter's 83% year-over-year decline. While the sales of our compliant products continue to be impacted by illegal products in the market, we noticed a quarter-over-quarter increase in device shipments, indicating that the demand for e-vapor products is still growing.
On the other hand, cartridge shipments remained low as many users still use illegally compatible flavored cartridges in conjunction with our compliant devices. We want to remind our users that using illegal cartridges may damage our devices and void the warranty. Due to the poor quality illegal cartridges often suffer severe leakage issues that can ruin devices and may cause other safety hazards.
As a fully compliant participant, in the e-vapor industry, we are dedicated to promoting the industry's recovery and long-term healthy growth. To that end, we continue to encourage users call 12313 if they find anyone selling illegal products. We are also conducting user education campaigns to increase awareness of the regulation and the dangers of illegal products. We hope these efforts will effectively reduce the sale and use of illegal products while better protecting every user.
Turning now to profitability. In the third quarter, our gross profit margin remained stable at around 25% due to the unfavorable change in our revenue mix. However, on a like-for-like basis, our gross margin -- gross profit margin for our core e-vapor business to provincial distributors continue to improve quarter-over-quarter. Thanks to our cost optimization initiatives and product design improvements.
We are confident these efforts will continue to drive improvement in our gross margin. Since the introduction of the new regulation framework, we have been actively adjusting and streamlining our businesses and implementing stringent expense control of greater overall agility. I'm happy to report that as a result, our non-GAAP operating expenses decreased by 27% on a quarterly basis. It's also worth noting that our non-GAAP operating expenses decreased by 48% compared with the same period last year.
Moreover, we reduced our non-GAAP net operating loss to just RMB 15 million from RMB 133 million in the first quarter of 2023 and RMB 67 million last quarter. Our non-GAAP basic net income per ADS was 0.149 and non-GAAP diluted net income per ADS was 0.146 for the same period. We remain confident that our profitability will continue to rise in the upcoming quarters as we strive to enhance our supply chain and operational efficiency. Encouragingly, we maintained positive operating cash flow for the second consecutive quarter with operating cash inflow of RMB 67 million in the third quarter of 2023, mainly due to improved management of our working capital and inventory.
Our cash position remains strong. As of September 30, 2023, we have cash and cash equivalents, restricted cash, short-term bank deposits, net short-term investments, long-term bank deposits net and net long-term investment securities net totaling RMB 15.1 billion. Our strong cash position will continue to support us in navigating the market dynamics. We aim to achieve additional cost savings and efficiency enhancements to accelerate our recovery.
Lastly, we are very pleased to report that our Board of Directors has approved a cash dividend of USD 0.01 per ordinary share or USD 0.01 per ADS to holders of ordinary shares and holders of ADS.
This concludes our prepared remarks today. We will now open the call to questions. Operator, please go ahead.

Question and Answer Session

Operator

(Operator Instructions) The first question today comes from Lydia Ling with Citi.

Wei Ling

This is Lydia from Citi. So my first question is regarding your overseas development, as just you mentioned, you have terminated a non-competition agreement with Relx Inc. So what's the rationale there considered to expand like export overseas expansion at this point? And how it works with your -- with the existing overseas business by your parent company? And do you have any detailed plan or target for overseas business that you could share to us? And also how do you think about the potential upside to our company? So this is my first question.
And the second question is happy to see the cash dividend declaration. So how do you consider the payout ratio? And what's the dividend policy looking forward?

Sam Tsang

Thanks very much, Lydia. So the first question is on the international expansion. And the second one is on the dividend. So our only operator is e-vapor business only in China, due to regulatory uncertainties and a relatively low social acceptance in the overseas market when it was IPO. But in the last 2 to 3 years, we have witnessed positive developments globally that changed our decision. First, many countries have established an encouraging and stable regulatory framework for this category becoming attractive and stable markets for a leading and compliance brand to enter and develop the presence.
Second, global adult smokers are increasingly perceiving e-vapor products as a mainstream effective harm reduction nicotine alternative evidenced by growing user penetration in many regions. These two external developments have been highly encouraging. For RLX itself, our franchise has become a household name with clear national market leadership. Internally, we have upgraded our organizational capabilities with adequate capabilities and resources to expand our franchise to areas outside China. To achieve our mission, we decided to terminate our non-competition agreement with Relx Incorporation, which enable us to seize growth opportunities in the international markets and establish a significant global presence outside China. We will share more details on our international expansion in the coming quarter.
So regarding your second question is on our dividend policy. As indicated in our earnings release, our Board approved our first cash dividend of USD 0.01 per ordinary share or per ADS to reward our value shareholders' continuous support. Despite macro volatilities and uncertainties, we are highly confident in our franchise future building on our international expansion, steady profit generation, robust operating cash flows and adequate capital reserve. The cash dividends and our announced share buyback program demonstrates our confidence in our prospects and commitments to returning shareholders despite the short-term volatility in the stock market. We plan to maintain a consistent and sustainable dividend payout policy that may grow progressively with our earnings.

Operator

The next question comes from Charlie Chen with China Renaissance.

Y. Chen

I have two questions here. The first one is about the industry. I can see the company actually grow revenue by roughly like 10% or so quarter-on-quarter. So I think in the past few quarters, China's e-cigarette industry has experienced kind of the regulators crackdown, resurrection of the illegal products, et cetera, et cetera. So I just wanted to have some color, what do you think will be the normalized industry growth going forward? Or is that too early to say? Or you have kind of the setup pattern of the future growth of this industry? So that's the first question.
And my second question is with all those cost-saving efforts we can see your company's non-GAAP EBIT margin has loss has narrowed quarter-on-quarter. So originally, in the past, we recall that management guided or aimed to have breaking even non-GAAP EBIT margin in the fourth quarter. So do you still think this target is achievable based on current circumstances?

Sam Tsang

So the first question is on the growth of our industry. And the second one is on the profitability of our company. So I think the user demand for National Standard products have improved overall compared to what you mentioned in March 2023 before the regulators initiate a special crackdown on illegal product. However, after the special action ended, our industry faced waves of challenges from illegal products as the illegal sales have become more secretive. At the beginning of this year, retailers will publicly display illegal products on shelves. Now after the special action, they only sell these products to users they are familiar with. Therefore, it's difficult to accurately estimate the demand for this category and predict the need for the National Standard products. We are confident in our regulators' enforcement and believe more users will gradually use National Standard products in the medium and long term.
So regarding your second question, I think as discussed in our second quarter earnings conference call, we have significantly optimized our cost structure and streamlined our operations over the past 2 quarters. As a result, the absolute amount of our gross profit improved by 7% quarter-over-quarter, and our non-GAAP operating expenses for the third quarter decreased by 27% quarter-over-quarter and 38% year-over-year. With our topline recovery and cost reduction efforts, we realized positive non-GAAP operating profit in September. We expect our non-GAAP operating profit to remain positive in the fourth quarter with our topline and cost structure don't change significantly in this or next month.
Furthermore, our operating cash flow has been positive for 2 consecutive quarters. In the third quarter of 2023, we achieved an operating cash inflow of RMB 67 million compared to a RMB 41 million inflow in the second quarter and a RMB 231 million cash outflow in the first quarter, demonstrating our abilities to adapt to the changes in macro and industry development quickly.

Operator

The next question comes from Peihang Lyu with CICC.

Peihang Lyu

This is Peihang at CICC. I have two questions here. The first one is about the product. Could you give us some color on the sales of the recent approved GB products in the third quarter? And how is the sales proportion for each major product? And my second question is about the channel, after the renewal of retail license and what is the most updated number of domestic outlets? And how is your profitability and your operating situation from your perspective?

Sam Tsang

So the first question is on our new products. And the second question is on the retail orders that we have. So for the first question, our user survey actually shows that 2 flavors that we launched a couple of months ago, chéng sè Relx (foreign language) are becoming increasingly popular among users. These flavors are now available at more stores nationwide. And in October, the first contribution of these two flavors to our Phantom series has already reached the mid-teens. Additionally chéng sè Relx Net Promoter Score now ranks #3 among our Phantom series just likely behind our best-selling (foreign language) flavors. We anticipate that the sales contribution of chéng sè Relx and (foreign language) will continue to rise. And in October, we also launched our fifth cartridge series, (inaudible), which is compatible with our Zeus device, but are more affordable than its cartridges. By the end of October, we have launched the [leading] series in more than 17 provinces.
And regarding your second question is about the number of retail orders. Number of retail orders has remained stable in the past few months, following regulator special crackdown in -- cracking down our illegal products -- on illegal products. Furthermore, more users have begun trying compliance products. As we explained in our opening remarks, only 40% of participants were aware that after October last year, retailers could only sell tobacco-flavored cartridges legally. As more and more users gradually become aware of the new regulations and the benefit of National Standards, such as required approvals before product launches and the assurance that all ingredients in the e-liquids are on the right lease, they will be increasingly interested in using national standard products. This will improve our retail products effectivity, enhance their profitability. Our self-operated stores profitability could reflect the overall sales profitability. These stores profitability has been increasing quarter-over-quarter and they have started to turn profits on the operational level in the past couple of months.

Operator

Due to time constraints, now I would like to turn the call back over to the company for closing remarks.

Sam Tsang

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

Chao Lu

This concludes the conference call. You may now disconnect your lines. Thank you.