Title

Presentation

RLX Technology Inc. beats earnings expectations. Reported EPS is $0.15, expectations were $0.01.

Operator: Hello, ladies and gentlemen, thank you for standing by for RLX Technology Inc Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After managements remarks there will a question-and-answer session. 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 Technologies’ 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 is affiliated advisers and representatives do not undertake any obligations to update this forward-looking information except as required under the applicable law. Please note that RLX Technologies 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 the call over to Ms. Kate Wang. Please go ahead.

Kate Wang: 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 with 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 irregularities among other industry participants continue to disturb the market order and adversely set the industry’s recovery with the negative impact of illegal labor 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. A survey conducted by Shanghai Jiaotong University revealed that 40% of users now mainly use national standard of compliant products, but 17% have now even tried compliant products. Furthermore, only 40% of users said they knew that legitimate retailers are only allowed to sell tobacco fluid products. Users’ lack of awareness of the new regulations has slowed the transition to compliant products as has the easy availability of legal flavored products, educating users about the new regulations, compliant product advantages, and the dangers of illicit 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 am pleased to say that these efforts paid off, reflecting our strong execution of our effective core strategy. We narrowed our operating loss and boosted cash flow during this quarter. We are also seeing signs of sequenced 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 LEILI, our fixed compliant series featuring of adjustable power at more affordable price than Phantom Pro and [indiscernible].

We have also quickly expanded our flavor offerings with 17 distinct tobacco flavors now available versus 2 back in October 2022. A wide selection of compliant product is designed to fulfill diverse demand across every user’s pace and budget. We will continue to closely monitor market demand and attract users feedback to inform our product refinements further, while leveraging our leading R&D capabilities and deep industry knowledge to develop our portfolio accordingly. A product value proposition to users extended far beyond our broad product selection. First, RLX has prioritized quality control and productivity since our inception. Supported by our strong research quality control and safety assessment capabilities, we can guarantee higher product quality and safety.

All of our products an ingredient, must meet international standards, and obtain regulatory approval before hitting the market. Furthermore, as a fully compliant participant, we greatly value user’s consumption clearance and provide outstanding after sales service. If users have problems with our product, we can call our hotline or visit our stores for assistance. Our excellent customer service team can respond and address user’s issues in a timely manner with professional service and [replacement] solutions. We also offer a one year warranty on all of our devices and cartridges. These unique advantages, add immense value to our products, and provide peace of mind for users. In contrast, illegal products are manufactured by unlicensed factories, leading to poor quality.

A lack of quality control and potential health and safety issues. Illegal products may have dangerously high nicotine concentration levels or contain levels of the Nickel or Chromium exceeding the standards as well as other band ingredients. Elastic cartridges also frequently have oversized tanks, which can create severe safety hazards when used in conjunction with many compliant working devices. We remain confident that our growing line of quality products will continue to earn more users recognition, and ultimately, their loyalty as adult smokers realized our product superiority and develop new habits. Meanwhile, we are trying to enhance users’ knowledge of new regulation and collaborating with regulators, to combat legal products to create a healthy demand in the market.

Now before I conclude, I’d like to share that our [indiscernible] and safe lab recently received customer testing facilities certificate approval from European technologies, becoming the first e-vapor brand in China to gain this certification. The recognition by the industry-leading authority indicates that our lab’s capabilities of testing electrochemical demand meets the global standard, qualifying our cash results for acceptance by 54th the UCC member countries and regions worldwide. Through our ongoing efforts in scientific research and development, we continue to enhance our productivity assessment capabilities and quality control. In conclusion, we continue to forge ahead during the quarter amid the challenging environment. We have made meaningful progress in our recovery over the past year, with an intense focus on our cost strategy to develop our portfolio and enhance efficiency.

Looking ahead, we see external headwinds persisting especially the lingering negative impact of legal products, and the uncertainties in the consumption environment. As such, we will deepened our commitment to offering compliance high-quality products to adult smokers and educating users on their various benefits. Meanwhile, to catch potential growth opportunities in the international market on November 10th, 2023, we terminated in existing non-commutation agreements with ILX Inc. which we had been entered into December 15th, 2020. Terminating this agreement gives us a 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 product strategy and the resilience in this model will dovetail our recovery, positioning RLX for long-term goals and sustainable value creation.

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 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 we present today are in R&D terms. I will now provide an overview of our operational and financial results for the Q3 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 remain 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 their 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 to call 12313 if they find anyone selling their new products. We are also conducting user education campaigns to increase awareness of the regulations and the dangers of illegal products. We hope these efforts will effectively reduce the sale and use of the 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, while our core e-vapor business to provincial distributors continued to improve quarter-over-quarter. Thanks to our cost optimization initiatives and product design improvements. We’re 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 all businesses and implement a stringent expense control for 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 from RMB15 million from RMB133 million in the first quarter of 2023 and RMB67 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 RMB67 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 and net long-term investment securities net totaling RMB15.1 billion. Our strong cash position will continue to support us in navigating 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 US$0.01 per ordinary share, or US$0.01 per ADS, to holders of ordinary shares and holders of ADSs. This concludes our prepared remarks today. We will now open the call to questions. Operator, please go ahead.

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

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Lydia Ling: My first question is regarding your overseas development as just mentioned, you had terminated noncompetition agreement with RLX team. So what’s the rationale that you consider to extent like, export overseas expansion at this point and how it works 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 about the potential upside to a company? So this is my first question. And the same 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?

Kate Wang: Thank you very much Lydia. So the first question is on the international expansion and the second one is on the dividends. So RLX operator e-vapor business only in China due to regulatory uncertainties and a relatively low social acceptance in the overseas market, when it was its IPO. But in the last two to three years, we have witnessed positive developments globally that’s changed our decision. First, many countries have established an encouraging and stable regulatory framework for this category, becoming attractive and stable markets for leading and compliance brand to enter and develop a 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 agreements with RLX Incorporation, which enable us to seize growth opportunities in the international markets in and establish a significant global presence outside China. We will share more details on our international expansion in the coming quarter. Regarding your second question is on our dividend policy. As indicated in our earnings release, our Board approved our first cash dividends of US$0.01 per ordinary share or per ADS to reward our valued shareholders’ continuous support.

Despite macro volatility 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 dividend and our announced share buyback program demonstrated our confidence in our prospects and commitments to returning shareholders despite the short-term volatility in the stock markets. 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. Please go ahead.

Charlie Chen: Thank you, management, for taking my questions. I have two questions here. The first one is about the industries. I can see the company actually grow revenue by roughly like 10% or so quarter-on-quarter. So I think in the past a few quarters, China’s e-cigarette industry experienced, kind of the regulators crackdown, resurrection of the legal product. 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 a setup pattern of the future growth of this industry? So that’s your first question. And my second question is, with autos cost saving effort, we can see your company’s non-GAAP EBIT margin 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 the target is achievable based on current circumstances?

Kate Wang: So the first question is on the growth of our industry and the second one is on the profitability of our company. I think the user demand for National Standard products has improved overall compared to what you mentioned in March 2023, before the regulators initiated a special crackdown on illegal products. However, after the special action ended, our industry faced waves of challenges from illegal products as their illegal sales have become more secretive. At the beginning of this year, retailers would 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 regulated 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 few 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 3% year-over-year. With our top-line 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 if our top-line 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 and operating cash inflow of RMB67 million, compared to a RMB41 million inflow in the third quarter and RMB231 million cash outflow in the Q1, demonstrating our ability to adapt to the changes in macro and industry development quickly.

Operator: The next question comes from Peihang Lyu with CICC. Please go ahead.

Peihang Lyu: This is Peihang at CICC. I have 2 questions here. The first one is about the product. Could you give us some color on the sales of the recent approved GV 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 their profitability and their operating situation from your perspective?

Kate Wang: So the first question is on new products and the second question is on the retail order sets we have. So for the first question, our user survey actually shows that 2 flavors that we launched a couple of months ago [Indiscernible] are becoming increasingly popular among users. These flavors are now available at most stores nationwide. And in October, the sales contribution of these 2 flavors to our Phantom series has already reached the mid-teens. Additionally [Indiscernible] Net Promoter Score now ranks number 3 among our Phantom series, just slightly behind our best-selling [Indiscernible] flavors. We anticipate that the sales contribution of Shenzhen Wuxin and [Indiscernible] will continue to rise. And in October, we also launched our 5th cartridge series, LEILI, which is compatible with ASUS device, but are more affordable than its cartridges.

By the end of October we have launched the LEILI series in more than 17 provinces. And regarding your second question, it’s about the number of retail outlets. The number of retail outlets has remained stable in the past few months, following regulators’ special crackdown 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 benefits of national standards, such as required approvals before product launches and the assurance that all ingredients in the liquids are on the right list.

They will be increasingly interested in using national center products. This will improve our retailers’ productivity and 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. Thank you for your questions.

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 RLX Technology’s Investor Relations team through the contact information provided on our website or TPG Investor Relations. Thank you.

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