Earnings Call Transcript - RLX Q1 2024

Operator, Operator

Hello, ladies and gentlemen, thank you for joining RLX Technology, Inc.'s First Quarter 2024 Earnings Conference Call. Today's call is being recorded and is expected to last approximately 40 minutes. I will now turn the call over to your host, Mr. Sam Tsang, Head of Capital Markets for the company. Go ahead, Sam.

Sam Tsang, Head of Capital Markets

Thank you very much. Hello, everyone, and welcome to RLX Technology's First Quarter 2024 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 Chief Executive Officer, Ms. Kate Wang, our Chief Financial Officer, Mr. Chao Lu; and myself, Sam Tsang, Head of Capital Markets. 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, targets, estimates, 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, advisers and representatives 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 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, CEO

Thank you, Sam. And thanks, everyone, for making time to join our earnings conference call today. I will begin with an overview of our international initiatives, followed by a discussion of illicit products' impact on our business before I hand it over to our CFO for a review of our financials. 2024 is off to a solid start. Our operations in Southeast and North Asia are running smoothly, and our international expansion is progressing well. Since terminating our non-compete agreement with RLX International in November 2023, our team has been diligently researching the regulatory environments and competitive landscapes of the markets worldwide to inform our strategic blueprint. After thoroughly evaluating various markets, we are ready to determine our next steps and develop tailored growth strategies for each region. With our leading product development capabilities and broad portfolio of premium products for adult smokers, we are confident that we can meet each market's unique needs. We plan to expand into additional regions, and we'll keep you updated on our progress in future calls. On product diversification, we are broadening our portfolio in response to rising living costs that are impacting users both domestically and overseas. By offering more SKUs across a wider price spectrum, we can cater to diverse consumer needs and capture additional demand. In overseas markets, we're expanding our offerings beyond closed systems, starting with e-liquid products, and we plan to introduce new open system devices at a later stage. Our recent launch of new e-liquid products in Southeast Asia has been well received, showing promising initial results. Regarding the regulatory environment in overseas markets, we are seeing the early impact of bans on these products. Retailers and adult users are shifting from disposables to other subcategories such as pod systems. As the leading global player in the pod system market, these regulatory changes present prime opportunities for us to increase our future market share. We are poised to capitalize on this transition with an effective marketing strategy and pipelines of compliant products that meet adult smokers' needs at every price point. Turning to the impact of illicit products domestically. Illicit products continue to challenge compliant products. However, we are encouraged by Chinese authorities' announcement of another round of special actions to crack down on illicit products in March. This initiative spans four months, a month longer than last year's. We're focused on improving case investigation and handling, and building a robust enforcement system for the industry. We are pleased to see China's regulatory authorities tackling these serious issues, though there is still a long way to go. We are already seeing some positive outcomes. For instance, authorities in Zhejiang Province successfully cracked a case involving the entire supply chain of counterfeit e-cigarettes from product to sales. They dismantled one illegal manufacturer and two production lines, sealing 40 sets of production equipment, over 35,000 disposable e-cigarettes, over 30,000 cartridges, over 2,900 devices and one million e-cigarette accessories. The seized goods were valued at more than RMB 10 million and the total amount involved in the investigation exceeded RMB 100 million. Additionally, authorities in Gansu Province recently uncovered an illegal e-cigarette manufacturing and sales enterprise operating online. They dismantled three illegal manufacturing sites, three storage sites and six retail shops, seizing over 2,800 disposable e-cigarettes and over 290,000 cartridges. The total value of seized goods exceeded RMB 8.8 million, with the total amount involved in the investigation surpassing RMB 110 million. As an industry leader and socially responsible company, RLX remains committed to advocating for a well-regulated e-vapor industry and collaborating with regulators to create an orderly and healthy market. Internationally, authorities are also increasingly cracking down on illicit products. In the United States, for example, the State of Florida has implemented a registry for these portable vapes. Starting March 1, 2025, manufacturers that sell prohibited products in the state will face a $1,000 daily fine per product until it is removed from the market. These regulations also apply to retailers, wholesalers, and distributors that ship products into Florida. Additionally, anyone who sells a nicotine product, including vapes to someone under 21 for the first, third or subsequent time will face a third-degree felony charge, punishable by up to $5,000 in fines and five years in prison. In the U.K., authorities are cracking down on unlicensed imports. Both border control and local authorities are working to cease unauthorized counterfeit products. The government is expected to announce new rules for the industry, which could include a ban on disposable vapes and a licensing scheme for retailers among other regulatory measures. As a legitimate player, we view these actions as positive developments that will contribute to healthy and orderly markets, benefiting our future business development. In conclusion, our strategic expansion initiatives are already yielding positive results, setting the stage for future success. We remain confident that e-vapor products will continue to gain traction as a harm reduction tool for adult smokers even as regulations evolve worldwide. With an outstanding product portfolio, agile operations, and deep industry expertise, we are ready to create and seize opportunities on a global stage. 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, CFO

Thank you, Kate, and hello, everyone. Before I start the detailed discussion of our financials, please note, unless otherwise stated, all the financials I will present today are in RMB terms. First, I am pleased to report that our strategic expansion into Southeast and North Asia has continued to deliver positive outcomes this quarter. Total net revenues increased to RMB 552 million, marking our fifth consecutive quarter of revenue growth. The inherent benefits of geographic diversification, along with our reduced reliance on the domestic market, have allowed us to capitalize on opportunities arising from harm reduction initiatives in the international markets. We are increasingly capturing organic growth from adult smokers transitioning from combustible cigarettes to reduced-risk products like e-vapors. We have a solid blueprint for ongoing expansion in place, and we are optimistic that our initiatives will continue driving progress across our financial metrics. We will provide further details in the coming quarters as we continue to assess various market growth potential, competitive landscape and regulatory environment. Turning to profitability, our overall gross profit margin for the first quarter expanded year-over-year from 24.2% to 25.9%. Despite the excise taxes on e-vapor products in China, our ongoing efforts to enhance supply chain efficiency, improved product designs, and increased utilization of our exclusive manufacturing plants are having a positive impact. Notably, the gross profit margin of our domestic business has improved quarter-over-quarter since the second quarter of 2023. We recorded a total operating loss of RMB 52 million for the first quarter. However, excluding the impact of share-based compensation, we achieved a positive non-GAAP operating profit of RMB 23 million, marking our second consecutive quarter of non-GAAP profitability at the operating level. This represents a significant year-over-year turnaround compared to a non-GAAP operating loss of RMB 133 million in the first quarter of 2023. Our cost reduction efforts and positive profit contributions from outside China were the main drivers of this quarter's success. Driven by our turnaround in operating level profit, our non-GAAP net income for the first quarter of 2024 increased by 13% year-over-year to RMB 208 million. For the same period, our non-GAAP basic net income per ADS was RMB 0.166, and non-GAAP diluted net income per ADS was RMB 0.159. Our cash flow and balance sheet remain healthy and strong, supported by enhanced working capital and inventory management. We recorded an operating cash flow inflow of RMB 4 million in the first quarter of 2024, a meaningful improvement from operating cash outflow of RMB 231 million in the same period last year. Additionally, we are currently experiencing a negative cash conversion cycle. Inventory turnover days stood at just 34 days in the first quarter of 2024, significantly reduced from over 100 days in the first quarter of 2023. As of March 31, 2024, our total financial assets, including cash and cash equivalents, restricted cash, and various forms of short-term and long-term deposits and inventories, totaled RMB 14.7 billion. In summary, we are confident that we are on the right track with our international expansion. Moving forward, we will continue to optimize costs and efficiency as we enter new markets and scale our operations. Our goal remains to deliver premium products to users while creating sustainable long-term value for our shareholders. This concludes our prepared remarks today. I will now open the call to questions. Operator, please go ahead.

Operator, Operator

And the first question comes from Charlie Chen with China Renaissance.

Charlie Chen, Analyst

I've got two questions regarding the domestic market. First, can you provide more details about the monthly sales momentum in the domestic market? Are there any month-to-month changes that you can share? Additionally, based on the current run rate, do you have new guidance or sales targets for the full year? The second question is about the domestic product pipeline. Can management provide more information on any new directions or requirements from regulators related to flavor, packaging, and technology?

Sam Tsang, Head of Capital Markets

Thanks very much, Charlie, for your question. So the first question is about our monthly sales trend as well as our targets internally. So the monthly sales of our China business has been relatively stable. Each month's sales could be subject to seasonal effects, for example, Chinese New Year and public holidays, and the overall trend has not changed. So as you may be aware, there is a special action led by the Chinese authorities ongoing, and we hope that positive trends will emerge as this initiative concludes. We are also working on launching new products with new designs and characteristics to compete effectively with illicit products. We are innovating and expanding our offerings to meet our user demands. We will share more details once our new product launches. Overall, our China business remains on track with our annual expectations and targets, and we remain optimistic about the market as the regulatory actions take effect and our new products enter the market. Your second question is about whether there are any regulatory changes, especially regarding flavors or other requirements. In late April, there are a few draft consultation papers being published by the Chinese regulators. The first change concerns product approval. Compared with the previous versions published in early 2022, the new draft did not include certain clauses related to the exports of e-cigarette products. It also stated that if an applicant is under investigation for suspected illegal activities, the regulators will not assess such an applicant's technical review application. The second change mainly concerns marketing campaigns. All marketing activities must be registered on the National Transaction Platform and must not violate applicable regulations. We believe the draft consultation papers are aimed to promote healthier and orderly industry development. Thank you for your questions.

Operator, Operator

And the next question comes from Lydia Ling with Citi.

Lydia Ling, Analyst

Management, this is Lydia Ling from Citi. Can you hear me?

Sam Tsang, Head of Capital Markets

Yes, we can hear you.

Lydia Ling, Analyst

I have two questions. The first one is about your overseas market. Can you share the year-to-date growth trend for the markets where you have already established a presence? Additionally, have you noticed any impact from the weak macroeconomic conditions on consumption in this category? I understand that you are entering new markets gradually, so I would like to know if any new markets were consolidated in the first quarter and what your expansion plan is for the second quarter. My second question is regarding the China market. You mentioned the ongoing measures against illegal products in China, so I am curious about the sales trend for the second quarter. Should we expect an improving trend in sales during this period?

Sam Tsang, Head of Capital Markets

Thanks very much, Lydia, for your questions. So regarding your first question about the international markets. We have made significant progress in strengthening our presence in Southeast and North Asia and have yet to enter new markets in the first quarter. Our non-China business has maintained steady growth despite the first quarter traditionally being a low season for this category, primarily due to weather-affected store traffic and the Holy Month of Ramadan in Southeast Asia. We are also aware of the weak macro of the international markets. The rising living cost encourages more adult smokers to consider value-for-money nicotine alternatives like e-vapor products. The trend of switching from cigarettes to harm reduction nicotine products like e-cigarettes has been clear, and the rise in living costs could also help accelerate the switch and user penetration. Our expansion strategy calls for prudent and calculated entries into new markets in the second quarter. We are working on expanding to certain countries this quarter, starting with Asia. Overall, we are optimistic about the positive growth potential of our international markets by capturing increasing market share to drive our growth in this quarter and beyond. Regarding your second question about the special action and its impact towards the second quarter, the special action against illegal products in China are positive developments for our industry. This year's special action is more comprehensive with performance of inspection and evaluation, a month longer than that of last year. The extended period allows for a more thorough inspection of the value chain from manufacturing and wholesale to retail. This year's special action focuses on multiple aspects, ensuring all entities fully comply with the regulations and cracking down on unlicensed entities. For manufacturers like us, this requires complying with production and operational standards and robust product quality assurance systems. Furthermore, authorities identify unlicensed activities and collaborate with our departments to shut down illegal operations and pursue legal responsibility for such violations. We fully support and are thankful to the Chinese authorities for their efforts to address these issues and promote a well-regulated e-vapor industry. So for the second quarter, we expect these actions to help stabilize the markets and remain optimistic that these efforts can support our growth and help us achieve our goals. Although it's still a bit early to predict specific outcomes for the second quarter. Thank you for your questions.

Operator, Operator

And the next question comes from Peihang Lyu with CICC.

Peihang Lyu, Analyst

This is Peihang from CICC. I have two questions here. My first question is what is the current level of the unit market share in the domestic market? How does the company perceive its share in the legitimate market? And the second question is that given the intensifying competition in the overseas market, we have also noticed increasing pressure on product ASP this year. How does the company view the price competition of the industry and its impact on your business?

Sam Tsang, Head of Capital Markets

Thank you very much, Peihang, for your questions. So the first question is about the illegal markets in China. We do see that the illicit market continues to post great challenges in the China market. Some market estimates suggest that illegal products account for the majority of the adult market size. These black market transactions are conducted through social media platforms, which is difficult to monitor and trade. Regulators are tracking down on illicit activities in the industry, including the two cases we mentioned in the opening remarks, and special actions are still ongoing. We hope better enforcement and new product launches will reduce the illicit market share. In terms of our market share in the legal markets, we are a leading brand, maintaining a stable market share over the last 12 months. We have strong brand equity and provide quality and innovative products that can meet our users' needs. Your second question is about our international market competition. We believe that competition in our industry primarily relates to product innovation rather than just pricing. Unlike other consumer categories, the growth of the e-vapor markets and market share movements among brands are driven by product innovation that meets users' evolving demand while complying with regulatory requirements. For instance, the tobacco product directive in the EU region limits the capacity of cartridges to no more than two milliliters. In response to user preferences for more puffs, products like 4-in-1 have emerged. These products provide four cartridges, each containing no more than two milliliters of e-liquid. This caters to user demand for convenience while staying compliant with EU requirements. We also see more new products offered to provide users who seek value-for-money options. Many brands, including us, have introduced e-liquid products, offering diversified options at various price points. Product diversification ensures that we can meet different user segments' needs without engaging in price competition. Overall, we believe that competition in the e-vapor market relies on product innovation, rather than price cuts, as this could harm brand equity. As the market and penetration of the e-vapor category continues to grow, we believe we can grow with the industry and increase our share by launching products that cater to consumers' preferences. Thank you for your questions.

Operator, Operator

And the next question comes from Xing Fang with CITIC Securities.

Unknown Analyst, Analyst

This is Pooja from CITIC Securities. I have one question here. We have observed that U.K. cigarette exports experienced a significant decline in March. Could you please share whether this downturn is related to the impending ban on disposable products? Additionally, could you provide some insight into which measures overseas markets are currently driving sales for the company's disposable products? How has growth been in this market? And how do you view the future trend?

Sam Tsang, Head of Capital Markets

Thank you very much. The decline in the U.K. e-cigarette exports in March is partially due to the anticipated ban on disposable products, which could take effect as early as April 2025. We have noticed trends indicating that players across the value chain are preparing for this change. For example, some brands that heavily focus on disposables have already launched and promoted their pod system products. Some retailers are also converting existing disposable users to other subcategories such as pod systems and open system products. We primarily sell our disposables in markets where they are permitted. Disposable products have gained popularity due to their convenience and relatively affordable pricing, and we have seen growth in our disposable products as well. The future of disposables varies by market and depends on local regulatory developments. If disposable products are banned in certain markets, we can convert users to other subcategories, since we are a leader in the pod system while also offering e-liquid solutions in select markets. Thank you for your question.

Operator, Operator

And due to time constraints now, I would like to turn the call back over to the company for any closing comments.

Sam Tsang, Head of Capital Markets

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 Piacente Financial Communications. Thank you.

Operator, Operator

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