Earnings Call Transcript - RLX Q1 2021

Operator, Operator

Hello, ladies and gentlemen. Thank you for standing by for the RELX Technology Inc.'s First Quarter 2021 Earnings Conference Call. Today's conference call is being recorded and is expected to last for about 40 minutes. I will now turn the call over to your host, Mr. Sam Tsang, Head of Investor Relations of the company. Please go ahead, Sam.

Sam Tsang, Head of Investor Relations

Thank you very much. Hello, everyone, and welcome to RELX Technology's First 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. On today's call, our co-founder, Chairperson of the Board of Directors and Chief Executive Officer, Ms. Kate Wang, will make some general remarks on our first quarter achievements and strategic focuses going forward. Then, our Chief Financial Officer, Mr. Chao Lu, will elaborate further on our specific initiatives and take us through our financial results for the first quarter ended March 31, 2021. Before we continue, please note that today's discussion will contain forward-looking statements made under the safe harbor provision 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 does not undertake any obligation to update its forward-looking information, except as required under the applicable law. Please note that RELX Technology earnings press release and this conference call include discussions of unaudited GAAP financial measures as well as unaudited non-GAAP financial measures. RELX Technology 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. Thanks, everyone, for making your time to join our earnings conference call today. First quarter 2021 was an eventful one for our company and the industry. In January, we successfully listed on the New York Stock Exchange. After listing, we continued to pursue our goal on product leadership in scientific research, technology and product development, supply chain production and distribution, and retail networks. Our net revenues for the first quarter grew 48% quarter-over-quarter. In March, the authorities announced a proposal seeking public comments regarding the revision of rules and regulations aimed at strengthening the supervision of e-cigarettes and addressing quality, safety risks, and false advertising problems, among others. Just yesterday, the newly revised law on the protection of minors was enacted. This process addresses the prevention of underage use of alcohol and tobacco, including e-cigarettes. We have always upheld user value, corporate value, and social value as the key pillars of everything we do. It is the relentless pursuit of these values that makes us the most trusted brand of choice and a leading force in our industry. The dynamic market and regulatory environment inspire us to keep pioneering on all fronts, swiftly and purposefully. For our users, we focus on value creation through product development to meet their diverse needs, and enhancing distribution and our high-quality network to ensure a seamless and best-in-class purchase experience. For our corporate stakeholders and partners, we focus on value creation through investing in science and technology to reinforce our sustainable advantage and empower everyone in our value chain. For society, we prioritize value creation through providing products of the highest quality and safety standards to adult smokers for harm reduction and by fighting against counterfeit products and illegal marketing and sales to minors. To keep pace with our business development, we have been steadily attracting and developing high-caliber talent to strengthen our capabilities. In the first quarter, we appointed Mr. Chao Lu as our Chief Financial Officer. He brings over a background of investment banking experience and a comprehensive understanding of China's health care industry. We are pleased to welcome him to our management team and believe he will be an invaluable addition to our company. With that, I will now turn the call over to Chao, who has been with us for more than two months now. He will elaborate further on some of the initiatives taken during the past quarter and go over our operational and financial results in more detail. Chao, please go ahead.

Chao Lu, CFO

Thank you, Kate, and hello, everyone. It has been an honor and a great pleasure to join RLX's management team. Value creation has been at the center of all our initiatives. Next, I will share some specifics regarding the initiatives we took during the first quarter. In March, responding to user demand, we released a new product, RELX Lite, with more affordable pricing. We will continue expanding and enhancing our product offerings as we seek to serve the diverse needs of our users in China. We also continued our expansion of offline distribution networks and retail channels across the nation to further penetrate e-vapor products among adult smokers. As of March 31, 2021, we’ve partnered with over 15,000 RELX Branded Partner Stores nationwide. We are excited to see an increasing number of branded store partners willing to start business with us to open RELX Branded Partner Stores, working together to better serve adult smokers in China. Meanwhile, as part of our consistent efforts to expand our industry-leading retail model nationwide, we have collaborated with various forms of retailers to diversify our distribution and retail network. In the first quarter of 2021, we opened our Quality Lab to further strengthen our quality assurance and control capabilities. We also started developing our second and third exclusive production plants to enhance our production capabilities. In terms of our efforts in scientific research, the Journal of Applied Toxicology published RELX Lab's science study on the cooling agent WS-23. The peer-reviewed journal article is part of our ongoing emphasis on scientific research. Looking ahead, we will keep investing in in-house lab research related to product quality and safety, physical chemistry, psychological and clinical elements, and the evaluation of long-term use of e-vapor products. Keeping up our commitment to corporate social responsibility, we remain dedicated to building and strengthening our trusted brands by consistently adhering to our strong ethical principles. We have continued investing in the Golden Shield Program to combat sales of counterfeit products, having delisted over 100,000 online links and ceased over 170,000 counterfeit products. In late April, we published our first ESP program, detailing our efforts and commitment to our stakeholders. Yesterday, following the newly revised law on the protection of minors, we were the first among all our peers to call on the entire industry to thoroughly study the relevant laws and regulations and strictly abide by them. Turning to financial performance, we started 2021 with good momentum as our first-quarter results came in above our expectations. Our robust top-line growth continued, driven by the expansion of our distribution and retail network, increasing user penetration among adult smokers. We remain devoted to implementing our cost optimization strategy and enhancing operating leverage. I will now provide a brief overview of our key financial results for the first quarter of 2021. Our net revenues increased by 48.2% to RMB 2.4 billion in the first quarter of 2021 from RMB 1.62 billion in the fourth quarter of 2020. The growth was primarily due to an increase in net revenues from sales to offline distributors, driven by the expansion of our distribution and retail network. Gross profit increased by 59.1% to RMB 1.1 billion in the first quarter of 2021 from RMB 694.1 million in the fourth quarter of 2020. Gross margin increased to 46% in the first quarter of 2021 compared to 42.9% in the fourth quarter of 2020. Operating expenses were RMB 1.2 billion in the first quarter of 2021 compared to RMB 852.6 million in the fourth quarter of 2020. Selling expenses increased by 48.2% to RMB 291.5 million in the first quarter of 2021 from RMB 196.7 million in the fourth quarter of 2020, primarily due to an increase in salaries and welfare benefits, branding material expenses, and shipping expenses. General and administrative expenses increased by 59.5% to RMB 712.8 million in the first quarter of 2021 from RMB 447 million in the fourth quarter of 2020, mainly due to an increase in salaries and welfare benefits and an increase in share-based compensation expenses, partially offset by a decrease in legal and consulting fees. Research and development expenses increased to RMB 211.6 million in the first quarter of 2021 from RMB 208.9 million in the fourth quarter of 2020, driven by an increase in salaries and welfare benefits, partially offset by a decrease in share-based compensation expenses and material expenses. Share-based compensation expenses recognized in selling expenses, general and administrative expenses, and research and development expenses in total were RMB 877.5 million in the first quarter of 2021 compared to RMB 656.1 million in the fourth quarter of 2020. Loss from operations was RMB 111.9 million in the first quarter of 2021 compared with RMB 158.5 million in the fourth quarter of 2020. Income tax expenses were RMB 176.3 million in the first quarter of 2021 compared with RMB 110.6 million in the fourth quarter of 2020, primarily due to an increase in taxable income. GAAP net loss was RMB 267 million in the first quarter of 2021 compared with RMB 236.7 million in the fourth quarter of 2020. Non-GAAP net income reached RMB 610.5 million in the first quarter of 2021. GAAP basic and diluted net loss per ADS were both RMB 0.174 in the first quarter of 2021 compared to RMB 0.165 in the fourth quarter of 2020. Non-GAAP basic and diluted net income per ADS were both RMB 0.398 in the first quarter of 2021 compared to RMB 0.292 in the fourth quarter of 2020. As of March 31, 2021, the company had cash and cash equivalents, restricted cash, short-term bank deposits, short-term investments, and long-term bank deposits of RMB 14.4 billion compared to RMB 3.4 billion as of December 31, 2020. The increase was primarily due to net proceeds raised in the company's IPO in January. As of March 31, 2021, approximately USD 1.65 billion, equivalent to RMB 10.8 billion, is denominated in U.S. dollars. Now turning to guidance. For the second quarter of 2021, the company currently expects net revenue to exceed RMB 2.85 billion, and non-GAAP net income to exceed RMB 720 million. The above outlook is based on the current market conditions, including those related to COVID-19, and reflects the company's preliminary estimate of the market, operating conditions, and user demand, which are all subject to change. This concludes our prepared remarks today. We will open the call to questions. Operator, please go ahead.

Operator, Operator

Our first question comes from Lydia Ling from Citi.

Lydia Ling, Analyst

And this is Lydia from Citi. So first, congratulations on the strong results achieved in the first quarter. I actually have two questions I would like to share or hear your views on. The first question is still on the regulation side. After the opinion in March and with the public feedback ending in late April, could you share with us any regulatory updates in this industry? What is your view on the current progress and your expectation on the timeline for the detailed regulation? My second question is on the latest competitive landscape for the China e-cigarette market. Have you observed any changes up to the March opinion announcement and how does your competitive market share evolve? We also noticed that store openings have been very aggressive in the first quarter. What about your peers? Did you observe any pushback in the openings in the second quarter after the announcement?

Sam Tsang, Head of Investor Relations

Sure. Thank you very much, Lydia. On the first question about the regulatory update, in response to the announcement made by MIIT on March 22, we submitted our feedback regarding the announcement before the deadline of April 22. We are absolutely supportive of the considerations mentioned in the announcement on March 22, which includes regulating the operating activities of the e-vapor industry and tackling potential safety issues of some of the e-vapor products in the market. Some past advertisements made by some market participants have been our focus in our daily operations. Regarding the timeline or updates, there have been no updates regarding the announcement according to the website of the regulatory authorities. We will keep monitoring the regulatory developments closely. Regarding the second question on the competitive landscape side, stepping into 2021, so far this year, as mentioned by both Kate and Chao, our business has remained on very strong growth momentum, as evidenced by our operational and financial results. Alongside our expansion, we also try to identify diversified demand to better serve adult smokers in China through our advanced technologies, product development, nation-wide distribution and retail network, as well as our enhanced supply chain and production capabilities. Regarding the market share or the landscape itself, according to our knowledge, most of our peers have witnessed a deceleration of growth or even a decline in financial or operating results from the beginning of the year. The major reason is that our commercial and product strategies have kept us competitive. As mentioned in the opening remarks, we plan to adhere to our strategies of value creation and invest more into scientific research, product developments, supply chain distribution, and most importantly, underage prevention, to widen our lead over other market players in the e-vapor market in China.

Operator, Operator

The next question comes from Charlie Chen from China Renaissance.

Charlie Chen, Analyst

I have two questions. Number one is since the announcement on March 22, have you seen any material changes or impacts on consumer behavior or your business? Any insights would be appreciated. Second question is, do you have visibility towards your production capacity and whether your largest supplier has sufficient capacity reserved for your growth for the rest of the year?

Chao Lu, CFO

Thanks, Charlie, for the question. On your first question, since the March 22 announcement, we have been closely monitoring the macro environment, market condition, and our own operating results. We have also gathered feedback from our business partners, including retailers, distributors, and suppliers through daily communication. We have been closely observing our operating and financial metrics, including retail sales value, frequency of purchases, and inventory levels through our own system. We continue to see sustained support from our business partners and users for our business development and our products. So far, we have not experienced material negative impact on our operating results since that announcement. We will keep monitoring the industry landscape, including the regulatory framework, while maintaining active communication with our trusted partners. We will aim to deliver value creation to our users, stakeholders, and society as a whole. On your second question regarding production capability visibility and our capacity with the partners, we strive to be agile in managing our supply chain and production plants. We formed our supply chain and production plans for various time frames based on multiple factors, including user demand, distributors, retail sales, and commercial goals, to ensure that we achieve an optimal inventory level while fulfilling user demand for our e-vapor products. As our e-vapor products contain multiple components, including e-liquid packaging, battery, and various materials, we have been discussing and communicating with our production needs periodically with our suppliers and manufacturers over the past year and the past quarter. Our suppliers and manufacturers have effectively fulfilled our needs. We remain vigilant on our suppliers' and manufacturers' capability and their actual production volume. I believe we can manage that capacity and expand or adjust accordingly. We expect our suppliers and manufacturers to be able to meet our needs under the current supply chain planning mechanism and fulfill our future expansion plans.

Operator, Operator

Our next question comes from Junhao Fan from CICC.

Junhao Fan, Analyst

I'm Junhao from CICC. I have two questions. The first question is what's your latest number of members, and how will the membership system help the company's operations? The second question is, has the industry's upstream raw material price increase affected the company's cost, especially for electronic components such as chips which have seen a price increase?

Sam Tsang, Head of Investor Relations

Sure, Junhao. So there are two questions. One is on the membership system, and the other one is on macro-level cost increases. Regarding the membership issue, we've been developing our membership system since 2019 to better serve our users with our reward system and enhanced experience. Currently, we have over 10 million members in our membership system on a registered basis, allowing us to keep updating them on scientific information, product details, store locations, and after-sale services. We will continue to enhance the membership system in an effort to better serve and reward our members as we assist smokers in using e-vapor products as a harm reduction alternative. Concerning the raw material pricing on a macro level, we are aware that the global economic situation is challenging. Prices of raw materials in the electronic industry, such as chips, have seen an upward trend. Consequently, we observe that some of our suppliers have experienced increased costs in the supply chain process. However, so far, our costs have not experienced any material adverse impact from the change in raw material prices. As a brand manufacturer, we will closely monitor developments in our supply chain and any operational or financial issues faced by our suppliers. If the costs of our products do increase, we will seek very active solutions to minimize any potential impacts on our financials or operating results.

Operator, Operator

The next question comes from Stephanie Lam from Haitong International.

Stephanie Lam, Analyst

Congratulations on a strong result. I have two questions. The first is regarding the store opening target. We noticed that some of your peers have been accelerating their store openings in China. I just wanted to check if we have any adjustments to our current store opening plans. My second question is related to new products. Could you talk about the price positioning of our future products? It would be great if you can also share the sales and testing progress of our sixth generation low-priced products.

Sam Tsang, Head of Investor Relations

Sure. Thank you very much, Stephanie. Regarding our store opening plan, I can explain the logic behind it. Our model's success in terms of Branded Partner Stores operating depends largely on whether there are enough potential users for our products in a given area. For each district where we have our Branded Partner Stores, we will monitor store productivity in conjunction with other factors to determine whether more stores are necessary, rather than simply comparing ourselves to peers. The implementation of our Branded Partner Stores has achieved great success in the past, and as of March 31 this year, we have partnered with over 15,000 RELX Branded Partner Stores nationwide. We consistently evaluate the pace of store openings based on comprehensive metrics, including productivity of existing stores. We will continue to expand based on these criteria while managing potential user traffic closely to avoid cannibalization amongst stores by enforcing distance requirements for most regions. Regarding product pricing and our latest developments, our product pricing strategy is dynamic and depends on user penetration in the industry and actual commercial feedback. We will continue to offer a range of products at various price points to fulfill differentiated needs of different types of adult smokers. For example, we will introduce more features for high-end products while managing costs for lower-end products to make them affordable for diverse smokers. As for the sixth generation product, we are conducting product testing in multiple cities and remain in the process of collecting preliminary feedback from users and business partners. It will require more time for us to evaluate the performance of these products and better design their scale and availability.

Operator, Operator

There are no further questions. This concludes our question-and-answer session. I'd like to turn the conference back over to management for any closing remarks.

Sam Tsang, Head of Investor Relations

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

Operator, Operator

This concludes the conference call; you may now disconnect your line. Thank you.