Earnings Call Transcript - WDH Q3 2022

Xiaojiao Cui, Partner and General Manager of Medical Crowdfunding and Patient Services

Thank you for joining Waterdrop's third quarter 2022 earnings conference call. Please note that the discussion today will contain forward-looking statements made under the Safe Harbor provision of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Potential risks and uncertainties may include, but are not limited to, those outlined in our public filings with the SEC. The company does not undertake any obligation to update any forward-looking statements, except as required under applicable law. Also, this call includes discussion of certain non-GAAP measures. Please refer to our earnings release for a reconciliation between non-GAAP and GAAP. Joining us today on the call are Mr. Shen Peng, our Founder, Chairman and CEO; Mr. Yang Guang, Co-Founder, Director and VP; Mr. Hu Yao, Co-Founder, Director and VP; Mr. Ran Wei, Partner and the General Manager of the Insurance Marketplace; Mr. Cui Xiaojiao, Partner and General Manager of Medical Crowdfunding and Patient Services; Mr. Richard Chen, Board Secretary and VP. They will be available for a Q&A section after the remarks. Now, I would like to turn the call over to our CEO, Mr. Shen Peng. Please go ahead.

Shen Peng, Founder, Chairman and CEO

Hello, everyone. Thank you for joining our third quarter 2022 earnings conference call. During this quarter, we have noticed increasing risks in the global economy and uncertainty surrounding the domestic economic recovery. However, domestic demand has recently picked up momentum, and we believe adjustments to COVID control measures will boost private consumption, providing strong support for the domestic economy's revival. This development will allow the insurance industry to return to a growth cycle and enhance the outlook for the medical and pharmaceutical sectors. In this context, Waterdrop has shown strong resilience and adaptability, maintaining good business momentum with a 10.1% revenue increase quarter-over-quarter. Following our recovery in the last quarter of last year, we have maintained a healthy level of profitability in every quarter this year. In the third quarter, our GAAP net profit reached RMB170 million, confirming that we have entered a phase of steady profitability. By the end of September, our cash and cash equivalents and short-term investments rose to RMB3.6 billion, even accounting for our share repurchases. We generated a positive cash inflow of RMB300 million this quarter. Our strong cash reserves and ability to generate positive cash flow position us well to navigate changes in the external environment. Our impressive operating results and evolving business trends over the past three quarters reflect our transition into a period of healthier and more sustainable growth, laying a solid foundation for future development. Our operating efficiency and business quality have steadily improved. We have fulfilled our commitment to achieve healthy and sustainable profitability ahead of our initial schedule, which illustrates management's effective strategic planning and execution. Looking ahead to the fourth quarter and beyond, we will continue to pursue steady progress in our business development initiatives, deepen our reforms, and invest strategically in new ventures while exploring innovative business models for healthy growth. As a leader in the medical crowdfunding industry, our subsidiary, Waterdrop Medical Crowdfunding, is dedicated to maintaining disciplined operations and fostering a healthy ecosystem. This quarter, we collaborated with judiciary hospitals and industry partners to combat unauthorized fundraising activities, and worked closely with authorities in Shandong province to address cases of fundraising fraud by malicious intermediaries. Through our stringent review processes and advanced algorithms developed by our Risk Management team, we have created a system that quickly identifies unauthorized fundraising activities. After months of investigations and on-site visits, we gathered substantial evidence that assisted the police in resolving the case. Thanks to our effective measures, there have been no detected unauthorized fundraising activities on our platform for several consecutive months. In the third quarter, we also advanced our business strategy for the Waterdrop Insurance marketplace, resulting in improved business quality and upgraded product and service offerings, alongside accelerated technological innovations. This strategic shift has led to higher-quality operating results. We are actively exploring broader innovation opportunities in the medical and healthcare sectors, expanding our reach by leveraging the strengths of existing businesses, including our successful patient recruitment business and our developing CRO business. These initiatives aim to provide users with comprehensive product and service coverage, enriching our ecosystem. In the third quarter, we firmly executed our share repurchase program, acquiring approximately 1.09 million ADS in total, and we will continue to proceed prudently with the program. By the end of September 2022, we had cumulatively repurchased around 5.8 million ADSs from the open market, totaling approximately USD 8.5 million in expenditure. Our focus remains on our shareholders' interests, and in September, we announced a one-year extension of our repurchase program, increasing the maximum repurchase amount to USD 80 million. This reflects our strong confidence in our corporate value and long-term sustainable development. In conclusion, we will maintain sufficient cash liquidity regardless of industry conditions and continue to have confidence and a patient outlook on the industry and our development. We will stay committed to our mission, concentrate on user value, solidify our business fundamentals, and pursue continuous advancements to strengthen our position for the next phase of development. Now, I will hand it over to Ran Wei to discuss the Waterdrop Insurance business development for Q3.

Ran Wei, Partner and General Manager of the Insurance Marketplace

Thank you, Shen Peng. Hello, everyone. Let me give you an update on our insurance business development. In the third quarter, the market for life and health insurance in China remained subdued with no significant improvement in premium growth due to the continued resurgence of COVID-19 and ongoing pension policy reform in the life and health insurance industry. At the same time, the demand for protection-type products remains soft which implies that both the demand and supply side of the market are somewhat subdued. Meanwhile, future volatility in the equity market, insurance risks, and ever-growing operating pressure have caused the overall earnings of the insurance industry to decline over the first three quarters of 2022. Against this backdrop, we continued to improve our operational efficiency, boost the quality of our business, and optimize existing offerings. We have proactively explored new customer acquisition channels and persistently engaged in product innovation to achieve long-term sustainable business growth despite the industry’s trends. We achieved an industry high GAAP net profit of RMB170 million in Q3 and our key operating metrics continue to reflect the high quality of our business relative to the industry. Now, I will walk you through the performance of our insurance business. First, steady progress has been made on our business model upgrade. In Q3, the quality and profitability of our insurance business continued to improve thanks to our persistent optimization of products and user experiences. Our first-year premiums increased by 8.4% from Q2. We revamped transaction processes based on analytical results to improve user perception of our service quality. The number of long-term insurance policyholders who reviewed their policies has also increased steadily. In terms of existing lead management, we further refined our market top platform operational model and costs, optimizing the sales conversion chain across all channels. To satisfy the lifetime protection needs of users, we have enhanced overall efficiency. As such, the user repurchase rate remains above 50% while simultaneously increasing the quality rate. To identify user needs more accurately and efficiently, we continue to optimize the algorithm model based on hundreds of user profiles. The number of users converted from short-term insurance products to long-term products increased by 14% from Q2. The results of our marketing strategies have outperformed expectations. Our new customer acquisition model has achieved an initial portfolio in Q3. The number of followers of our video accounts decreased by 110% quarter-over-quarter, and the total insurance premiums originated from this account decreased by 219% sequentially. Leveraging our video content and the sales conversion capability across the supply chain, we have reached a significant volume of directed traffic. This helped decrease our customer acquisition costs by 180% quarter-over-quarter in addition to the improvement of our capacity, both in long-term insurance planning and our long-established sales experience. We have cooperated with more external practical providers to acquire a greater number of high-quality leads, thereby driving sales conversion for our long-term insurance products. In Q3, the sales productivity per lead under this partnership increased by 177% sequentially. Second, we are exploring new customer acquisition channels to drive sustainable business growth. In Q2, we set up dedicated second-level business units that adopt the insurance plan bundle to promote the online brokerage business. In Q3, we mainly focused on cultivating talent and capabilities in retail, targeting the characteristics of customer needs under the insurance plan bundle. We developed operational standards for our user management systems. We leveraged major trading platforms and retail companies to facilitate customer acquisition while exploring a one-on-one customer service bundle. These efforts helped diversify our suite of insurance offerings, expanding both user reach and user experience. Compared to last quarter, the premiums and revenues generated from these units increased by 42% respectively. Going forward, we will continue to pace our online project team and strengthen our content creation capability. Additionally, we have significantly invested in offline profitability. In Q3, we launched Waterdrop Family Insurance Needs Diagnostics, a system designed to help brokers identify new customer needs and present appropriate insurance plans. This customer-centric system empowers brokers to identify protection needs based on family size, household income, and expenditures, guiding them to offer professionally customized insurance solutions. At the end of September, our offline project team had raised more than RMB100 billion, an increase of 52% quarter-over-quarter. We have extended our offline brokerage business to major cities, including Beijing and Shanghai. Moving forward, we will optimize the early eco-systems of our established network and steadily expand our offline outreach business. Third, we continue to innovate products. To meet protection needs of customers with pre-existing conditions, in Q2, we launched Waterdrop Blue Ocean, a series of critical illness products that waive health declarations, thereby expanding the eligible user group. This product series achieved substantial recognition in the market and generated sizable sales. In Q3, we also launched a series of medical insurance products that similarly waive some health declarations. Additionally, we worked with our insurer partners to co-develop customized critical illness insurance products for children, which offers additional medical service benefits for leukemia. The insurance uptake for our customers under the age of 14 increased by 20% quarter-over-quarter. Meanwhile, the needs for asset allocation in a low-interest-rate environment will continue to enrich our product offerings and improve our capabilities. Our self-operated insurance products saw an increase of 23% quarter-on-quarter. Fourth, we are focused on leveraging insurance technology. In addition to launching Waterdrop Family Insurance Needs Diagnostics, we upgraded the entire process of insurance claims assistance services to optimize user experience. Based on our analysis of numerous claims cases, we have integrated best practices throughout our online claims assistance processes. Empowered by our digital capability, we have enhanced our claims assistance services. For instance, our intelligent optimal selling business system now employs OCR-based extraction technology to improve service efficiency. We also have a product customization assistant that uses claims settlement insights to generate innovative insurance product recommendations. In the future, we will continue to invest in our claims service systems to provide better assistance for our users. This concludes my briefing on our insurance business. Now, let me hand over to the representative for an update on our Medical Crowdfunding and Patient Recruitment business.

Unidentified Company Representative, Company Representative

Thank you, Ran Wei. I would like to share some updates on our medical crowdfunding business. At the end of Q3, a total of 420 million donors have helped over 2.69 million patients create more than RMB55.3 billion from our platform. Our user numbers and fundraising amounts have remained stable even after we implemented a service fee. In the third quarter, the Operational Transparency Committee continued to enhance our operational control related to authenticity and transparency on our medical crowdfunding efforts, launching new initiatives to increase the transparency of fund flows for each donation. For example, we have enhanced fund flow disclosure with defined visual details and statements on fundraising pages. When a patient needs funding, the bank will issue payment through our platform and the patient. The fundraising page will disclose information such as how much cash has been withdrawn by the patient, the service fee charged, third-party payment fees, and the amount of funds available for withdrawal. Fund flows related to each donation are now easily traceable. Meanwhile, after several months of effort, we worked closely with the police in Shandong to crack down on fundraising fraud executed by malicious individuals, resulting in the arrest of 17 suspects. Through various effective measures, the platform has not detected any malicious fundraising activities for several consecutive months. Notably, our Waterdrop Medical Crowdfunding Platform has integrated with the community of shared users initiated by the World Internet Conference, thereby enhancing our reach. From a global perspective, most average families face significant financial stress caused by limited resources, particularly in remote areas with lower social security. When they encounter crises, they may choose to forgo necessary medical treatment due to financial burdens. Our medical crowdfunding leverages the internet to connect and facilitate financial aid more efficiently. We have thus built a protective network for millions across numerous countries and regions, gaining wide recognition. For the patient recruitment business, in Q3, the E-find Patient Platform sustained high growth momentum, adding over 900 patients for clinical trials with a quarter-on-quarter growth rate of 36%, bringing our total number of clinical trial programs to over 400. We have collaborated with more than 100 innovative pharmaceutical companies and CROs across China and globally, with the number of patients and partners continuing to increase this quarter. Our E-find platform has established collaboration with leading CROs, enabling us to support international clinical trials initiated by pharmaceutical companies. For a significant lung cancer clinical trial project initiated by a leading domestic pharmaceutical company, our platform demonstrated exceptional strength, achieving 42 patient enrollments within nine months despite COVID lockdowns in China. Pharmaceutical companies later awarded us for our recruitment efficiency, making us the expected exclusive partner for future projects. Our new digital patient recruitment capabilities have helped build an excellent reputation and a crucial position in the industry. This concludes my part, and I will now turn it over to Hu Yao to discuss our technology innovation updates.

Hu Yao, Co-Founder, Director and VP

Thank you. Hi, everyone. I'm going to discuss our third quarter technology innovation update across five key platforms. Our chatbot not only acts as the ears and voice of our virtual employee but also has a human-like mindset, especially in insurance marketing situations. First, let's talk about the upgrades made to our chatbot. In the third quarter, we introduced new optimization algorithms that enhance the accuracy of our Automatic Speech Recognition, allowing our chatbot to better grasp user intent. We implemented two algorithms: one to identify and filter background noise, and another designed for recognizing multi-sentence user responses. This significantly boosts our chatbot's understanding of users, similar to human interaction. Secondly, in terms of the chatbot's responses, we have integrated voice cloning technology that allows it to interact with users while mimicking the tone of our top-performing sales staff, greatly improving the flow of dialogue and overall user experience. Furthermore, based on our proprietary intelligent risk control model, we have expanded the chatbot's functionalities to estimate sales conversion rates, select optimal outbound calling plans, and generate complaint alerts, facilitating timely and effective communication with users. Next, we are enhancing our intelligent marketing operations through AI technologies. Our AI-powered matching system performs essential functions including the initial allocation of leads, scheduling follow-up calls, and lead reassignment. The upgraded Version 4.0 of our lead allocation module features greater flexibility for AI-based decision-making, including better lead sorting and matching. As a result, our allocation efficiency increased by 12% compared to Version 3.0. Additionally, using AI to determine lead reassignment has improved our efficiency by about 16%. Overall, Version 4.0 of our AI-powered system has become extremely reliable and effective in lead management, reinforcing our position as an industry leader. Moving on to the medical algorithm platform, our proprietary extraction algorithm for medical records accelerates the completion of medical records and expedites our patient recruitment process. The classification algorithms implemented in our medical data center have notably improved data governance efficiency, achieving an accuracy rate of approximately 95%. Moreover, our intelligent verification algorithm can automatically respond to more than 20 types of inquiries, significantly enhancing claims processing efficiency. In this quarter, we officially launched AI video production services within our Waterdrop broker app, enabling brokers to create personalized marketing content in just minutes. Finally, we have upgraded our intelligent risk control platform. All risk control products have been unified into a single platform, offering comprehensive risk control support while substantially reducing potential PR risks. For example, we have developed models that detect unauthorized fundraising activities and identify malicious intermediaries with high accuracy for user protection. Additionally, we have implemented a sensitive information masking model to ensure user privacy by automatically identifying and concealing personal information in uploaded documents. Thank you. I will now hand it over to Yang Guang to discuss our third quarter financial performance.

Yang Guang, Co-Founder, Director and VP

Thank you, Hu Yao. Hello, everyone. I will now walk you through our financial highlights for the third quarter of 2022. Before I go into details regarding the financial performance, please be reminded that the numbers reported here will be in RMB, and please refer to our earnings release for detailed information on our comparative business financial performance on both a year-over-year and quarter-over-quarter basis. Despite the challenging external environment brought on by the pandemic and slow economic growth, we have moved forward into profitability with four consecutive quarters of positive earnings as we have meticulously pursued a high-quality operational strategy since Q3 of 2021. Net operating revenue increased by 10% quarter-over-quarter and decreased by 0.9% year-over-year to RMB772 million, primarily due to a drop in insurance-related income. For Q3, operating costs and expenses decreased by 50% year-over-year to RMB639 million as a result of effective cost control measures implemented since Q3 of 2021. On a quarter-over-quarter basis, operating costs and expenses rose by 17%. Breaking that down, operating costs were RMB341 million, up by 15% year-over-year, largely due to increased professional and outsourced customer service fees. We recorded direct costs of RMB63 million related to crowdfunding service fees as we began to charge these fees in April 2022, and there was a RMB19 million increase in estimated costs from the termination of the mutual aid plan based on final settlement information—partially offset by an RMB85 million decrease in personnel costs. On a quarter-over-quarter basis, operating costs rose by 40%, influenced primarily by a RMB64 million increase in professional and outsourced customer service fees compared to Q2 2022. Total marketing expenses decreased sharply by 82% year-over-year to RMB137 million for Q3 2022. This decrease was primarily driven by an RMB500 million drop in marketing expenses to third-party traffic channels, alongside a reduction of RMB124 million in outsourced sales and marketing service fees to third parties. On a quarter-over-quarter basis, marketing expenses remained stable compared with RMB144 million for Q2 2022. General and Administrative expenses fell by 26% year-over-year in Q3 to RMB82 million due to decreases of RMB8.7 million in share-based compensation, RMB9.9 million in personnel costs, and RMB5.4 million in rental expenses. On a quarterly basis, G&A expenses remained stable compared to RMB86.1 million in Q2 2022. R&D expenses decreased by 23% year-over-year to RMB78 million, mainly due to a decrease of RMB19 million in personnel costs and share-based compensation, but increased by 11% quarter-over-quarter, reflecting a RMB7.7 million increase in research and development personnel costs and share-based compensation. During Q3, we reported a non-GAAP profit of RMB215 million and a U.S. GAAP net profit of RMB169 million, compared to an adjusted net loss of RMB453 million during the same period of 2021. The profit generated over the last four fiscal quarters illustrates our achievement in cost discipline and profit enhancement. As of September 30, 2022, our cash and cash equivalents and short-term investments rose to RMB3,588 million, reflecting a RMB300 million or 9% increase from the end of the previous quarter, as we continue to generate positive operating cash flow, offset by investing and financing cash outflows. We have once again reinforced our financial guideline to achieve a non-GAAP profit in the year 2022. Going forward, we will continue our efforts to consolidate our business, enhance our revenue quality, and optimize our costs. That's it for the results. Now, let's turn to our Q&A.

Operator, Operator

The first question today comes from an analyst with CICC.

Unidentified Analyst, Analyst

This is Qingging from CICC. First of all, congrats on the results. We noticed that you have a sufficient cash reserve. My question is, what's your plan for utilizing it? That's all for me.

Yang Guang, Co-Founder, Director and VP

Thank you for the question. As mentioned earlier, at the end of September, our cash and cash equivalents and short-term investments totaled RMB3.6 billion. Even taking into account our share repurchase, we were able to generate a positive cash inflow of RMB300 million in the third quarter. Our ample cash reserves and our operational ability to generate positive cash flow put us in a very strong position to meet our strategic goals and withstand the shifting external environment. We will continue to maintain reasonable and sufficient cash reserves. Meanwhile, we confirmed that we have adequate working capital for daily operations and enough funds to build our medium- to long-term competitive edge to achieve healthy, sustainable development. Firstly, we will use our funds to carry out our share repurchase program. Since our IPO, we have utilized our own funds to cumulatively buy back 5.8 million ADS from the open market for a total consideration of approximately $8.5 million. Based on our strong confidence in our corporate value and long-term sustainable development, we announced a one-year extension of our repurchase program in September, with the maximum repurchase amount raised to $80 million. We intend to reserve the repurchased shares for our employee incentive plan to align employees’ interests with company growth. Secondly, we will consider strategic investments at the appropriate time and deploy a portion of funds for strategic investments and acquisitions. These will focus on strengthening our product innovation capabilities, technological advantages, and the synergies across our unique services to penetrate deeper into the industry while further enhancing our ecosystems in insurance, healthcare, and technology. This year, we will invest in healthcare sector directives, capitalizing on our established advantages in patient relationships and leveraging big data analytics, which will lead to breakthroughs in medical innovation. Our patient recruitment and CRO business has made remarkable progress. Although new business initiatives may not yield significant revenue and profit in the short-term, we believe they will create a competitive edge for the company in the long run and inject momentum into long-term growth. That's all for the questions.

Operator, Operator

The next question comes from Edwin Liu with CLSA.

Edwin Liu, Analyst

Thank you for the chance to ask questions. I have two inquiries. First, concerning the crowdfunding platform, since we just completed our first full quarter of charging service fees, could you share a breakdown of revenue and profit for this segment along with any emerging trends? My second question is about guidance—would management be able to provide expectations for operating revenue and net profit for this year and next year?

Yang Guang, Co-Founder, Director and VP

Thank you for the question. Our Waterdrop Medical Crowdfunding platform implemented service fees in April of this year, beginning with a 3% charge on funds raised, capped at RMB5,000 for each campaign, to cover operational costs and help patients with critical illnesses raise capital. User numbers and fundraising income remained stable post-implementation. By the end of September, we generated approximately RMB120 million in service fees cumulatively, with Q3 revenues of RMB59 million, accounting for around 2.8% of total funds raised in that quarter. The rate is below 3% as we still subsidize campaigns for some patients. Direct operating costs for the crowdfunding platform were RMB54 million, but we also faced indirect costs related to IT and risk control. The service fee was sufficient to cover most direct operating costs overall. However, our Waterdrop Medical Crowdfunding platform remains on a healthy growth trajectory as we aim to maintain its growth steadily and continue enhancing services while exploring monetization scenarios. We plan to provide premium fundraising services for more patients and build a robust health advocacy system for the public. Regarding our 2022 profit guidance, we initially set a target of achieving a non-GAAP profit for our established business by the end of this year. We've made good progress throughout our strategic transformation, witnessing improvements in our operational and financial performance. Our revenue has gradually stabilized, returning to a growth trend quarter-over-quarter. Since achieving an adjusted net profit in Q4 last year, we have consistently maintained profitability in each quarter of 2022. In Q3, our net profit reached RMB170 million on a GAAP basis. Despite external uncertainties, we have established a foundation for healthier and more solid growth. We anticipate maintaining profitability in Q4, targeting a net profit of around RMB500 million for the full year of 2022, surpassing our initial goals.

Operator, Operator

The next question comes from Thomas Wang with Goldman Sachs.

Thomas Wang, Analyst

I have a quick question about the increase in operating costs in the third quarter. Can you explain what is causing that increase?

Yang Guang, Co-Founder, Director and VP

The increase in operating costs was mainly driven by the recording of certain crowdfunding-related direct costs of RMB63 million, which were reclassified from marketing expenses as we began charging for crowdfunding services starting in April this year. Consequently, we have seen increased costs associated with providing these services, particularly customer service fees related to crowdfunding.

Operator, Operator

The next question comes from Susie Liu with Bank of America.

Unidentified Analyst, Analyst

This is Susie Liu from Bank of America Securities. My question is about future expansion strategy. We see that Waterdrop has already established a competitive advantage in Tier 3 cities or below, but which area are you focusing on? Going forward, are there any strategies to expand your business in Tier 1 and Tier 2 cities? Could you please share more details on your strategy?

Ran Wei, Partner and General Manager of the Insurance Marketplace

Okay. This is Ran Wei speaking. I'll talk about our expansion strategy into first and second-tier cities. Currently, over 80% of our users come from Tier 3 cities and below, which is consistent with our operation distribution. From the perspective of absolute user numbers, we have an edge in the industry even in Tier 1 and Tier 2 cities. We have four strategies for expansion. First, our online brokerage business is focused primarily on Tier 1 and Tier 2 cities. We provide diversified business models such as organization-based models along with AB patterns and agent models tailored to local conditions while launching the best systems to help brokers diagnose customer needs and provide appropriate insurance solutions. This enables us to cater specifically to middle-class families in those cities with more professional and objective services. Second, we will leverage our customer insights to enhance our product offerings and develop product lines that are more appealing to Tier 1 and Tier 2 city users. Third, we aim to address issues that are top concerns in targeted communities to improve customer acquisition, thus enhancing user experience and expanding our reach among businesses in Tier 1 and Tier 2 cities where recognition about insurance is already higher. Lastly, we are working closely with emerging white-collar workers and investing in promotional campaigns to enhance our brand visibility and reputation among customers in Tier 1 and Tier 2 cities. That's all. Thank you.

Operator, Operator

We are now approaching the end of the conference call. Thank you for your participation in today's conference. You may now disconnect. Have a good day.