111, Inc. Q2 FY2024 Earnings Call

Hello, everyone, and thank you for joining 111's Conference Call today. On the call today from the company are Dr. Gang Yu, Co-Founder and Executive Chairman; Mr. Junling Liu, Co-Founder, Chairman and CEO; Mr. Luke Chen, CFO of 111's Major Subsidiary; and Mr. Haihui Wang, COO. As a reminder, today's conference call is being broadcast live via webcast. The company's earnings press release was distributed earlier today and together with the earnings presentation are available on the company's IR website. Before the conference call gets started, let me remind you that this call may contain forward-looking statements made under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements are based upon management's current expectations and current market and operating conditions and relate to events that involve known and unknown risks, uncertainties and other factors, all of which would cause actual results to differ materially. For more information about these risks, please refer to the company's filing with the SEC. 111 does not undertake any obligation to update any forward-looking statements as a result of new information, future events or otherwise, except as required under applicable law. Please note that all numbers are in RMB and all comparisons refer to year-over-year comparisons, unless otherwise stated. Please also refer to the earnings press release for detailed information of the comparative financial performance on a year-over-year basis. With that, I will turn the call over to 111's CEO, Mr. Junling Liu.

Good morning, and good evening, everyone. Thank you for joining our second quarter 2024 earnings call. The information we will be discussing is also available in the slides posted earlier today on the company's website. I encourage you to download the presentation as well as the earnings report from our Investor Relations website at ir.111.com.cn. As for our performance in the quarter, we're pleased to report that we achieved operational profitability for the second consecutive quarter, which was driven by our ongoing improvements in operational efficiency that overcame challenges in the macroeconomic environment. In today's call, I will discuss the current macro environment, highlight the opportunities ahead, and present our key financial achievements. I will also cover how we are leveraging new technologies to enhance operations, recent patent milestones, and our efforts on the supply side. Finally, I will outline our future growth strategy before handing over to our CFO, Mr. Luke Chen, who will provide a detailed analysis of our financial performance. First, China's complex economic situation is impacting many industries, and healthcare is not immune. The challenging environment is prompting industry stakeholders to explore innovative models for retail development. Despite volatile conditions, there are positive trends in the healthcare industry that present valuable opportunities. The national anticorruption campaign in the healthcare sector initiated in mid-2023 is intensifying this year. Recent developments indicate a broader and more comprehensive approach with regulatory and ethical oversight now targeting an entire industry chain. We anticipate that this rigorous scrutiny will evolve into a long-term process for greater transparency and integrity in healthcare transactions, particularly in hospital procurement. A key outcome of this campaign is the acceleration of transitioning drug sales and prescriptions to retail pharmacies, which offer a more accessible and transparent alternative to the traditional hospital system. This shift is strongly encouraged by the state. Given our expertise in the out-of-hospital pharmaceutical markets, we're well-positioned to capitalize on the significant growth opportunities this shift brings over the long term, along with the expected continued expansion of retail pharmacy stores across China. By offering a comprehensive and cost-efficient product range, coupled with an unwavering commitment to customer experience, we aim to boost market share in this sector, where challenges and opportunities coexist. In parallel, the digital transformation of the healthcare value chain is continuing to gain momentum. The progress is supported by strong initiatives for the industry's high-quality development. In June, China's State Council issued key tasks for deepening medical and health system reform in 2024. The focus is on integrated development and the governance of medical insurance, healthcare, and pharmaceuticals, while highlighting the critical role of information technology and digitization in driving these reforms. As a leader in this digital revolution, we are dedicated to transforming the industry through our fully digitized operating system by providing both upstream and downstream customers with advanced digital technologies that will enable them to further cut operating costs and increase efficiency. Our cutting-edge digital solutions enhance every aspect of operations, from sales and procurement to customer demand analysis, product inventory management, and warehouse allocation. The meaningful progress we made earlier this year has persisted into Q2, underscoring our ongoing success in digitization. As aforementioned, even with these macroeconomic challenges, we generated profit from operations for two consecutive quarters, reflecting the effectiveness of our growth strategies and business model. In the second quarter, our income from operations reached RMB 3.3 million compared with a loss from operations of RMB 41.4 million a year ago. Non-GAAP income from operations was RMB 8.5 million compared with a non-GAAP loss from operations of RMB 17.2 million in the same quarter of last year. The profitability is primarily driven by ongoing improvements in operational efficiency, supported by consistent enhancements across nearly all business functions. In the second quarter, total operating expenses accounted for 6% of net revenues, a decrease of 120 basis points from the previous year, specifically making significant reductions in various expense categories. We've managed to cut fulfillment expenses to 2.6% of net revenues during the quarter, down from 2.7% a year earlier, reflecting a decrease in fulfillment costs by 7.3%. Our general and administrative expenses fell to 0.5% of net revenues from 1.1% a year ago. Selling expenses decreased to 2.3% as a percentage of net revenues from 2.6% in the previous year. Technology expenses were 0.5% of net revenues as well, down from 0.7% a year ago. Excluding share-based compensation, operating expenses as a percentage of net revenues dropped 70 basis points to 5.8%. Additionally, our operating cash flow remained positive for the second consecutive quarter. Our operational efficiency stems from strategic investments in infrastructure and optimal staffing allocation with a focus on key areas that drive long-term sustainable growth. Over the years, we've developed highly sophisticated digital capabilities that allow us to deliver exceptional value and performance to our customers while significantly reducing both technology and staffing expenses. We have always aimed to become the most efficient healthcare e-commerce operator in the industry. Despite our relatively small revenue, we've already achieved a level of operational efficiency that can compete against some of the more established players. We are committed to setting an industry benchmark for efficiency while maintaining and improving profitability. As we grow and refine our operations, we expect further reductions in operating costs, driving even higher efficiency. Our commitment to this goal is unwavering as we believe it will be a key competitive advantage and help us build a unique business model. We can also invest those savings from increased efficiency into other strategic areas such as innovation, market expansion, and customer engagement to support future growth. Next, let's move to how we adopted mobile technology approaches to drive significant improvements across various operational factors. Continuous technological advancement is a cornerstone of our strategy, enabling us to build a more resilient, efficient, and customer-centric business poised for greater returns in the future in the evolving healthcare e-commerce industry. First, we developed merchant bidding tools and an automated operating system and integrated a price index driven by big data to deliver intelligent merchant pricing. This has not only reinforced 111's value proposition of low costs but also enhanced procurement efficiency. Notably with our digital investment promotion platform and the billing subsidy campaign as the core operational strategies, the procurement conversion rate has risen to a historical high of over 32%. This has significantly improved customer satisfaction and long-term loyalty, which are crucial for sustainable growth. Second, our supply chain fulfillment has seen remarkable improvements in cost reduction and efficiency management through technology-driven enhancements. The optimization of algorithms has led to a notable 11% increase in overall efficiency in warehouse shelving and replenishment and the strategic adjustments in automatic grouping have reduced picking parts by 15%, further boosting outbound efficiency. Additionally, the implementation of a digital logistics network has cut last-mile delivery costs by over 5%, underscoring our commitment to operational excellence. Third, our application of AI in product matching has significantly elevated the accuracy and efficiency of our offering, not only in pharmaceutical products but also in medical devices and health supplement products. The creation of comprehensive databases and the development of sophisticated entity recognition and similarity models have doubled the matching rate. We are dedicated to consistently and continuously advance and upgrade our technological capabilities, which position us as an industry leader in operational efficiency, cost reduction, and customer satisfaction. We're pleased to announce the acquisition of four new patents, bringing our total to 28. Among these is the invention patent for a method for pricing human resource demand and personnel scheduling system, which offers accurate predictions and intelligent scheduling significantly enhancing HR management efficiency and supporting informed decision-making. Additionally, we secured a breakthrough patent for an adaptive anti-crawler method and a system based on information categories. This technology bolsters our data protection efforts, reducing the risk of breaches, lowering operational costs, and improving overall efficiency through automated cost measures. We also obtained two more invention patents, a drug retrieval method, and a system based on principal component spectral angle distance and a system for enhancing client load balancing based on URL grouping granularity. These digital technology innovations further improve our operational efficiency, reinforcing our pursuit of quality and growth. Collectively, these patents not only safeguard our intellectual property but also enhance our market competitiveness, providing robust technical support for our long-term growth and driving the digital transformation of the pharmaceutical industry. Furthermore, we continued to strengthen the supply side during the second quarter. First, our transshipment model, Kunpeng, has streamlined logistics and reduced transportation costs, delivering robust progress by consolidating shipments to one warehouse before intelligent distribution, significantly improving efficiency and lowering internal distribution costs. This also adds value to the external supply chain, showcasing our commitment to leveraging digital technology to empower the sector. Additionally, this approach is particularly cost-effective for penetrating remote regions of China, and we now offer this service to merchants for a separate fee. In the second quarter, we established a vertical network across five major fulfillment centers, East China, Central China, South China, North China, and Southwest China through a trunk-plus-branch delivery model. This is paving the way for a national Kunpeng pharmaceutical logistics network, ensuring efficient last-mile delivery in supply dense areas with full control of the supply chain. Kunpeng now operates 20 trunk transportation routes and first-mile warehousing services, servicing 72 external clients, up 105% from 37 in Q1. The network supports our business scale of over RMB 200 million and has achieved total cost savings of RMB 2.95 million to date. Kunpeng is transitioning from a cost center to a profit center, enabling external supply chains by providing professional pharmaceutical logistics and distribution services to upstream and downstream partners. This has helped clients reduce costs by 15% and also addresses industry pain points like mixed cargo handling, high damage rates, and inefficient acceptance processes with a 55% reduction in delivery damage rates. This improves our service quality and enhances our customer engagement, solidifying our role as a key enabler in the pharmaceutical supply chain. With the expansion of the Kunpeng logistics network and the last-mile delivery services, delivery expenses decreased. Combined with reduced warehouse labor and packaging material costs from improved efficiency and lower warehouse expenses, this resulted in a 7% year-over-year reduction in fulfillment costs to RMB 88 million in the second quarter. Moreover, to support future growth and advance our strategy for the nationwide Kunpeng logistics network, we plan to add two more JV fulfillment centers in the third quarter, bringing the total to 13. This expansion includes a second center in Wuhan and a new center in a city in the Northwest. We expect the expansion of our fulfillment centers will enhance our logistics network, improve service across diverse regions, reduce delivery times, and increase overall efficiency. Our supply side efforts are also demonstrated in our expanded cooperation. First, in the second quarter, we entered into a strategic direct supply partnership with comprehensive pharmaceutical enterprise, Beijing Scrianen Pharmaceutical, to enhance nationwide drug accessibility and distribution, particularly for Scrianen's flagship products like Scrianen folic acid tablets. The partnership builds on our existing collaboration since 2017, utilizing big data, digital marketing, and cloud services to help Scrianen's medications and pregnancy-related products reach a broader market more efficiently. Second, during a recent visit to ApicHope Pharmaceutical Co., we engaged in discussions with several pharmaceutical firms regarding various partnership opportunities, resulting in the formation of an alliance named 1Pharmacy. The objective of this alliance is to foster innovative collaboration and address market challenges through joint efforts. The partnership aims to build a comprehensive, high-level, and diversified network by focusing on products with distinctive features such as exclusivity, long-term commitments, traditional Chinese medicine, and insurance coverage. This initiative highlights 111's commitment to expanding its partnership network on a broader scale. Finally, let me dive into our strategies for growth in revenue, margin, and profit. Our core strategy is to provide a highly efficient, cost-effective, one-stop shopping experience that addresses customer needs and solidifies our competitive position. By harnessing data analytics and market research, we can fine-tune our product portfolio to match customers' preferences while prioritizing low prices through intelligent digital tools. Additionally, we will continue to strengthen our partnership network with pharmaceutical companies. By expanding cooperation, we plan to broaden our extensive medicine offerings on our digital technology empowered platform, driving shared growth through enhanced sales, especially in lower-tier cities. Our digital marketing network plays a pivotal role in this strategy, providing a robust platform to highlight our partners' products. Through focused marketing initiatives, we will enhance brand awareness and penetrate previously underserved markets. This strategic expansion of our partnership network not only benefits our pharmaceutical partners but also strengthens our position as a leading e-commerce platform in the pharmaceutical sector, which serves as a foundation for sustained long-term growth. As we drive higher sales volumes and optimize our product offerings, we will see a positive impact on our overall profitability. Another growth engine is our private label business, which generates pleasing results. Driven by increasing demand from customers, its revenue advanced 35% from the previous year in the first half. This line of business features three brands and offers customers a diverse range of products, whereas the company enjoys a healthy gross margin of 29%. This also raises our brand equity and builds customer trust. Moreover, we will expedite our investment in the JBP platform. This innovative model has been increasingly attracting new partners and significantly expanding our product lineup, highlighting its compelling value proposition and effectiveness in engaging various stakeholders. By improving the platform to better meet the needs of our partners and expanding its reach, we anticipate a broader and more diverse partner base leading to increased product offerings and sales opportunities. As we continue to refine and scale the platform, we believe it will strengthen our competitive position and become a critical catalyst for long-term growth and profitability. Operational efficiency is central to our strategy, and we are committed to investing in cutting-edge technologies to streamline processes, minimize waste, and elevate productivity. Our emphasis on AI innovations and digitization is crucial. By embedding AI and fully digitizing throughout our operations, we aim to generate even greater operational efficiency, enhanced customer engagement, and foster new products and services. We are confident these efforts will cement our market leadership as well as stimulate our growth opportunities. Digitization is important to our future and is driving our industry-leading operational efficiency. With our internal operating system being 100% digital, we've not only improved our financial performance but also established us as a transformative force reshaping the entire industry. Our technological ecosystem extends beyond our operations, providing both upstream and downstream customers with access to our advanced digital tools and expertise. Looking ahead, we believe our continued focus on digitization will maintain our competitive edge in the market, enabling us to achieve higher revenue and profit levels. With that, I will hand the call over to Mr. Luke Chen to walk through our financial results. Thank you.

Thank you, Junling, and good morning or evening, everyone. Moving to the financials, my prepared remarks will focus on a few key business and financial highlights. For details on our second quarter 2024 results, please refer to Slides 17 to 20 in Section 2 of our presentations. Again, our comparisons are year-over-year and all numbers are in RMB unless otherwise stated. Let's start with the second quarter results. Total net revenues were RMB 3.4 billion, and gross segment profit was RMB 207.6 million, relatively flat compared to the same quarter last year. Total operating expenses for the quarter decreased 18.1% to RMB 204.3 million, as a percentage of net revenue, total operating expenses for the quarter was down to 6%, down 7.2% as we continue to enhance our operating leverage and optimize our operational efficiency. Specifically, fulfillment expenses as a percentage of net revenue for the quarter were down to 2.6% from 2.7% in the same quarter of last year. Sales and marketing expenses as a percentage of net revenue for the quarter was 2.3%, down from 2.6% in the same quarter of last year. General and administrative expenses accounted for 0.5% of net revenues, down from 1.1% in the same quarter last year. Technology expenses amounted to 0.5% of net revenue, down from 0.7% in the same quarter of last year. As a result, income from operations was RMB 3.3 million compared to a loss from operations of RMB 41.4 million in the same quarter of last year. Non-GAAP income from operations was RMB 8.5 million compared to a non-GAAP loss from operations of RMB 17.2 million in the same quarter of last year. Non-GAAP net loss attributable to ordinary shareholders was RMB 8.8 million compared to RMB 33 million in the same quarter of last year. As a percentage of net revenue, non-GAAP net loss attributable to ordinary shareholders decreased to 0.3% in the quarter from 0.9% in the same quarter of last year. As you can see, we are improving our financial performance quarter-by-quarter and maintain operational profitability for the second consecutive quarter. Please refer to Slides 21 to 25 of the appendix section for selected financial statements. A quick note on our cash position as of June 30, 2024. We had cash and cash equivalents, restricted cash, and short-term investments of RMB 615.5 million. We are pleased to report positive operating cash flow for two consecutive quarters. As of the date of this earnings release, the company had a total outstanding amount of RMB 1.1 billion, which has been included in the balance of the redeemable non-controlling interest and accrued expenses and other current liabilities, according to a group of investors of 1Pharmacy technology pursuant to the equity investment made in 2020, as previously disclosed. As of the date of this earnings release, we have received redemption requests from certain of such investors for a total redemption amount of RMB 0.2 billion in accordance with the terms of their initial investment in 1Pharmacy technology. Furthermore, the company has entered into written agreements and/or commitment letters with investors representing the majority of the total recurring amount. We're continually negotiating with these investors to firm up the redemption request. This concludes our prepared remarks. Thank you. Operator, we are now ready to begin the Q&A session.

Your first question comes from Xipeng Feng with CICC.

This is Xipeng from CICC, and thank you for taking my questions. And congratulations on the company's progress. Well, I have two questions about financials. The first one is, I see that the OpEx ratio in the second quarter decreased compared to that of the second quarter in 2023. So what's your guidance on the expenses ratio in the long run? And my last question is, well, we noticed that the company achieved operating profit in the second quarter. So I just wonder, what's the drivers behind the results and what's your guidance for net profit for the year? Thanks.

Xipeng, yes, good to see you on the call. Thank you for the questions. So let me address the first question first with regards to the OpEx. Perhaps let me start with how we run a lean operation. First of all, we have an in-house developed operating system, which comprises dozens and dozens of other systems. It's 100% digital. At any given time and anywhere, the management can access real-time operations, whether it's sales in various regions or different types of customers, or categories of products, or allocation of tasks to the sales team, or fulfillment operations, etc. The whole operation is transparent and with real-time data available, we can make decisions and adjustments faster. With continuous optimization of operations, we achieved operational efficiency that can match some of the well-established designs in the industry. Remember, compared to those large players, we have the sales of hundreds of billions and our revenue was still relatively small at RMB 15 billion last year. With a bigger top line, we can further scale down our operational expenditure. We are very confident in that. Our estimate is that if we can run sales at a scale of RMB 20 billion or more, we should be able to operate under 5%. With regards to your second question, how we drove into profitability, it's really like what I've said, first of all, operational efficiency is our core competence and our principle is to provide customers with the richest selection with competitive prices and good services. Obviously, moving into the future, we will continue to invest to build a bigger supply base to ensure that our product assortment meets customers' needs. And of course, one of the cost strategies this year is that we're going to relentlessly pursue competitive prices. This will drive customer loyalty, generate more customers, and increase our average revenue per user (ARPU). Coupled with operational efficiency, we are really well-positioned to achieve our goal and sustain our profitability, at least for 2024 if the market conditions remain the same.

Thank you. Okay, that's very clear and short and thanks for the sharing.

Your next question comes from Zoe Bian with Citi.

Thank you for taking my question. This is Zoe from Citi. And I have three questions. The first one is, given that the offline pharmacy has an operating pressure this year. And I want to know, in case the overall customer demand is decreasing, how will we increase the penetration rate into the pharmacy clients? And the second question is, if your current strategy is still trying to improve profitability instead of revenue growth? And the third question is, how the retail price comparison policies affect 111's operation? Thank you.

Right, Zoe. If I understood your question correctly, you mentioned that offline pharmacies are facing pressure and asked about how we can enhance our penetration rate. Your second question was whether profit is the main focus for the company. Finally, you inquired about how we address price comparisons from the pharmacy's procurement team.

Yes.

Okay. If that being the questions, let me just address them one by one. First of all, we anticipate that in the short term, our end customers will experience some challenges and it will be hard to maintain the same-store sales as in the past. However, this presents a great opportunity for 111 to help those pharmacists to overcome the challenges. Indeed, our priority for 2024 will be focusing on profitability; in the meantime, we are optimizing our selection team to ensure that our offerings can meet our customers' demands. A lot of efforts have been made on the supply side, and we made tremendous progress on providing the richest selection for our customers to make it a one-stop shop. We believe that the shopping experience is crucial, especially for small to medium chains. And this way, we can continue to grow our wallet share. As for the price comparisons, we have always anticipated the fact that more and more customers are going to multiple platforms to compare prices before they place an order. This year, we've made low prices our overarching operational strategy. We always believe that the way to win the market is to offer the greatest selection at low prices. Let me also add, although the industry is under pressure, if you look around, this is one of the broad industries as more and more stores are opening. The recent data shows that the overall number of pharmacies has reached 700,000, last year it was still in the 500 range, right? This suggests that we're in the right industry. With more stores opening up, we have more opportunities to service them. And with the recent anti-corruption campaign going on, we also anticipate that the growth from hospital drug sales will peak, and more and more medicines will be sold through online and offline pharmacies in the long term, and that's where 111 is well-positioned to take advantage of.

Thank you.

Your next question comes from Jessie Lu with HSBC.

Thank you for taking my question. This is Jessie from HSBC, and congratulations on another solid quarter. I have two questions. The first one is on financials. We saw that the net cash generated by operating activity was nearly RMB 100 million in this quarter. So can you help us understand the key factors that contribute to this? The second question is on your Kunpeng logistics model. We saw that not only does it help the company reduce costs and improve efficiency, it also empowers the industry chain. Can management share more color and update on the development of the system? Thank you.

Jessie, this is Luke. Let me answer your first question. Yes, our business objective for the quarter was very clear: to turn to profit and achieve positive operating cash flow. So we have been very careful to improve our working capital, specifically our accounts payable turnover days and our inventory turnover days. If you compare our accounts receivable balance and inventory balance between June 30 and March end, you will see clearly that we made improvements. Additionally, we also introduced supply chain finance from third parties to our customers, mainly our pharmacy customers. So they are using third-party financing to make payments to us for the purchase of drugs. Now this creates a win-win situation: a win for the pharmacy, which gets financing to purchase necessary drugs, a win for this third-party financing institution, which gets customers; and a win for us as well, because we get immediate payment upon their purchase. Now moving forward, we will continue to pay particular attention to other working capital items, specifically the inventories, the turnovers, accounts receivable turnovers, as well as accounts payable turnovers. We are quite confident that we will continue to see positive operating cash flow and overall cash flow in the coming quarters.

Okay, let me address the question about the Kunpeng project. I want to explain how we started this project. Essentially, we optimized the allocation of our products across all our fulfillment centers. We currently have 13 fulfillment centers nationwide, so we need to place the right products in the appropriate centers to be closer to our customers and reduce transportation or fulfillment costs. This requires us to ship products between warehouses. Initially, we performed transshipments between our five major warehouses, but we found that relying on third-party logistics led to high costs and significant damage rates. Therefore, we established our own transshipment routes. This change resulted in a substantial decrease in costs and a 55% reduction in damage rates. We expect our routes among the major hub fulfillment centers to accommodate more clients. Currently, we serve over 70 clients with a scale of RMB 200 million, and we believe this business model will continue to thrive, benefiting more customers while saving them about 15% in costs.

Thank you.

Your next question comes from Robert Sassoon with Water Tower Research.

Hi, thanks for taking my questions. I have three actually, if I may. Let me start with the first question. Could you provide some more details on 111's plans for building new fulfillment centers in the second half of the year? How many new centers do you plan to add and where will they be located?

Okay. Robert, you want me to take your question first, okay, the fulfillment centers? Currently, we have already launched 11 fulfillment centers across the country. As you mentioned about our future plans, especially in the second half of the year, we will expedite our process of setting up those fulfillment centers through a new model—working with local partners to set up JV fulfillment centers and also franchise fulfillment centers. So far, besides the 11th fulfillment center we already have, there are seven new ones in the preopening process, including warehouse decoration, stock training, and system testing, as well as the inbound logistics process. These seven fulfillment centers are located in various provinces, including Guangdong, Shandong, Hebei, Xinjiang, Hubei, Hunan, and Chongqing, targeting to open from September to probably November or December. In the next three or four months, these seven fulfillment centers will be opened. Besides these seven, which are almost ready to launch, there are more new fulfillment centers in our pipeline, mostly in Northeast or Southwest of China. We believe that with the setup of these fulfillment standards, we will be able to provide a much better selection, better prices, and improved service level agreements (SLA) to our customers across the country, especially in the sub-tier cities.

Yes, thank you for those details. My second question is strengthening partnerships is one of the company's key growth strategies. So could you share some updates on new partnerships with pharmaceutical companies?

Yes. We have already set up a direct sourcing relationship with more than 400 pharmaceutical companies, bringing rapid growth to our central purchase business. I think your question is more than that; besides the simple buyer-seller model, we are building a full process to help lease pharmaceutical companies on their digital marketing capability. For example, we launched an ecosystem we call Telescope. This allows for prices and visualization of distribution status across a network of more than 20,000 pharmacies nationwide. Besides those distribution statuses, it also visualizes the dynamic consumer and sales data and also the sales price, which pharmaceutical companies would be very interested in. Also, there is market penetration analysis spanning 34 provinces and over 600 cities, providing year-over-year or month-over-month, week-over-week, and day-over-day overview of those sales data chains. With Telescope and other digital tools, we are confident to further strengthen our strategic partnerships with pharmaceutical companies on the transformation from traditional multi-tiered distribution to a digital marketing model.

Thank you. And I have a final question. Obviously, digital technology is at the core of your business model. So can you discuss the progress you've made in digital technology in the second quarter and particularly focused on the application of AI technology in your platform?

Okay. Thank you, Robert. Technology has always been our core confidence and we have made a significant investment in it, achieving quite some progress in various parts. Junling mentioned a few, and let me just discuss in a little bit more detail. The first one is about the bidding system. We have a merchant platform allowing merchants to bid, providing automated bidding with a price index for intelligent pricing, allowing optimization of their total mix of sales versus profit. We found that through this bidding system, the total conversion rate has improved from starting with 27-28% to now reaching a historical high of 32%. That's quite significant. We also use various optimization modeling algorithms to optimize our supply chain. Junling mentioned that we optimized the picking path and the order mixing for replenishment, shelving, and replenishment, reducing costs of picking by 15% and replenishment costs decreased by 11%. Also, let me mention about AI technology and how we apply it. A year ago, we launched data services on the Shanghai Data Exchange, which was medical data for medicine. We have extended that technology to non-pharmaceutical products. One is for our medical device database, and the other is for health supply database. We use AI technology heavily in the algorithm to increase the accuracy of product matching. In fact, we increased the matching rate and accuracy by 50%. Hope that answers your question.

Yes. Thank you very much. That's a lot of details. So I'll jump back on the line.

Your next question comes from an individual investor, Mike O'Neal.

I have two questions. First, how many new patents do you secure recently, how many patents does your company currently have in total? The second question is how many private label products does your company have on shelf, and will you focus on accelerating your private label business this year? Could you please provide more detail on how the company plans to achieve this? Thank you.

Yes. Let me answer the patent question. Junling mentioned that last quarter alone, we acquired about four patents. Now we have a total of 28 patents. Several of these patents relate to the application of AI technology. For example, we've developed voice recognition combined with large language models to improve our voice services, for our customer service and sales training. We also have a patent for photo-based drug retrieval; basically, taking a picture of the boxes, the system will immediately recognize which medicine it is using AI technology and our big data.

For your second question regarding the private label, we currently have about 200 private label SKUs registered and launched at 111. We have a couple of brands: Guan Zhao for our chain store customers and Huang RongYao, which is aimed at our individual stores. Additionally, we have products focused on battery supplements. These items have been well-received by our pharmacy clients and are sold in various pharmacies throughout the country, including remote areas like Xi Jin and Shenyang Province. We have more SKUs in development, covering OTC, RX, battery supplements, and medical devices. Private label products have become significant contributors to both margins and revenue. They also support our customers, primarily small and medium-sized stores or individual shops, that do not have the resources to create their own brands. Our brand, Guan Zhao, provides an attractive option for them to set themselves apart from competitors and larger key accounts. These private label products generate sustainable profit for 111 and our pharmacy clients, and they help build long-term relationships due to their exclusivity. We will continue to invest in this area as we see an increasing number of products in OTC, RX, and even Chinese medicine. Thank you.

In closing, on behalf of 111's Management team, we'd like to thank you for your interest and participation in today's call. If you require further information or have any interest in visiting 111 in Shanghai, China, please let the company know. Thank you for joining us on the call today. This concludes the call.