Earnings Call Transcript - YI Q3 2020

Monica Mu, Investor Relations Director

Hello, everyone, and thank you for joining us today for the 111 Third Quarter 2020 Conference Call. On the call today from 111 are Dr. Gang Yu, Co-Founder and Executive Chairman; Mr. Junling Liu, Co-Founder, Chairman and CEO; Mr. Luke Chen, CFO of our major subsidiary; Mr. Harvey Wang, Co-COO; Mr. Barry Zhu, Co-COO; Ms. Monica Mu, Investor Relations Director; and Mr. Alex Liu, Finance Director. As a reminder, today's conference call is being broadcast live via webcast. In addition, a replay will be available on our website following the call. The Company's earnings press release was distributed earlier today, and together with our earnings presentation, are available on the Company's IR website at ir.111.com.cn.

Junling Liu, Co-Founder, Chairman and CEO

Good morning and good evening everyone. Thank you for joining our 2020 third quarter earnings call. As the COVID-19 pandemic continues to make headlines globally, I'd like to start on this topic to provide some context to this call. As much of the world sees the resurgence of coronavirus cases and the continued economic downturn as a result, China has been one of the few bright spots with the pandemic successfully under control and the economy is starting to pick up. In addition to being something to be celebrated in its own right, the economic recovery in China has also created a positive environment for our operations. However, as a company and a country, we continue to stay vigilant for any new wave of infections. I want to thank the staff of 111 for their diligent dedication to meeting the needs of our customers and consumers, as well as all healthcare workers and the scientists for their unwavering determination in this long fight against the pandemic. Before diving into the numbers, I would like to provide a couple of corporate news updates. Firstly, Mr. Luke Chen, until recently CFO of 111, has been appointed CFO of Yao Fang Information Technology in Shanghai, the 111 subsidiary preparing for listing on the Shanghai Stock Exchange's STAR board. We thank Luke for his work in setting a strong financial foundation for 111 and believe that in his new position, he will guide Yao Fang towards a strong growth trajectory and successful IPO. In the meantime, in addition to my role as CEO, I will step in as acting CFO alongside Luke during the transition until a new CFO is appointed.

Luke Chen, CFO

Thank you, Junling. Moving to the financial section on Slide 12, you can see the details of the third quarter 2020 results from Slide 13 to 15 of our presentation. I would like to highlight a few key business and financial metrics, focusing on year-over-year comparisons. All numbers are in RMB unless otherwise stated. Our total net revenue for the quarter grew 113% to RMB2.36 billion, which exceeded the top end of our guidance range. Our B2B segment revenue grew 134% to RMB2.2 billion. Revenue contribution from E-Channel, which was previously disclosed as a separate segment, has been incorporated into the B2B segment this quarter. The strong growth in the B2B segment was attributed to robust performance from our existing customers, as well as newly added customers in our network.

Operator, Operator

Thank you, sir. We have the first question from the line of Sherry Yin. Please ask your question.

Sherry Yin, Analyst, JPMorgan

Thank you for taking my question. This is Sherry from JPMorgan. Congratulations on strong third quarter results. I have three questions today. My first question is about the business strategy updates. We saw many encouraging partnerships that 111 has established over the past few months. Could you give us a business strategy revisit, if any major change? My second question is specifically for Dr. Yu. We know that Dr. Yu was key management in Amazon's worldwide supply chain operation. As the market is recently turning a lot of attention to Amazon's big move into the online pharmacy industry, could you help us on this and the major difference between China and the U.S. online pharmacy market? And my last question is about last week's NNPA announcement of the online drug regulation change. Could you share more details about these regulatory updates and implications for 111's business operation and competitive landscape? That's all my questions. Thank you.

Junling Liu, Co-Founder, Chairman and CEO

Thank you, Sherry. I'll take on the first question and then let Yu continue. Regarding future strategy, first of all, I believe we will deliver well over $8 billion in revenue this year, and we will be very close to profitability. However, we still want to run this business as a startup. We have laid out our mission, which is to digitally connect medicine with patients and healthcare services. To accomplish that mission, I'd like to use three keywords. The first keyword I want to emphasize is digitization. I think everybody would agree that this industry is relatively backward in China regarding digitization. We have been investing heavily in our doctor-patient interaction platform so that we can move doctors and patients to the digital world. We're also digitally tracking the entire value chain from the point when the drug leaves the factory all the way to the patients. It's also impressive to realize how much enthusiasm there is for digital marketing, including patient education, doctor education, and pharmacist education, etc. I couldn't have imagined that a live cast from two of our internal staff on our app could generate over RMB10 million in sales within two hours. The next keyword I want to mention is infrastructure. Essentially, we are laying the groundwork for the next generation of healthcare delivery in China. We can reach consumers directly through our 300,000 plus pharmacy network, as well as through doctors. This can be understood as B2C, B2B2C, and B2D2C using our supply chain, cloud-based solutions, and big data, all part of this infrastructure. The third keyword I'd like to use is commercialization. Our view of the future is that pharmaceutical and biotech companies are going to face tough competition with the BVP implementation. The majority of pharmaceutical companies will focus on innovative drugs. As we all know, there have been many new biotech companies listed recently on the Hong Kong and Shanghai Stock Exchanges. I don't think it will take long before most of these newly listed companies face challenges in commercialization unless their drugs get approved. This is an area where we have been investing heavily. Our omni-channel commercialization platform will be in a great position to assist them. To recap, the three keywords are digitization, infrastructure, and commercialization. This is the strategy we are implementing, and those are the areas we are investing in. So, I'll pass on the next questions to Dr. Yu.

Dr. Gang Yu, Co-Founder and Executive Chairman

Thanks, Sherry, for asking the question. Let me address your second question regarding Amazon's recent launch of their online drug store sales. I think Amazon started this in early 2003 and 2004 when I was part of the company, specifically a product company called Drugstore.com. However, during these many years, this category has not developed as quickly as other categories. In China, acceptance in online doctor consultations and online drug purchases is more aggressive for several reasons. One reason is the widespread penetration of mobile devices and a growing number of online e-commerce customers; we are certainly in a vibrant market. Additionally, the Chinese government's policies are more favorable. As you know, a recent policy allows online prescription drug sales and expands coverage for online consultations by medical insurance, encouraging online healthcare. This has all facilitated the growth of China's online health industry. Regarding your third question about last week's new...

Junling Liu, Co-Founder, Chairman and CEO

Third question.

Dr. Gang Yu, Co-Founder and Executive Chairman

The third question, right. It mainly concerns retention of feedback. In fact, we participated in the whole discussion with the Chinese government and provided our feedback. I consider this a very positive development for the entire industry and certainly very positive for us. The overall direction of the policies will be more open to online healthcare and will involve more rigorous scientific monitoring, management, and quality control. Certainly, these policies will allow compliant, transparent companies with higher efficiency to thrive. I believe we are in a great industry to participate in, and we feel that all these new policies and changes are very beneficial to us.

Sherry Yin, Analyst, JPMorgan

Yes. That's very clear and helpful. Thank you.

Operator, Operator

We have the next question from the line of Bingyu Chen. Please ask your question.

Bingyu Chen, Analyst

Thanks for taking my questions, and congratulations on these results. I actually have several questions. First of all, we have seen that the B2C segment is developing rapidly. Can you share the reasons behind this growth and how you plan to maintain that momentum? Secondly, regarding profits, we see an increase in the gross margin in the B2B segment, but fulfillment costs are also rising. Could you let us know how you've managed to achieve that? Lastly, can you share more details about the increased number of orders? Thanks.

Harvey Wang, Co-COO

Okay. This is Harvey. I will take these three questions regarding B2B growth, B2B margin, and order volume increase. First, our B2B customer base has exceeded 300,000, representing about 60% of our total market in China. Additionally, revenue from our existing customers is also increasing rapidly. The growth is primarily driven by our strength and capability in digital marketing. For example, we offer a comprehensive solution to pharmaceutical companies to commercialize their drugs through our digital marketing tools. We also enable our B2B customers with cloud-based digital services, such as cloud pharmacy services, cloud clinic, cloud inventory, and cloud CRM. Internally, we have also developed two tools, one called Hawkeye and the other called Turbo, to utilize big data and Internet technology to establish mechanisms for our sales force, allowing them to acquire more customers, activate existing customers, and improve overall business operations, particularly in lower-tier cities which contribute significantly to our B2B business. These digital marketing technologies and tools enhance our sales force efficiency. Regarding the margin side, there are three reasons why we maintain a good margin trend while also achieving three-digit growth. First, as Junling just mentioned, we are increasingly sourcing directly from pharmaceutical companies. Second, we launched our Price Intelligence System (PIS) to build a smart pricing mechanism that improves profits without negatively impacting sales growth and expansion. Third, we also introduced more higher-margin SKUs in the past quarter, which helps pharmaceutical companies promote the sales of these SKUs through our digital marketing platform, simultaneously boosting margins. Lastly, concerning the increase in B2B order volume, we experienced a significant rise in order volume due to expanding our SKU selection through our new supply chain model, which has grown vastly. We believe SKU selection is essential for customer experience, and through continuous innovation in our supply chain technology and network, we've improved operational efficiency and lowered fulfillment costs to 2.5%, as Luke highlighted. We've passed on savings on fulfillment costs to our customers by lowering the free shipping threshold, which has improved customer buying frequency, order volume, and ARPU, ultimately increasing net revenue. Is that clear, or do you have any other follow-up questions?

Bingyu Chen, Analyst

Yes. It's very clear, and thank you for your answer. I have no further questions. Thanks.

Harvey Wang, Co-COO

Thank you.

Operator, Operator

We have the next question from the line of Rachel Yang. Please ask your questions.

Rachel Yang, Analyst, HSBC

Okay, thank you. Hi, first congratulations on such a strong third-quarter result. This is Rachel from HSBC. I actually have four questions. The first one is on your digital healthcare platform. Could you share the recent progress and achievements of that platform, and what's the plan for next year? Because the online medication market is quite competitive nowadays with many internet giants entering, how do you think your technology or facilities could differentiate you from those giants? This is my first question regarding the digital platform. My second question is about your cloud services. What do you offer, and do you charge standalone pharmacies for the cloud services you provide? My third question is about your logistics systems. We read from the PPT that you have a logistics system that covers all provinces and that you have the capability for 24-hour delivery in over 300 cities. How does that compare with other online medication players? Lastly, on the financial front, we know that we are already cash flow positive and we anticipate reaching a total top line of RMB10 billion next year. How far do you think we are from financial break-even? These are my four questions.

Junling Liu, Co-Founder, Chairman and CEO

Thank you. I'll take the first question then. If I understood correctly, you are asking about our digital solutions, right? At the heart of our digital platform is the doctor-patient interaction platform. Additionally, we also digitally track the drug flow from factory to patients. In the past, many transactions occurred offline. Over the last few years, we have built capabilities in digital marketing and have seen tremendous progress. Our smart sourcing significantly assists pharmacies when placing orders. In the past, they would use paper to piece together what SKUs they needed to replenish, taking half a day to call different suppliers. With our digital tools, they can complete their procurement in five minutes instead of half a day. Of course, one of our best successes in the industry is our Patient Care Program, which includes D plus one, D plus seven, T minus seven, and T minus ten follow-ups. Let me quickly go through that: For instance, on the diagnosis day, assuming the patient is prescribed medication, we send educational materials related to the disease on day one. On day seven, we emphasize the importance of following the doctor's prescription. For T minus, our system will automatically send reminders for refills. Should there still be no refill occurring by T minus zero, our pharmacists will follow up with a phone call to determine the status. We also take great pride in the digital marketing we conduct for pharmaceutical companies, especially regarding patient, doctor, and pharmacist education. We have created a matrix of high-traffic media assets in China, and during a recent diabetes education program sponsored by Eli Lilly, we had over 5 million users participate during the live session, with a total viewership exceeding 10 million. This significant reach demonstrates our advantage compared to traditional methods. We plan to leverage this capability fully going forward. I'm not sure who should take the next question.

Dr. Gang Yu, Co-Founder and Executive Chairman

Let me answer the question on cloud services. We provide cloud service systems that persist throughout the ecosystem, including doctors, pharmacies, pharmaceutical companies, insurance companies, etc. For example, we help pharmacies establish online presences, which significantly increases their reach. We also help convert pharmacies into clinical ones, enabling them to receive prescriptions to fill orders. Moreover, we provide online inventory systems to ensure product availability, as well as cloud CRM to help pharmacies manage customer relationships and retention. Our customer satisfaction currently stands at 99%, and we're proud of the feedback we've received regarding on-time delivery, selection, pricing, and overall service quality. These metrics guide our focus.

Luke Chen, CFO

This is Luke. Let me address the questions about financial performance, cash position, and our break-even point. We are excited about our achievements in the third quarter, particularly regarding our cash position. As of September 30, 2020, we had a total cash balance of RMB1.2 billion and have achieved positive cash flow from operating activities for the quarter and for the year-to-date period. We believe this trend will continue, generating positive cash flow in future quarters. As for the break-even point, we won't provide guidance at this stage, as we are still in investment and expansion mode. We aim to avoid missing growth opportunities due to overly cautious investment strategies. That said, we believe that the strong top line growth and improved margin profile, alongside operating efficiency, will allow us to further reduce net losses as a percentage of net revenue and lead us to profitability in the foreseeable future.

Rachel Yang, Analyst, HSBC

Thank you, Gang Yu and Luke. Just a small follow-up on the delivery system. Can you share how your capabilities compare with other online medication players?

Dr. Gang Yu, Co-Founder and Executive Chairman

I believed I answered that question. We consider ourselves very efficient, covering over 80% of our customers with timely deliveries, utilizing our strong fulfillment abilities. We maintain the lowest fulfillment costs in our industry, and we are continuously optimizing our entire supply chain while prioritizing customer experience.

Rachel Yang, Analyst, HSBC

Okay, thank you for the clarification. I have no more questions.

Operator, Operator

We have the next question from the line of Xipeng Feng. Please ask your question.

Xipeng Feng, Analyst

Thank you for the question, and congratulations on the corporate progress. I have just one quick question. I've noticed that many well-known pharmaceutical companies have entered into collaborations. Have you established any strategic partnerships with 111 this quarter? Are those collaborations extending beyond drug procurement into areas like Big Data, digital marketing, and brand building? What advantages does 111 provide to pharmaceutical companies interested in working with you?

Junling Liu, Co-Founder, Chairman and CEO

That's a great question. Certainly, we have enjoyed an increased number of strategic partnerships with top global pharmaceutical companies. The main reasons for this include our scale as a U.S. public company that adheres to high compliance standards and transparency, as well as our highly efficient supply chain, broad coverage, and deep penetration. Additionally, we possess unique capabilities in omni-channel drug commercialization and have demonstrated our commitment to innovation in the digital space. These factors make 111 a preferred partner among many pharmaceutical companies.

Xipeng Feng, Analyst

That's very helpful. Congratulations again on the great progress for the Company. Thanks.

Operator, Operator

We have the next question from the line of Horace Cheng. Please ask your question.

Horace Cheng, Analyst, IDEATE Investments

Hi, congratulations on the great results. I have three questions for the team. The first question is the key differences between 111 and JD Health and Ali Health, particularly regarding the B2B side. Secondly, your non-GAAP net loss has continued to narrow. Is this trend sustainable, and can you elaborate on your gross margin outlook? Lastly, could you share some progress on the listing on the STAR Board? Thank you.

Junling Liu, Co-Founder, Chairman and CEO

Thanks, I will take the first question. The differences between 111 and JD Health as well as Ali Health are quite significant. Our positioning is different from Ali Health and JD Health. JD is calling their business JD Health, and Ali refers to theirs as Ali Health, while we are focused primarily on drugs. They are more consumer health-oriented. We are very specific in our positioning, as we can't compete with their massive traffic scales. We concentrate on drug commercialization, and our business model and digital solutions provide greater value to pharmaceutical companies. Additionally, there's no one in the industry with the B2C and B2B infrastructure that we possess. As for JD's B2B model, we haven't seen much impact in that area. Still, they mainly utilize the marketplace strategy to provide value to pharmacies, whereas we function as a first-party business, presenting a better customer experience and unique infrastructure. This is our competitive advantage, which we aim to fully exploit. I'll pass the gross margin question to Luke.

Luke Chen, CFO

We are confident that we will continue to narrow our losses and achieve profitability, which is sustainable. We expect to maintain triple-digit growth as scale is imperative. With that, we will establish direct partnerships with pharmaceutical companies. We're not only generating revenue from product sales but also from services. During the upcoming quarters, we have improved our margin profile from 1.4% to 2.6%, and we see the possibility of gross margins reaching up to 5% or even 8% through better product mix and a focus on high-margin products. We see substantial room for improvement in our gross margin profile. Along with improving operational leverage and efficiency, we anticipate that our net loss percentage of net revenue will continue to decrease, bringing us closer to our break-even point. Concerning the listing plans of our subsidiary in China, we are progressing according to schedule, and we will disclose information as required by SEC rules.

Horace Cheng, Analyst, IDEATE Investments

Yes, thank you very much.

Operator, Operator

We have the next question from the line of Chen Gu. Please ask your question.

Chen Gu, Analyst

Yes, can you explain why there's been a slight decrease in both revenue and margins in the B2C segment? Is margin correlated to volume such that as volume decreases, profit margins decline as well? Thank you.

Junling Liu, Co-Founder, Chairman and CEO

As I mentioned in my remarks, it was a conscious decision to invest in better infrastructure to deliver long-term value for our business. We are confident we'll return to a growth trajectory soon. As for margins, while there was a documented decline, it remains above 20%, which is within a reasonable range when compared to other B2B platforms. We're comfortable with that percentage, and moving forward, we expect improvements in both top line and gross margin.

Chen Gu, Analyst

Can you elaborate on your infrastructure investments? Is this a response to heightened competition from giants like JD or Ali? What changes have you implemented?

Junling Liu, Co-Founder, Chairman and CEO

It's clear that we won't compete against the major traffic players; instead, we must carve out a unique space. Therefore, we are investing in infrastructure, such as the patient buffer interaction platform, to acquire customers more efficiently. We're also creating virtual clinics for doctors and collaborating with pharmaceutical companies to introduce new drugs through our digital platform. This strategic approach is crucial as we believe it will foster sustainable growth both top and bottom line.

Chen Gu, Analyst

If I were a pharmaceutical company looking to educate and interact with patients, I might choose a platform with more substantial traffic like JD or Ali, where I can access a larger audience than what you're currently offering. How do you respond to that?

Luke Chen, CFO

I can answer that quickly. Over 70% of our sales are from prescription drugs, emphasizing our commitment to professional and prescription products rather than merely health awareness items. This differentiation is another reason why pharmaceutical companies choose to partner with us, as we've also launched specialized hospitals for conditions like diabetes and skin diseases.

Chen Gu, Analyst

Thank you.

Operator, Operator

We have the next question from the line of Sheng Hui. Please ask your question.

Sheng Hui, Analyst

Yes, good evening. Thanks for taking the question. It's great that you reached nearly 60% of all pharmacies in China, but it looks like sales to each pharmacy average around RMB8,000. My question is how much further do you think you can go regarding sales to the average pharmacy?

Junling Liu, Co-Founder, Chairman and CEO

Although we are covering 60% of the market, there's still significant room for growth. Each year, the pharmacy market size is much larger than our current volume. We believe we have substantial opportunities to grow our business while also improving our gross profit. The ARPU, or average revenue per user, has been increasing quarter-over-quarter.

Luke Chen, CFO

It's noteworthy that our penetration remains low concerning wallet share. We can certainly maintain strong growth for a longer period.

Operator, Operator

I think we're already wrapping up...

Junling Liu, Co-Founder, Chairman and CEO

At this time, I'd like to hand the call back to Monica for any closing remarks.

Monica Mu, Investor Relations Director

Thank you, operator. In closing, on behalf of the entire 111 management team, we'd like to thank you for your interest and participation in this call. If you require any further information, please email us, and thank you for joining us today. This concludes the call.

Operator, Operator

Thank you, ma'am. Ladies and gentlemen, that does conclude the conference for today. Thank you for participating. You may all disconnect.