111, Inc. (NASDAQ:YI) Q3 2022 Earnings Call Transcript

111, Inc. (NASDAQ:YI) Q3 2022 Earnings Call Transcript December 1, 2022

Operator: 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; Mr. Harvey Wang, COO; and Ms. Monica Mu, Investor Relations Director. As a reminder, today’s conference call is being broadcast live via webcast. The company’s earnings press release was distributed earlier today, together with the earnings presentation, are available on the website at edge.media-server.com/mmc/p/kpnswevm. Before the conference call get started, let me remind you all 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 filings 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.

Junling Liu: Good morning, and good evening. Thank you for joining our Q3 2022 earnings call. What we’ll be discussing here is also provided in the slides posted earlier today on the company’s website. I encourage you to download the presentation, along with the earnings report at ir.111.com.cn. In today’s call, I will add some color to some of the latest regulatory developments in the healthcare industry and the latest development in COVID policies and how the company rose to the challenges and opportunities. I’ll also cover our strategies for building growth momentum, improving operational efficiency and strengthening supply chain capabilities. Then Mr. Luke Chen will walk you through our financial results. COVID zero restriction policies in China continue to create tremendous challenges to our business in Q3.

More and more cities are experiencing the rising numbers of infected people and consequently, the number of cities that had lockdown increased significantly. The supply chain in general was severely disrupted and the transportation and other logistics were tightly regulated in epidemic hit areas. Our biggest challenge was to deliver the goods to our customers and the replenished stock in time. I’m proud to report that our team truly stood out in dealing with those unprecedented challenges, they literally have to move mountains to fulfill badly needed medicine for our customers and patients. Our online and offline digital platform proved to be highly effective in dealing with the pandemic. We spared no efforts in meeting patients’ demand in epidemic hit cities for medical consultation and drugs.

We have provided free online consultations for customers in over 370 cities and provided over 3,000 medicinal products covering more than 400 diseases in the last few months. Since the beginning of the COVID-19 pandemic, our online hospital 1 Clinic has been offering free online medical consultation services. Recently, we also provided government approved a dedicated delivery fleet for medical products for some provinces hit by the pandemic. Even with the approval, the fleet had to overcome cross-provincial logistic challenges due to different control policies to deliver drugs to patients staying in mobile field hospitals, quarantine hotels and other facilities. The last few weeks saw the number of infected people in quite a few provinces is rising sharply and a lockdown followed.

A few of our fulfillment centers are under lockdown right now, which is very disruptive to our business. We believe that COVID-19 will continue to create challenges to us in the near future, but I have very strong faith in our team and believe we will be able to serve customers with our utmost effort as we have done in the last few quarters. Please allow me to take a moment to brief you the latest regulatory developments. As you know, China just finished its 20th National Congress of the communist party in October. One of the very important themes is its focus on construction of a healthy China, which includes enhancing managements of major chronic diseases and boosting preliminary disease control capabilities and improving treatment and health management.

Opening remarks from the 20th National Party Congress provided us a broad direction on where China’s health care industry may be heading over the next few years. The following initiatives will create great regulatory tailwinds for the industry. One, encouraging innovation. The government is supportive of domestic innovation with the intention to bring in newer and better therapies to China and the world. The initiative will provide a better environment to allow China to act as a global innovation hub in the space of innovation drugs. This will mean that there will be more opportunities for 111 to launch and commercialize new drugs with its integrated digital platform. Two, strengthening infrastructure for preventative, chronic and infectious diseases.

Importance of early diagnosis, early treatment and early rehabilitation was stressed from the remarks. The government pledged an increase in funding for routine health screening, chronic disease management, infectious disease control and mental disease treatment. We anticipate the digital technologies can play a key role in the areas of disease prevention, chronic disease management and the containment of infectious diseases. Three, revitalizing TCM or Traditional Chinese Medicine. In recent years, the government has set TCM as a strategic priority and has issued plenty of supportive policies, including relatively less price cut compared to other types of drugs in the government run VBP, where many drugs had to drop prices sharply, not to mention encouraging modernization and practicing of TCM.

Significant efforts have also been made to promote the standardization of Rx TCM granules, which should improve safety and efficacy as market penetration increases. The policy is already having an effect in the market as we have seen a gradual pickup in our sales of TCM. Four, focusing more on the youth and elderly care. With the birth rate falling for the 5th year in a row in 2021, the government implemented policies to boost the birth rate such as the third child policy, tax deductions, longer maternity leave, enhanced the medical insurance, housing subsidies and additional financial support for the third child. I’m happy to report that some of our private label products are specifically targeting infants and children. As we broaden our portfolio, we should have a range of products for use and elderly.

In addition, the State Council announced 20 prevention and control measures to further optimize the COVID-19 response, under which China will roll out and implement precise, reasonable and efficient epidemic control measures for public needs. Although it’s early days, and there have been various implementation approaches in different provinces and cities and even obvious deviation from the announced control measures are taking place, we see this as a very positive move. In fact, yesterday, we saw media coating senior officials that with the decreasing toxicity of the Omicron variant, the increasing vaccination rate and the accumulating experience of outbreak control and prevention, China’s pandemic containment faces new stage and mission. This potentially indicates an adjustment of the current COVID measures.

One of the major capital cities, Guangzhou was saying yesterday that the city has adjusted the designation of risk levels and pandemic containment measures to a varying extent in all its 11 districts. We very much welcome the new development in the fight against COVID-19 and look forward to the time when the pandemic is behind China where business can operate as usual. Despite the economic downturn and material adverse impact on the offline retail sector in general in the third quarter, we managed moderate growth in revenue and a solid growth in gross margin. Our net revenue for third quarter increased by 0.1% year-over-year to RMB 3.3 billion, while our gross segment profit increased by 22% year-over-year. Our efforts to improve our margin profile continued to deliver positive results during the quarter.

Our overall gross segment margin as a percentage of net revenues improved to 6% from 5% in the same quarter of last year. Given the circumstances, this hard-burnt margin growth is quite an accomplishment. This achievement came from optimized product assortment and the smart pricing, as well as improved team efficiency and technical capabilities. Our B2B business remains the key contributor of our revenue growth, which reached RMB 3.25 billion. Gross profit of our B2B segment rose to RMB 180 million, an increase of 27% year-over-year. B2B segment margin improved to 5.5% from 4.4% in the same quarter of last year. We also improved the B2C segment margin to 22.4% from 19.7% in the same quarter last year. We will continue reducing procurement costs as well as optimizing our product assortment and structure.

We were able to leverage our digital capabilities to deliver more value-added services to our partners. The market continues to show strong demand for our diverse service offerings. Our value-added services include marketplace vendor services, digital marketing, supply chain management, online medical consultation, e-prescription services, patient education, drug commercialization tools, et cetera. Even during the pandemic, our service revenue reached RMB 32.57 million, representing a growth of 34% over the same quarter of last year. As our business continues to expand and as we position ourselves as an effective commercialization partner, we will continue to offer value-added services to pharmacies and pharmaceutical companies. In addition, we continued to enhance our operational efficiency.

And as a result, total operating expenses as a percentage of net revenues decreased to 8.4% in this quarter from 10.2% in the same quarter last year. Sales and marketing expenses were down to 3.2% from 3.9%. General and administrative expenses were down to 1.4% from 1.6% and technology expenses were down to 0.9% from 1.7% in the same quarter last year. We expect this momentum to continue as we scale while we continue to focus on delivering superior services to our customers. Although the current macroeconomic environment has resulted in challenges to our business, we’re still committed to executing our strategy to continue to grow our revenue and gross margin. I’m pleased to report that our non-GAAP loss from operations was narrowed to 1.5% of net revenues as compared to 4.1% in the same quarter last year.

We’re getting closer and closer to profitability. We’re also pleased to see that our operating cash flow and overall cash flow were in the black for the quarter, which is a major milestone of our business. As of Q2 2022, 111’s virtual pharmacy network reached approximately 413,000 pharmacies, covering more than 70% of the total number of pharmacies in China. As of September, our cold-chain service has deployed in over 270 cities, over 80% of which can complete orders within 48 hours. This capability has provided convenience for rural consumers in particular. In order to continuously improve gross profit, we have carried out a platinum product program. At present more than 400 pharmaceutical companies and over 1,000 SKUs have become part of this program.

The revenue of B2B high-margin products in this quarter has increased by 15% year-on-year and contributed 0.9% increase to the overall B2B gross profit. I’m pleased to update the progress we have made on our private label initiative. As our network of pharmacies continues to grow and it’s time we should introduce some private label products. Not only will this help our pharmacy customers to improve their gross margin, but this helps with our own margin as well. We partnered with some pharmaceutical manufacturers to build a suite of products, which include medicines, health supplements, medical devices, et cetera. So far, we have already developed three brands, which are and over 90 SKUs launched or already in production schedule, targeting specific market segments.

Although this part of the business is still at its infant stage and no conclusions can be drawn yet, we believe these proprietary products will significantly increase our gross profit and enhance downstream customer stickiness. As we deepen our relationship with upstream pharmaceutical companies, we were able to help them to improve their digital marketing efficiency and drug commercialization efforts. Now let me provide a couple of examples. Since the recent launch in China by of its innovative drug, which successfully completed clinical trials in China and abroad and is China’s only approved targeted oral drug for atomic Atopic dermatitis for teenagers. We actively participated in the launch of the medicine, leveraging our patient management platform, we now offer a full life cycle closed-loop services for the drug, covering online plus offline consultation and post-diagnosis consultation and refuel service, which effectively help patients control disease progression.

In addition, we’ll help patients improve medication compliance and effectively reduce profile rates. We also provided full-time caring medical professionals to respond to patients’ questions online in a timely manner. Within the span of one month, we have served patients in 16 provinces. Also in November, Hua Medicine rolled out dorzagliatin a first-in-class glucokinase activator in China, providing type 2 diabetes patients with a new treatment option. With a strategic partner in its national rollout of the drug, leveraging our advantages in the smart supply chain capabilities and digital platform, we were able to assist our medicine in its launch of the drug across all channels. We have also enhanced the accessibility of the new drug through reservation registration by medical professionals and a full life cycle patient management, thus providing more patients with convenience to access new therapeutic treatments.

The launch was so successful that inventory was depleted so fast that Hua Medicine is scrambling to increase its capacity of manufacturing to cope with the supply shortage. Looking ahead, we will continue to pursue the enormous market opportunities from the digital transformation of the health care market in China, which given the country’s mass population provides us with opportunity to connect millions of people in lower-tier cities via our direct B2C platform and our broad network of pharmacies. In order to bridge the gap in consumer access, we will focus on strengthening every facet of our S2B2C model and advancing our strategic plan to expedite business expansion. On the infrastructure side, we’ll keep improving the AI and data processing capability of our technology, asking its power to handle higher volumes with greater predictive ability.

Our technology platform today can access point of sales data of over 10,000 pharmacies for those SKUs we are commercializing. We believe this network of pharmacies and the number of SKUs will commercialize will grow at a fast pace in the near future. With this, we will be able to provide retail pharmacies greater control and cost efficiency to drive their store sales growth and at the same time, further deepen the share of wallet among our existing retail pharmacy customers. The platform’s enhanced capability will also allow us to virtually deploy more digital modules and features which will connect more upstream suppliers and result in better sales and the margins for our pharmacy customers. On the supply side, the services we provide to pharmaceutical companies in support of their commercialization efforts help deepen our relationships with them allowing us to source an even wider selection of medications and health-related products for our pharmacy customers and a benefit in consumers.

This commercialization services also represents a major growth opportunity for us. Globally and in China, medical innovations have been happening at an unprecedented rate. As more and more new medications and devices come on to the market, competition becomes increasingly intense. 111’s support during our product launch can improve our company’s market position and increase the likelihood of a successful launch. Ultimately, our integrated online and offline platform is a win-win for all. As we help to transform the health care system for the better, we believe that there are significant opportunities for us in the age of industrial Internet to expedite the digital transformation of health care system in China. We will work relentlessly to strengthen this model and pursue growth opportunities post COVID-19.

Operationally, our priorities will be delivering revenue and margin growth, strengthening supply network and reduced procurement costs, continuing to improve operational efficiency, optimizing fulfillment cost and broadening our service offerings. We have come a long way since our IPO in 2018. From a new kid in the block 4 years ago, we have now established ourselves as one of the major players in the digital health care service industry. As we continue to expand the coverage of pharmacies and broadening our drug supplier’s network, plus our advanced digital capabilities with supply chain infrastructure, we’re uniquely positioned to create value for all our partners in the value chain. 111 was certified by the Chinese Ministry of Science and Technology as a National High-tech enterprise again.

We were also recently awarded the prize of National E-commerce Demonstration Enterprise by the China Ministry of Commerce. Our remote consultation and chronic disease prescription refill service platform has also been selected as a case study in digital solutions for economic control and production resumption by the Shanghai Pudong New Area, Science and Technology Commission. We’re very proud that our efforts have earned us such distinction and are committed to continuous innovation and implementation. Moreover, we have received critical claim from local governments, hospital specialists and patients for our online hospital services and a continued support for Tibetans living in Gansu City Sichuan province for hydatid disease control. All the ESG efforts carry our core values, and we will firmly fulfill our social responsibilities as we have done in the past.

We wish to thank all the investors who have supported us all along. I will now hand the call to Mr. Luke Chen to walk through our financial results. Thank you.

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Luke Chen: Thank you, Junling. Good morning or evening, everyone. Moving to the financials. My prepared remarks were focus on a few key business and financial highlights. You can refer to the details of the third quarter 2022 results from Slide 11 to 14 in Section 2 of our presentation. Again, our comparisons are year-over-year and our numbers are in RMB unless otherwise stated. Let’s start with the third quarter results. Third quarter has been very challenging for our business due to negative impact from COVID lockdowns in many cities and province. We have tried our very best to work with local governments, as well as logistic companies to fulfill our customer patient orders as these medicines are badly needed. Total net revenues for the quarter grew 0.1% to RMB 3.35 billion, and the total gross profit for the quarter grew at 22% to RMB 202 million and the gross margin improved from 5% to 6%.

B2B segment was the major contributor for total gross profit and margin improvement. B2B segment revenue grew at 0.8% to RMB 3.25 billion, while gross segment profit for B2B increased by 27%, with gross segment margin up from 4.4% to 5.5%. This was attributable to our optimization of selection portfolio and competitive pricing. We had also focused on our sales on higher margin products and launched private label products with much better margin. Our B2C segment revenue decreased 20% to RMB 100 million, with gross segment margin improved from 19.7% to 22.4%. Total operating expenses for the quarter were down 17% to RMB 283 million. As a percentage of net revenue, total operating expenses for the quarter were down to 8.4% from 10.2%, which reflected continuous improvement in our operational efficiency.

Fulfillment expenses as a percentage of net revenue for the quarter was around 3%, comparable to the same quarter last year. Sales and marketing expenses were RMB 108 million, representing a decrease of 18% year-over-year. As a percentage of net revenues, sales and marketing expenses for the quarter was 3.2%, down from 3.9% in the same quarter of last year. We believe this trend will continue as we further build up our scale and improve our sales team efficiency. General administrative expenses were RMB 46 million, representing a decrease of 13% year-over-year. As a percentage of net revenues, G&A expenses accounted for 1.4% down from 1.6% in the same quarter of last year, which was attributable to our continuous optimization of our supporting functions.

Technology expenses accounted for 0.9% of net revenue, down from 1.7% in the same quarter of last year. We completed major tech development programs, and we believe that current spending reflect appropriate amount of our investment in technology. As a result, non-GAAP loss from operations narrowed to RMB 48.7 million compared to RMB 135.9 million in the same quarter of last year. As a percentage of net revenues, non-GAAP loss from operations decreased to 1.5% in the quarter from 4.1% in the same quarter of last year. Non-GAAP net loss attributable to ordinary shareholders was RMB 64.9 million compared to RMB 213 million in the same quarter of last year. As a percentage of net revenues, non-GAAP net loss attributable to ordinary shareholders decreased to 1.9% in the quarter from 6.4% in the same quarter of last year.

As you can see, we are improving our financial performance quarter-by-quarter, and we are getting very closer to profitability. We are also very pleased to report that we have achieved positive operating cash flow and overall cash flow for the quarter. Please refer to Slide 15 to 19 of the appendix section for selected financial statements. And a quick note on our cash position as of September 30, 2022, we had cash and cash equivalents, restricted cash and short-term investment of RMB 866 million. This concludes our prepared remarks. Thank you. Operator, we are now ready to begin the Q&A session.

Operator: Thank you Your first question comes from Kathy Chen with CICC. Please go ahead.

Unidentified Analyst: Hi. This is Kathy from CICC. Thank you for taking my question and congratulations on your progress. I have two questions in total. The first one is that, looking forward, I’m wondering what will be the company’s operational focus? And the second one is that as on the gross margin of the B2B business continuously increased and very appreciative if you can share with us the key factors sustainability?

Harvey Wang: Junling, are you going to take the first question?

Junling Liu: Sorry, I was on mute. I apologize, Kathy. So thank you for your question. I’ll answer the first question. So looking ahead, if we look at our operational – priorities, I would say the following. So we’re going to focus on the top line and client growth. So we’re going to the supply network, we’re going to reduce procurement cost and we will focus on improving operational efficiency and in terms of sales and marketing, the logistics, the G&A, et cetera. And we also want to grow the services. And the last point I want to make is that we’re going to continue to really invest in innovation. There’s a lot we can do with the asset that we have built so far, and we’re going to continue to exploit our technology capabilities to deliver value for both the upstream and downstream customers. Thank you.

Harvey Wang: Yeah, this is Harvey. I would take your second question regarding the B2B margin. And yes, you are right. Our B2B gross profit increased 27% year-over-year. And this improvement came from our continuous effort to reduce our procurement costs, as Junling just mentioned and through either our direct sourcing from pharmaceutical companies, et cetera, and also our efforts to optimize our product assortment and our cost structure. Regarding your question of this sustainability, when – as we can expect the overall economy and environment gets better. We will further tighten our partnership with pharmaceutical companies, and we will get more room to promote our digital marketing capability. So I believe the B2B profit, the gross profit improvement trend will continue. Thank you, Kathy.

Operator: Your next question comes from Lauren Cai with HSBC. Please go ahead.

Unidentified Analyst: Hi. Thanks, management for taking my question. Congratulations on your solid results, especially your positive operating cash flow this quarter. This brings me to my first question about cost control. Can management share more details on what’s been done to contain costs? And can these measures or this trend sustain going forward when macro environment turns better and we may need to increase investment to gain more growth? And for my second question, I want to ask about on your outlook for next year. Is China gradually easing COVID control measures, how would it impact our business? Thank you.

Luke Chen: Yes, Lauren. I will take your first question regarding the cost control. And yeah, it is very encouraging to see that as a result of our continuous efforts, we are seeing – we enhance our operational efficiency, and our total operating expenses have decreased to 8.4% from 10.2% of Q3 last year. And this is actually from every single element we are doing our best. Our sales in marketing expenses decreased from 3.9% to 3.2%. And our technology expenses and also our G&A decreased from 1.7% and 1.6% to 0.9% and 1.4%, respectively. When the overall environment is getting better, definitely, there will be even better news for us. When the overall economy and environment are getting better, we definitely expect this momentum to continue. As at that time, the demand of our customers will be released and increased with our volume growth, we will definitely see scale. Thank you.