111 Inc (YI) 2018 Q3 法說會逐字稿

Hello, ladies and gentlemen. Thank you for standing by for 111, Inc. Third Quarter 2018 Earnings Conference Call. (Operator Instructions)

I would now like to turn the meeting over to your host for today's call, Mr. Rene Vanguestaine from Christensen. Please proceed, Rene.

Thank you, Desmond. Hello, everyone, and thank you for joining us today for 111's third quarter 2018 earnings conference call. The company's results were released earlier today and are available on the company's IR website at IR.111.com.cn as well as on GlobeNewswire Services.

On the call today from 111, Dr. Gang Yu, Co-Founder and Executive Chairman; Mr. Junling Liu, Co-Founder, Chairman, and CEO; Mr. Weihao Xu, Chief Financial Officer; and Ms. [Monica Mu], IR Director. Mr. Yu will discuss the company's business operations and highlights followed by Mr. Xu who will go through the financials and guidance. They will be available to answer your questions during the Q&A session that will follow.

I'll 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. These statements constitute forward-looking statements within the meaning of Section 21-E of the Securities and Exchange Act of 1934 as amended and as defined in the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements can be identified by terminology such as will, expects, anticipates, future, intends, plans, believes, estimates, target, confident, and similar statements. Among other things, the business outlook and quotations from management in this announcement as well as 111 strategic and operational plans contain forward-looking statements. 111 may also make written or oral forward-looking statements in its periodic reports to the U.S. Securities and Exchange Commission, in its annual report to shareholders, in press releases and other written materials, and in oral statements made by its officers, directors, or employees to third parties.

Such statements are based upon management's current expectations and current market and operating conditions and relate to events that involve known and unknown risk, uncertainties, and other factors, all of which are difficult to predict and many of which are beyond the company's control. Forward-looking statements involve inherent risks, uncertainties, and other factors that could cause actual results to differ materially from those contained in any such statements. Potential risks and uncertainties include but are not limited to uncertainties as to the company's ability to comply with extensive and involving regulatory requirements, its ability to compete effectively in the evolving PRC general health and wellness market, its ability to manage the growth of its business and expansion plans, its ability to achieve or maintain profitability in the future, its ability to control the risks associated with its pharmaceutical retail and wholesale businesses, and the company's ability to meet the standards necessary to maintain the listing of its aliases on the NASDAQ global market, including its ability to cure any non-compliance with NASDAQ's continued listing criteria.

Further information regarding these and other risks, uncertainties, or factors is included in the company's filings with the U.S. Securities and Exchange Commission. All information provided here is as of the date of today, and 111 doesn't undertake any obligation to update any forward-looking statement as a result of new information, future events or otherwise except as required under applicable law.

It is now my pleasure to introduce Mr. Junling Liu. Mr. Liu, please go ahead.

Thank you, everyone, for joining us today for our third quarter earnings call and also this is the first one as a public company. Before getting into our operational results, I want to share with everyone that there are two fundamental problems we're trying to address with the integrated online and offline healthcare platform we built.

The first problem, the Chinese [chronic ill] patients need to visit hospitals on a monthly basis to get a refill. An average outpatient hospital visit takes about three hours with endless queues and about 85% of chronic ill patients need to obtain refill prescriptions through the hospital channel. This system creates tremendous pain for customers. 111 has built out the necessary infrastructure to relieve pain for customers. With our 1 Drugstore and 1 Clinic, we enable customers to enjoy a refill service without even leaving home. Our online doctors from 1 Clinic can issue electronic prescriptions based on the patient's history and the diagnosis, and our 1 Drugstore can deliver the drug to the customers' doorsteps.

The second problem we want to address is the extremely inefficient drug distribution system in China. And today, China has about 450,000 pharmacies and 13,000 distributors compared to three major pharmacy chains and three major distributors in the United States. The biggest pharmacy chain in China has a little over 1% of market share in terms of the number of stores, and the majority of the stores are small chains and standalone stores.

The fragmentation makes it impossible for the majority of the pharmacies to receive adequate services. They typically buy from lower end distributors at bulk, resulting in longer inventory days and uncompetitive prices. Our solution to this problem is to source directly and bypass the 13,000 distributors, and service the pharmacies directly. By doing this, we enable the pharmacies to enjoy much shorter inventory days on hand and far more competitive prices.

And I would like to move on to our Q3 results. Our total revenues were RMB497.6 million, growing more than 100% year-over-year. The growth was mainly driven by the growth in our B2B segment as we continue to build our offline pharmacy customer network. Our B2B segment serves more than 130,000 stores now with revenue growing more than 13-fold year-over-year.

This growth allows us to clearly see the strong scalability in our business. While our revenue grew more than 100%, we have also achieved a great scaling effect in our business with each operating cost component growing at a slower rate year-over-year. For example, fulfillment expenses grew 46% while selling expenses grew 54%. Excluding share based compensation and one-time expenses, G&A expenses grew 35%. While we continuously invest in technology, R&D expenses grew 69%.

In addition to adding more pharmacy customers for the B2B segments, we're continuing to see improvement in customer stickiness to our platform. For example, we're seeing customers buy a wider range of product from our platform, especially the shared wallet for those who have been on our platform for more than one year is increasing. Our cloud services, which includes our smart sourcing platform, are also seeing higher adoption rates among our customers as we begin rolling it out to standalone pharmacy customers as well.

Turning to our B2C segment, we're exploring new ways to add customers and improve customer experience while carefully controlling marketing expenses. During the quarter, our in-house developed PAMS, that's spelled like P-A-M-S, which stands for Prescription Automatic Management System, was released on 1 Drugstore. The system uses machine learning to screen and match customer's drug usage profile with a drug [fixed-rate] database to avoid any side effects from a prescription containing multiple drugs. We're also working with pharmaceutical companies on direct-to-patient drugs where we can use our digital technology and nationwide logistic network to provide a better data feed and geocoverage.

Given this is our first call as a public company, I would like to take the opportunity to provide a bit more color on our enabler business model and our core capabilities. We see ourselves as one of China's health care ecosystem enablers. For pharmacies, we provide inventory on-demand, we help lower procurement and fulfillment costs, and optimize product offerings.

For pharmaceutical companies, we help them reach growth segments of the market. We provide them with data and supply chain insights that allow them to understand where demand is coming from and how best to service it. We also give them targeted marketing and branding support. For medical professionals, we provide a better patient management system that helps them improve utilization and patient flow.

And lastly, we give customers end-to-end diagnosis to treatment solutions. We provide them with improved access to drugs and efficient, cost effective services.

During the quarter, we started to work with several commercial insurance companies. We see them as good partners in the ecosystem we're building. We will share more details in due course. Our company's name represents the three pillars of our business: 1 Drugstore, our B2C segment; 1 Drug Mall, our B2B segment; and 1 Clinic, our online hospital business. Each one of these segments helps to enable our partners. Our focus for further monetization will be on our B2C and B2B segments once they have been built to scale and customer loyalty has been strengthened. 1 Clinic is a critical component as it gives the unique capabilities in the health care ecosystem.

Supporting our three businesses are four fundamental core capabilities. One, smart supply chain management where we focus on lowering costs and adding more direct sourcing relationships. Two, big data, which leverages the enormous amount of valuable data we obtain from many touch points on our platform and customer interactions. For example, I mentioned that as we roll out our smart sourcing system to more customers, we're gathering valuable insights into what drugs are sold most through retail channels in any specific geographical area. Three, cloud-based services, which I discussed earlier, allowed us to enable our customers and retain them. Four, medical expertise. PAMS, that is P-A-M-S, is the result of our continuous investment in this area. We believe our core capabilities, combined with our unique business model, will drive the long-term sustainable growth of our business.

Looking at the broader regulatory environments, we're seeing a whole series of conducive policies in our tailwinds. Firstly, back in April this year, State Council published policy to promote Internet Plus healthcare to encourage digital solution providers to participate in the healthcare platform. Even President Xi Jinping specifically pointed out let the data do the walking instead of patients. In July this year, the Minister of Health followed up with specific policy implementations.

Secondly, China FDA is encouraging innovative new drugs and high quality new drugs to come to market. They issued new guidelines to expedite the approval process. We're actively pursuing and working with pharma companies to bring those new drugs to the market via our platform.

Thirdly, health care reform is progressing as we speak. Policies such as two-invoice system, zero markup, and the 30% ceiling of drug sales in public hospital revenue are being implemented and enforced nationwide.

The timing of those new policies is great for us. We're marching at full speed so we can take full advantage of the benefits those policies will bring. I'm also pleased to report that so we strengthened our management team by having two executives coming on board, Mr. Harvey Wang and Mr. Barry Zhu, whose respective Chinese names are Wang Haihui and Zhu Pengcheng recently joined us as Co-COOs. The company believes that together they will bring great skill sets in operations and sales management, given their extensive experiences across a range of industries, including ecommerce, technology, manufacturing, and logistics. Prior to joining 111, Harvey and Barry co-founded and served as Chairman and CEO of Urfresh respectively, a fresh produce platform, from 2015 to 2018.

Before that, Harvey once served as the VP of Operations for Yihaodian, a Chinese online grocery business, from 2010 to 2015. He also served as Sales Operations Director for Dell Asia-Pacific between 2001 and 2010. He received his Master of Business Administration degree from Xiamen University. And Barry Zhu used to be Chief Merchandising Officer and VP of Platform Business from 2010 to 2015 for Yihaodian. He also served as a Regional Manager of North Market for P&G China between 2005 and 2010. Barry received his Juris Master's degree from Peking University. I'm very excited to have them on board and feel confident that they will make great contributions to our business.

In conclusion, the China's healthcare industry is going through a transformation, and we're extremely excited to become an active participant in the transformation. We feel very confident with our market positioning and believe that our T2B2C business model will enable us to deliver long-term value to our customers and shareholders.

With that, I will hand the call to our CFO Weihao to walk you through our financial results in this quarter. Weihao?

Great. Thank you, Junling. As I review our financial results, please allow me to note a few things first. First of all, all numbers quoted are in RMB terms. And secondly, all the percentage changes refer to year-over-year change unless otherwise noted.

So to start, first, net revenue increased 100.3% to RMB497.6 million mainly due to the significant increase in product revenue from the B2B segment, which increased by more than 14-fold to RMB276 million. Product revenue from B2C segment decreased by 3.4% to RMB218.3 million due to more cost effective customer acquisition, which reduced marketing expenditure of our B2B segment by almost 50% year-over-year.

Operating costs and expenses increased 100% to RMB627.5 million. Going into further details of our costs and expenses, first, our cost of products sold increased 115% to RMB482.1 million primarily due to increase in revenue and changing revenue mix with a much higher proportion from the B2B business. Fulfillment expenses increased 46.8% to RMB20.7 million, primarily as a result of growth of our B2B business.

Selling expenses increased 50% to RMB77.3 million mainly due to the recruitment of additional sales staff and expansion associated with the expansion of our B2B business. Excluding share-based compensation, our selling expenses increased only 43%.

General and administrative expenses increased in 98.5% to RMB26.4 million mainly attributed to increase in managerial staff, IPO fees, and share-based compensation expenses. Excluding share-based compensation, G&A expense increased only 56%.

Technology expenses increased 69.7% to RMB20.2 million primarily due to investments in platform and product development, which includes the recruitment of technology-related staff. Excluding share-based compensation, technology expense increased about 60%.

Overall, loss from operations was RMB129.9 million compared to RMB65.3 million in the same quarter of last year. Non-GAAP loss from operations was RMB115.1 million compared to RMB62.6 million in the same quarter of last year.

Net loss was RMB126.4 million compared to RMB62.2 million one year ago. Non-GAAP net loss was RMB111.6 million compared to RMB59.6 million last year.

As of September 30, 2018, the company had cash and cash equivalents and short-term investments of RMB1,236.9 million compared to RMB461.2 million as of December 31, 2017, primarily due to the cash injection from IPO process.

So for the fourth quarter of 2018, we expect total revenue to be between RMB480 million and RMB530 million representing year-over-year growth of approximately 74% to 92%. This forecast is based on the current market conditions and reflects the company's current and preliminary estimates of the market and operating conditions and customer demand, which are all subject to change.

So this concludes our prepared remarks. Operator, now, we are ready to begin the Q&A session. Thank you.

(Operator Instructions) Our first question comes from the line of Leon Chik from JP Morgan.

So I think the guidance -- so, basically, the third quarter sales was double last year and RMB97 million higher than second quarter. So the low end of your fourth quarter is actually below this number and even the mid-end doesn't have much growth. Could you maybe go through that? Thanks.

Leon, thank you for the question. Let me take a shot at this question. So the way we think of our business, really, we divide it into two pieces: one is the B2B side of the business; the other is B2C. The way we think about this is that our B2B business actually is still on a very fast growth trajectory even though we don't break down the guidance in terms of B2B and B2C businesses. So the estimates that we're giving here is actually a reflection of still very high paced growth on the B2B side. That's that.

So if we look at it on an annual basis with this forecast [wrench], we're still looking at more than -- about 94% growth on the higher end. So I think being new to the market, being first time as a public company, I just want to give our investors a reasonable expectation in terms of how we deliver our number.

Next question comes from the line of Virginia Yu from Citigroup.

Thanks, management, for taking my questions and I have two questions here. So number one, can management have more guidance for us for in terms of margins and expenses for the fourth quarter and also for year 2019? And secondly, can I also ask about the new ways of exploring in order to acquire more new B2C customers?

Let me first answer your questions on the margin expenses. As you might see from our Q3 results, our margin is really a reflection of how we think about grow our B2B business. As part of the investment into this business, we also see that we expanded our number of store from more than 100,000 when we delivered three months ago to about 130,000 stores, more than 130,000 stores. So with that growth pace, we actually invest a lot in some sort of pricing, which kind of reflect in the way of our gross margin number.

So while we're still very much focused on increase our customer base, I want to remind you that there are about 450,000 retail pharmacies out there. As Junling just pointed out, there's a huge amount of inefficiency out in this market. So I think there's still a very big addressable market we're trying to get those pharmacy as our customer. So that's our most and foremost important task to go out there. So I think this investment in terms of margin can continue for a few quarters as we grow our business.

So if we move on to the second part of our income statement looking at other expenses such as our fulfillment expense, our selling expense, our G&A, and technology. So if we think about -- if we look at the business model, right, our fulfillment expense is very much a variable cost. So it's going to go in line with our revenue. However, as you've seen from the quarter's results or this year's results, year-to-date number, our fulfillment expense also has seen a significant scaling effect because our -- that's one of our strong suit, is supply chain. So we think this fulfillment cost will also see scaling effect as we grow our revenue.

And then when you look at the selling expenses, as I mentioned, if you look at two business, for the B2C side, we cut our selling expense this year by half while maintaining the revenue line, right? And the rest of the selling expense right now are pretty much just human capital, which is the selling staff that we have on the ground. So for that, we're not seeing much increase of headcount anymore. So I think we have a pretty healthy sales force out there to serve our customer. So that's where -- if I look at Q4, maybe there's some slight growth, but looking further around the horizon, in 2019, we don't think there's much increase in that as well.

Then we look at the G&A and technology. Those are really the almost like half-quarter efforts. All the cost there is really just the human resource cost. So in same sense with the selling expenses, we don't see much further growth. In other words, we think all the expenses component that I just described will have a much better scaling effect as we grow our revenue at a fast pace.

Yes. So, Virginia. This is Junling. If I may add, I can be very specific on what we're doing to increase our margin. So first of all, we're going to grow the volume. We believe scale is going to give us the bargaining power and also with the product mix because right now we're pretty much focused on the hot selling products or the best sellers, and typically those products would have a much lower margin and that's our strategy. In order to acquire more customers, that is a necessary step. And once we have established a broad base of customers and once they developed a degree of reliance on our services, we'll be able to add a lot more products into the portfolio. And thirdly, obviously, we can look at the optimization of the pricing. And with that, we believe the margin is going to improve over time.

And with regards to your second question on the new ways of the custom acquisition, on the B2C segment, where we're focusing now is really on the chronic ill patients. Now we have 300 million to 400 million chronic ill patients in China, and there is a big, big market out there. So the only thing we're mindful is that we're not going to do it in the traditional B2C where you burn a lot of marketing dollars to acquire those customers because we learned pretty quickly that -- can you acquire customers? Yes, you can. But if you burn marketing dollars, usually you will get those technology savvy customers, and those customers actually are typically relatively young, and young people don't fall sick that easily. And as a matter of fact, they're actually lousy customers, if I may use that term. And they're good as a person, but healthy people don't take too much drugs. And that's why we need to focus on chronic ill patients.

And obviously, we're having a whole number -- a whole heap of initiatives to really focus on new ways of growing our customer base instead of following the old ways of spending marketing dollars. Those initiatives include we're working with the pharmaceutical companies on DTP, that's the direct-to-patient. There are many, many new drugs that the CFDA is expediting in the approval process and that we believe we have a fair chance to participate in the new drugs.

And also, as I mentioned, we've been working with insurance companies and so on where we can be their PBMs. The beauty of working with those partners, that means by providing a service to them, we deliver great value to them, and in the meantime, we actually acquire customers free of charge.

So those are the things that I want to add in addition to what Weihao has briefed you.

(Operator Instructions) We have another question from the line of Alicia Yap from Citi.

I have a question on the new senior management hire of Mr. Wang and Mr. Zhu. I'm just kind of curious given they actually were the chairman and founders of the Urfresh Group, although I understand they probably worked together at Yihaodian on their previous venture, but just can you give us some kind of background that are they no longer serving the chairman in India-owned new venture on the Urfresh after they joined 111? And then in terms of other -- what would be their key role in terms of what they could bring us for the business focus? For example, will Mr. Zhu more focusing on the B2B side or any of the strategic side? If you can share more detail, it would be great. Thank you.

So they have terminated their Urfresh business, and we are extremely lucky to grab them at the right time. And so they no longer have other obligations at all. So they're full time actually, more than full time, into our business. And the way we want to arrange them is to really -- collectively, they're going to run our businesses. And right now we're going through organization realignment and that would be out in due course. So they just came on board and at the moment, we're still working through the various options within our organization.

But what I would like to say is that with them on board, they're the best professionals we have come across in our profession, at least in my profession. And they're very, very capable people, and I'm extremely excited to have them on board. And we feel so much more confident with the strengthening of our management team.

We're looking forward to get more information. I have one follow-up. I'm sorry I missed a little bit of the answer of the previous question. But I guess I have more questions in terms of the bigger picture. Given what we have seen, a lot of the company has been reporting more cautious guidance or citing for all this macro and a softening economy. For our understanding, we thought that healthcare should be more resilient. And I don't think our lower-than-expected guidance for 4Q was there any of these macro concerns, right? It's more purely our business expansion impact rather than macro. Should we assume that is correct?

Yes. We feel pretty confident that we should be able to deliver the numbers we guided, and obviously we have great momentum in our business. So 94% or 92% growth is not -- something that is not impressive enough. And I think even with that growth, we should be happy with where we are in our business, and that will give us a pretty strong year for 2018. And obviously the management is confident with the numbers we provided.

We have a follow-up question from the line of Leon Chik from JP Morgan.

I think you mentioned your sales force staffing level is currently sufficient. You're not planning to add. Just curious how you can sustain growth for the next few years without adding any sales force. And if you can achieve that, shouldn't that mean your marketing cost as a percentage of sales would come down quite significantly in the next few years?

Thank you, Leon. Let me give a shot on this question. So, first of all, I want to say that our selling expense as a percentage of revenue has been declining over the time. That has been a trend that we've established. So you're right, this trend is going to keep going up, which our selling expense as a percentage of revenue is going to keep coming down.

Well, going back to your earlier comment about how we think about our sales force going to satisfy our growth needs in the foreseeable future. So if you think about the value and the purpose of our sales force on the ground, really serve two things. One, these sales people are out there acquiring new customers onto our platform, right? So inevitably, these people will have to be out there on the ground visiting clients on a very frequent basis to get those new customers onto the platform.

But second piece of their job is really try to maintain these customers onto the platform, right? So we do believe as these new customers adding onto the platform, now we have other more efficient ways to keep these customers on the platform instead of having a human body actually knocking the door on a too frequent basis. For example, Junling just mentioned, right, we have our smart sourcing system which is something our customer are actually using on a very frequent basis, which is a better reminder of our platform than our sales people coming to their store. And other examples, such as up some of the -- with the technology, with our digital CSO, maybe that's a new term I'll bring out, right, we do have these internal tools. We actually have more efficient ways to say, hey, for this [sales, what's] the last time you visit any specific store and how much sale that person generated. We can have that transparency across the entire sales organization.

So what I'm trying to say is that even with the number of stores growing, I think we have a better and more efficient way to manage the sales team and create similar and even higher, much higher, efficiency out of this team of people.

Junling, any comments?

No, I mean, I think, Leon, it's not that we're not adding sales force anymore, but we think the number of sales team we have right now is close to peak. And the incremental costs of the sales team is going to be rather moderate, even if we add some. But as a scaling effect, the percentage of revenue is going to continue to scale and scale significantly.

Okay. Thanks for clearing that up. Thanks.

(Operator Instructions)

Operator?

There are no more questions at this time. I would like to hand the call back to Mr. Vanguestaine for closing remarks.

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

Thank you. Ladies and gentlemen, you may now disconnect your lines. Thank you for your participation.