111 INC

Good day and thank you for standing by. Welcome to 111, Inc. Second Quarter 2021 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your first speaker today, Ms. Monica Mu. Please go ahead.

Monica Mu - Investor Relations Director

Thank you, operator. Hello, everyone, and thank you for joining us today for 111's second quarter 2021 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, COO; Ms. Tiffany Jugal, SVP of Investor Relations and Business Development; 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.

Before we get 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 markets and operating conditions and it relates 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 our earnings press release for detailed information of our comparative financial performance on a year-over-year basis.

With that, I will turn the call over to our CEO, Mr. Junling Liu.

Liu Junling - 1Co-founder, Chairman and CEO of Yaowang

Good morning and good evening, everyone. Thank you for joining our 2021 second quarter earnings call. For the benefit of those who are new to the 111 story, I would like to take a moment to summarize our business. I'll also cover our recent operational performance before handing the call over to Luke, to discuss the financials. We will include our prepared remarks with guidance for Q3 2021, after which we will open up the call for Q&A.

From the very beginning, 111 has been on a mission to transform and advance the health care services industry in China through technology by connecting patients with medicines and the medical services. We have already achieved significant progress in this mission over the past decade with the establishment of three innovative technology platforms. 1 Pharmacy, which is currently one of the largest online retail pharmacies in China and it was also one of the first entities to receive an online pharmacy license; 1 Clinic, which provides consumers with a myriad of cost-effective health care services; and 1 Medicine Marketplace, a one-stop shop for pharmacies in China to source medicines from a wide array pharmaceutical companies.

We curated a powerful ecosystem underpinned by leading-edge technology that focuses on the customers first, while benefiting all parties in the health care space: patients, pharmaceutical companies, pharmacies and doctors.

Patients benefit through greater access to medication with increased options, including newly approved medicines, faster than ever before. Doctors benefit by being able to prescribe drugs that's unbound to just one hospital system, thus expanding their range of treatment options and leading to higher success rates. Pharmacies benefit by leveraging our scale to provide better pricing and a wider selection to more customers. Pharmaceutical companies benefit through expanded access to doctors and the patients with less geographical friction and the ability to sell products through multiple channels without relying exclusively on hospitals for sales. 111 benefits, too, by being able to acquire products at lower cost and offer revenue-generating services to pharmacies and pharmaceutical companies.

We're well positioned in the health care industry within an evolving regulatory environment in China designed to ensure integrity, data security and innovation as we enter the Fourth Industrial Revolution in this dynamic market. We're confident that these changes will provide all companies, including 111, a more equitable environment to deliver value to our customers and shareholders while supporting the government's desire to reduce the cost of health care, which is aligned with our investment in the platform, aimed at reducing cost by leveraging technology.

Before we get into business performance, I would like to briefly talk about the current regulatory environment. During the last few weeks, various news outlets have reported over 40 instances where the Chinese government charged companies with violations ranging from antitrust to breaches of data security. On the surface, these actions might be perceived to have short-term risk and uncertainty. But we believe that these policies will help spur innovation in the long term by curbing anticompetitive practices and leveling the playing field. These changes will provide all companies, including 111, a more equitable environment to conduct business.

Delving further into the details of the policies, it is our understanding that the government's intent is to address the following: one, antimonopoly concerns of one company becoming too dominant in industry; two, anticompetitive business practices such as requiring merchants to sell exclusively on a single company's platform; three, practices that stifle innovation by preventing smaller and regional players from competing with large conglomerates; four, vast amounts of sensitive data being collected without oversight or a uniform set of governing standards; five, income inequality; and lastly, sixth, the growing cost of health care.

The only category that pertains to 111 is the last one, concerning the government's desire to reduce the cost of health care, which also aligns with our goals. We believe that everyone deserves access to affordable health care, which is why we have developed a platform aimed at reducing costs by leveraging technology.

Our suite of enterprise solutions provide small- and medium-sized businesses with the technology and tools to improve and expand their businesses. Our nationwide footprint also provides access to quality health care services that were previously unavailable to consumers in smaller and rural cities.

Although 111 has already grown significantly since our IPO in 2018, vast opportunities for growth remain. Thus, we welcome policies aimed at containing unfair practices and allowing all companies an equal opportunity to compete. As such, we view the recent regulatory actions as a tailwind rather than a headwind for 111.

Moving on to recent performance. We continue to achieve exceptional results with net revenue in the second quarter increasing 87% year-over-year to RMB 3 billion, marking the 12th consecutive quarter of year-over-year growth since our IPO.

Our B2B segment continues to deliver excellent growth, accounting for RMB 2.9 billion of total revenue, up 99% year-over-year. Further, in support of our objective to diversify our revenue stream, we have seen growing demand for 111's service offerings, which include marketplace vendor services, online medical consultations, cloud and e-prescription services, digital marketing, supply chain management and others.

We're pleased to report that overall service revenue grew 125% year-over-year, with B2B service revenues totaling RMB 16 million, representing a 397% year-over-year increase.

Non-GAAP net loss attributable to ordinary shareholders as a percentage of net revenues decreased from 4.9% in the second quarter of 2020 to 3.9% in this quarter, which shows our continued progress towards profitability. Net loss for Q2 2021 was primarily attributed to an increase in R&D and technology expenses as these expenses are expected to grow at a slower pace going forward.

In addition to growing our top line, we are laser focused on growing our margins. Gross margin for our B2B segment grew 120% from Q2 2020, mainly from optimizing product categories, improving in our supply chain and implementing SaaS tools to improve efficiency of various business processes. We expect this trend of margin growth outpacing revenue growth to continue as we keep making strides towards becoming profitable.

Other key initiatives for improving gross margin include, enhancing our supply chain infrastructure and expanding our partnerships with domestic and global pharmaceutical companies.

In conjunction with our efforts to improve our margins, we also continue to make strides to improve internal operating efficiency. As a percentage of revenue, both selling and marketing expenses, and general and administrative expenses decreased sharply in this quarter. Additionally, we implemented an algorithm that enables deliveries of high-velocity products, which has significantly improved the efficiency of each warehouse and lowered labor costs.

Although our operating expenses increased to RMB 323 million for the second quarter, up 82% year-over-year, these outlays were purposeful with a strong emphasis around investing and improving our proprietary technology in areas of digital health, big data analytics and SMART supply chain technology, as evidenced by the 18 patents we have secured in these areas. By doing so, 111 has laid a solid foundation for healthy long-term growth as we move towards our goal of transforming the health care landscape in China. It should also be noted that these operating expenses thresholds are expected to have peaked for 2021.

We're also further developing our online and offline digital marketing capabilities with an emphasis on enabling our pharmaceutical partners to promote new and existing products. This includes our new digital marketing tool, HawkEye and Turbo, that connects pharmaceutical companies with pharmacies and patients directly to promote high-margin special specification SKUs.

We also leveraged the online marketing capabilities already developed for our B2C model to promote sales in our B2B model. Our proprietary marketing and education tools, such as live telecast, e-courses and online shows, are designed to equip pharmacists with training to facilitate consumer education.

Our robust SMART supply chain has always been one of our core strengths. In the second quarter, we expanded the number of partnerships with domestic and global pharmaceutical companies, now totaling 381 direct sourcing partners, up 47% from 259 partners a year prior. By sourcing directly from more pharmaceutical companies such as Bayer, Eli Lilly, Novartis, Omron and Sanofi, we have created a more efficient supply path, leading to increased profits.

Meanwhile, we continue to strengthen our supply chain infrastructure, including expanding our fulfillment capacity. Today, we have eight fulfillment centers strategically located to maximize efficiency, which enables us to deliver to customers in more than 890 cities within 24 hours.

To meet the growing demand for our services, we plan to expand to approximately 243,000 square meters of fulfillment capacity towards the end of this financial year, more than doubling the amount of space we had at the start of the year. While this will increase our fulfillment cost in the short term, the investment will position us for future growth.

We have also increased the market coverage of 111 to 65% while achieving a high average revenue per user. At the end of the second quarter 2021, we covered 355,000 pharmacies in our network, which is up from 260,000 pharmacies one year ago. Moving forward, we do not anticipate that this will be - we do not anticipate that we will be adding pharmacies to our network at the same rate as we have in the past given that we're already covering about two-thirds of the total market. However, we will focus our efforts on growing established relationships with our existing customers.

During the second quarter, purchases from existing customers comprised 95% of the total revenue, which demonstrates our customers' high level of loyalty and satisfaction. While our B2C segment is not yet achieving our desired expectations in the short term, it remains a core strategy given the overreaching market trends and our commitment to provide access to affordable health care products and services to patients nationwide, including innovative medication and therapies that would not be available otherwise. This includes upgrades to our 1 Clinic platform, which we have completed the buildout of a full medical product line, which includes a patient education portal, marketing tools, digital representatives, a doctor-patient management platform and an Internet hospital.

There are currently over 20,000 doctors using our platform to connect with and provide online consultation services to patients nationwide. As some of you may be aware, there is a large disparity in access to health care across the country, and 111 is proud to play a part in bridging that gap.

Our 111 drug commercialization platform has made solid progress in providing patients with innovative therapies, such as Eli Lilly's Trulicity, Taltz and Verzenio, which treat diabetes, severe plaque psoriasis and metastatic breast cancer, respectively; as well as Novartis' Cosentyx, which treats plaque psoriasis; and Sanofi's Dupixent for the treatment of eczema.

Finally, I would like to provide an update on the exciting progress 111 has made around a new initiative that will further our growth strategy. We're excited to achieve the milestone in eclipsing 10,000 stores across China that have joined our recently launched digital franchise initiative, which we branded as 1 Health Membership rewards program. This exclusive loyalty-driven program features an annual fee and allows members access to privileged benefits, including use of our centralized procurement and a suite of digital solutions as well as educational materials to help these pharmacies manage and expand their businesses. We were delighted in the overwhelming response by our network of pharmacies, and we plan to build upon the early success of this program by offering a larger selection of products and expanding our service offerings.

Beyond these highlights, we continue to strengthen our team, provide innovative services and capitalize on our technology-enabled infrastructure as our business grows. We're focused on not only growing our top line but also improving our margins. We are confident that our leading position in the health care service sector, along with industry tailwinds, position 111 well for continued growth as we transform health care services in China and ultimately deliver excellent value to our shareholders.

Finally, I would like to thank our shareholders for their continuing support.

With that, I will hand the call to Luke to walk through our financial results. Thank you.

Luke Chen - Chief Financial Officer

Thank you, Junling. Moving to the financial section on Slide 13 of the PPT we have posted on our website. You can see the details of the second quarter 2021 results from slides 14 to 16 of our presentation.

I would like to highlight a few key figures and financial metrics and our focus on year-over-year comparisons. All numbers are in RMB, unless otherwise stated.

Total net revenues for the quarter grew 86.5% to RMB 3.0 billion, which was at the higher end of our guidance range. Our B2B segment revenue grew 99.2% to RMB 2.9 billion, reaching a new record high for segment revenue in a quarter.

Our B2B - B2C segment revenue was down 23.9% to RMB 127 million year-over-year. The decrease in our B2C segment growth was primarily attributable to the Q1 and Q2 2020 being unusually strong quarters for B2C segment as we were selling higher volumes of pandemic-related PPEs. We expect this downward trend will be reversed as we launch several initiatives to accelerate the growth of this segment.

Our B2B gross margin was 3.8%, up from 3.4%, while our B2C gross margin remained stable at around 20%. The improvement in gross margin of our B2B segment reflects our ability to continuously improve the margins while maintaining substantial top line growth. Overall, our gross profit grew by 58.8% to RMB 134.6 million, and the combined gross margin was 4.5%, down from 5.2% a year ago. This decrease was primarily attributed to our B2B segment growing at a faster pace than the B2C segment.

Total operating expenses for the quarter were up 82.2% to RMB 323.4 million. As a percentage of net revenue, total operating expenses for Q2 2021 decreased to 10.7% compared to 10.9% in the same quarter last year.

Fulfillment expenses as a percentage of net revenue for the quarter was 2.8%, up slightly from 2.7% in the same quarter last year. This was mainly attributable to the costs associated with opening new fulfillment centers and upgrading our existing facilities to support our growth. As these new and expanded facilities reach full capacity, we expect the fulfillment expenses to decrease.

Sales and marketing expenses as a percentage of net revenue for Q2 '21 were 4.4%, down from 5% in the same quarter of last year. G&A expenses as a percentage of net revenue was 1.7%, down from 2.4% in the same quarter last year. Technology expenses accounted for 1.7% of net revenue, up from 1.1% in the same quarter last year. This was primarily driven by an increase in the number of personnel in R&D and IT teams. We believe that continuing to invest in our team and technology and service offerings in the area of digital health, big data and SMART supply chain will strengthen our market-leading position. As a result, non-GAAP net loss attributable to ordinary shareholders in Q2 2021 was RMB 118 million as compared to RMB 78.8 million in the same quarter last year, which accounted for 3.9% of net revenue, down from 4.9% a year ago.

As to the guidance for the third quarter 2021, on Slide 18, the company expects total net revenue to be between RMB 3.31 billion to RMB 3.55 billion, representing a year-over-year growth of approximately 40% to 50%.

In addition to growing our top line, we are laser focused to growing our margins. We expect the trend on margin growth outpacing revenue growth to continue as we keep making stride towards becoming profitable.

It should be noted that this outlook is based on the current market conditions and reflect the company's current and preliminary estimates of the market and operating conditions as well as consumer demand, which are subject to change. Please refer to slides 21 to 23 of the Appendix section for our selected financial statements.

A quick note on our cash position. As of June 30, 2021, we had cash and cash equivalents, restricted cash and short-term investment of RMB 1.2 billion, largely unchanged from March 31, 2021.

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

Question & Answers

Operator

[Operator Instructions]. Your first question comes from the line of Xipeng Feng from China International. Please ask your question.

Xipeng Feng - China International - Analyst

Okay. This is Xipeng from CICC. Thank you for taking my questions and congratulations on the company progress. Well, I have three little questions, actually, and my first question is about policies. Well, as you may notice, the health care and Internet industry suffered from several newly implemented policies in the most recent several months. So I just wonder, in your opinion, what is the impact of China's recent policies on the Internet and health care industry or even through the company?

And my second question is, what is the primary factor behind your B2B growth - profit growth? What will be the main growth driver in the future? And my third question is, how do you propose to continue on both your revenue and gross margin growth? Thank you.

Liu Junling - 1Co-founder, Chairman and CEO of Yaowang

Yes. Thank you, Xipeng Feng. I think I'll take your first question with regards to the policy in the recent months. I actually spoke a bit about it in my script. And, I mean, obviously, especially in recent weeks, we have seen a lot of those developments in the policy area. As I said in the past and during the call earlier, that those policies are more intending to address the antimonopoly, the anticompetitive practices, etc. And obviously, the government has a great ambition to curb the cost of health care. That is quite related to us. As far as we are concerned, we like and welcome those policies because we are in the business to help the government to reduce the health expenditure. We want to make things more transparent. And we want to digitize the overall health care industry. And obviously, with our technology-enabled platforms, we're in a position just to do that.

So on the anti-monopoly and anticompetitive practices, that is really music to our ears because we actually believe that the industry needs to have a fair playing field. And what the government is actually doing is to have leveled or in the process of leveling the playing field to enable companies - or many companies, including ours, to compete in a good environment. So overall, we view those policies as very, very positive. It is going to be a tailwind for 111 instead of a headwind for 111.

I'll pass on to Harvey to answer your other questions.

Harvey Wang - Chief Operating Officer

Yes. On your second question regarding the B2B margin, yes, our margin - B2B margin improvement mainly comes from the following actions: we have introduced more high-margin products in the past quarter; and we also upgrade our PIS, Price Intelligence System, to optimize our pricing; and we have introduced more direct sourcing from our pharmaceutical partners to upgrade sourcing towards the source; and last but not least, we are seeing a continuous improvement on our supply chain efficiencies. And we believe those actions will continue to benefit us on the ongoing margin improvement.

And on your third question regarding the - continue our revenue and margin growth, I think while we still drive our revenue, our top line growth, our focus will be on more margin growth, on more quality growth. And we will continue to expand our supply chain network. And for example, we will reach more direct sourcing from pharmaceutical companies. And also, we will further expand our fulfillment centers to provide a better customer experience. And furthermore, we will continue to enhance our digital marketing platform and expand our high-margin business.

Xipeng, I hope I answered your questions.

Xipeng Feng - China International - Analyst

Okay. That's very clear. And I think we can be excited on the future achievement of the company. Congratulations again on the company progress. Thanks.

Liu Junling - 1Co-founder, Chairman and CEO of Yaowang

Thank you, Xipeng.

Operator

Your next question comes from the line of Zoe Bian of Citi. Please ask your question.

Zoe Bian - Citi - Analyst

This is Zoe Bian from Citi. Thank you for taking my questions. I have three questions. The first is, are there any updates on your partnerships with pharmaceutical companies in the second quarter this year? The second one is about the 1 Health Membership program. The program has already partnered with over 10,000 pharmacies. How integrated are these partnerships? And how much revenue or profit do you expect in the future? And what's your future plans to develop this business? My third question is, can you share more color on the technology expenses recently? Thank you.

Gang Yu - Co-Founder and Executive Chairman

Okay. Probably I'll take the first and the third, okay? So talking about our partnership with pharmaceutical companies, we have made a tremendous progress during the past quarter. As Junling had mentioned in the report, that we have reached direct sourcing relationships with 381 global pharmaceutical companies compared to 259 at Q2 last year. So this is quite a progress. As people know, that it takes a long time to build such a direct sourcing strategic partnership.

Not only that, we also introduced - just this quarter alone, we introduced fou8r innovative drugs into our cloud direct-to-patient management system, including Dupixent from Sanofi, Taltz from Eli Lilly, Verzenio also from Eli Lilly. As you can see that the first one we started was Trulicity brand from Eli Lily. Now we have three heavyweight, innovative drugs, all selling on our unique platform. We also have donafenib from Zelgen. So as we are accelerating the partnership with the pharmaceutical companies, we provide - we are really the choice for commercialization.

Also, let me take the third question. You asked about what we invest on technology, okay? We heavily invest on our technology team and our system development, okay, especially in the following areas. Number one is assortment management. We want to introduce a full category, but we need to decide what to be sourced internally, what to be offered by our GBP partners, what to be offered by our marketplace partners. So those are needed to be decided by our assortment management system.

We invest on Price Intelligence System. We have a team that works on big data analytics, offering our decision support tools. We continuously upgrade our supply chain management system. And also, we build SaaS tools. So this is why we increased our service revenue, okay? We build SaaS tools for pharmaceutical companies as well as for pharmacies. For example, for pharmacies, we have a CRM system. We have an O2O sales management system for pharmacies, where we build a system for their - for them to manage their sales reps. We have also built a digital marketing system. So we have built a lot of systems. This is also reflected by 18 patents we have received during the past half year.

Let me turn the second question to Harvey.

Harvey Wang - Chief Operating Officer

Yes. So regarding the 1 Health project, it is a very strategic project, which is also a very important part of our S2B2C model. There are now more than 11,000 pharmacies have joined this 1 Health program through a digital franchise model. And these pharmacies have paid us digital services fee to use our SaaS-based tools, including the CRM tool and also SaaS-based O2O tools. They are also enjoying the benefit from the centralized procurement and also enjoying a much more competitive price.

And this program, as I just mentioned, is a very important portion of our S2B2C model and we are now connecting pharmaceutical companies with pharmacies on product commercialization and as well as we are connecting those pharmaceutical companies through those pharmacies with the end patients or consumers through our CRM tools. And it becomes an online/offline closed loop. Thank you, Zoe.

Zoe Bian - Citi - Analyst

Thank you, management. Very clear. And congrats again on the very strong revenue growth.

Liu Junling - 1Co-founder, Chairman and CEO of Yaowang

Thank you, Zoe.

Operator

Next question comes from the line of Richard from Ideate Investments. Please ask your question.

Richard Gao - Ideate Investments - Analyst

Hi. This is Richard Gao from Ideate Investments. Thanks for taking my question. I got two. The first one is, do you have any plan to further expand your supply chain coverage? And the second one, what's the status of your STAR Market IPO?

Gang Yu - Co-Founder and Executive Chairman

Okay. I'll take the first question. I think Luke will update you on the second one. Yes, we are - currently, we have eight fulfillment centers in the eight major cities in - across the country, and we plan to double our fulfillment center throughput capacity in this year. And also, we will continue to offer better logistics services, including - currently, we provide within 24 hours delivery in 890 cities and even same-day delivery in 12 major cities.

Luke, you want to take the second question?

Luke Chen - Chief Financial Officer

Yes. We are still working on the listing in the STAR Market, and we're still analyzing the policy updates for the STAR Market. So we will disclose and update the status according to SEC rules. Meanwhile, we will be focusing on improving margin and reaching profitability. Rich, I hope we answered your questions.

Richard Gao - Ideate Investments - Analyst

Okay. Yes. Thanks and congrats again for very strong quarter and first half year. Thanks.

Liu Junling - 1Co-founder, Chairman and CEO of Yaowang

Thank you, Richard.

Operator

Your last question comes from the line of Junjie Huang of HSBC. Please ask your question.

Junjie Huang - HSBC - Analyst

Yes. Thank you, management, for taking our questions on congratulations on the remarkable progress. This is Junjie from HSBC. I hope to have two questions on behalf of Rachel Huang. So our first question is on the service-related revenue, which had very strong growth. So, could you please help us break down the growth drivers? And do you think that this will become a significant source of revenue in the future?

And our second question is on the bottom line. So we can see that our non-GAAP net loss ratio has decreased significantly to 3.9% this quarter. We're just wondering on our progress, if this even will accelerate. Thank you very much. That's all my questions.

Gang Yu - Co-Founder and Executive Chairman

For your first question regarding services-related revenue, yes, we are offering services to our upstream and downstream partners, including the marketplace vendor services, online medical consultation, cloud and e-prescription services and digital commercialization to those pharmaceutical companies and also supply chain management, etc. We will continue to expand our services offering with the expansion of our S2B2C platform and also with the launch of more and more SaaS-based tools in this S2B2C platform.

Luke Chen - Chief Financial Officer

And Junjie, it's Luke. Let me answer your second question. Improving our bottom line will be a key focus for us going forward. In this quarter, we have already made strides in improving our margins as well as improve our internal operating efficiency. Now the efficiency came from many factors, showed our strong commitment and represented efforts in optimizing our offerings in the area like better assortment management, best pricing, lead operations and high efficiency of our BD team via application of our SMART tools. So we expected to see continued improvement in our net loss with a goal of breaking even within the next 12 to 18 months.

So Junjie, I hope we answered your questions.

Junjie Huang - HSBC - Analyst

Yes. Thank you very much management, very helpful.

Liu Junling - 1Co-founder, Chairman and CEO of Yaowang

Thank you, Junjie.

Operator

As there are no further questions, I'd now like to turn the call back over to the management for 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 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.

Operator

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111 INC

Q2 2021

Earnings Transcript

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