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111, Inc. (NASDAQ:YI)
Q2 2019 Earnings Call
August 15, 7:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Hello, ladies and gentlemen. Thank you for standing by for 111 Inc.'s second quarter 2019 earnings conference call. At this time, all participants are in listen-only mode. After management's prepared remarks, there will be a question and answer session. As a reminder, today's conference call is being recorded.

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

Tip Fleming -- Christensen & Associates

Thank you, Operator. Hello, everyone. Thank you for joining us today for 111's second quarter 2019 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 are Dr. Gang Yu, Co-Founder and Executive Chairman, Mr. Junling Liu, Co-Founder, Chairman, and CEO, Mr. Luke Chen, Chief Financial Officer, Mr. Harvey Wang, Co-COO, Mr. Barry Zhu, Co-COO, and Miss Monica Mu, Investor Relations, and Mr. Alex Liu, Finance Director. Junling will give an overview of the company's performance and operations, followed by Luke, who will discuss financials and guidance. They will be available to answer questions during the Q&A session that follows.

I have to remind you that this call may contain forward-looking statements made under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements are based upon management's current expectations and current market and operating conditions and relate to events that involve known and unknown risks, uncertainties, and other factors, all of which could 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 take any obligation to update any forward-looking statement as a result of new information in future events or otherwise, except as required under applicable law.

With that, it is now my pleasure to introduce Mr. Junling Liu. Junling, please go ahead.

Junling Liu -- Co-Founder, Chairman, and Chief Executive Officer

Thank you, Tip. Thanks, everyone for joining our second quarter 2019 results discussion. My comments will correspond to the slides which we posted with our press release earlier today on the investor relations section of our website. If you have not already done so, I would encourage you to download the slides at ir.111.com.cn.

Let me begin by sharing our key financial and operating metrics for the second quarter. Our net revenue was up 109.2% year-over-year and 27.8% quarter-over-quarter to 838.2 million RMB, which exceeded the high end of our guidance for the third consecutive quarter. The overall growth rate hit a record high since our IPO last September and we have actually been seeing an acceleration in our growth. Gross profit was 42 million RMB, which was an all-time high for us and an increase of 72% year-over-year and 26.5% quarter-over-quarter.

Turning to slide six, our overall revenue growth was mainly attributable to the robust performance of our B2B segment. Since our IPO, due to the existing revenues from both existing and newly added pharmacies, our B2B revenue has been expanding at approximately 40% for three consecutive quarters. It was up 253.4% year-over-year and 41.4% quarter-over-quarter to 649.9 million RMB this past quarter.

This acceleration revenue growth is underpinned by three factors. First, we are rapidly expanding purpose pharmacy client base. As shown on slide six and seven, during the quarter, we added 20,000 pharmacies into our virtual pharmacy network, generating 76 million RMB of additional income and increasing revenue by 16.5% for the quarter. At the end of June, we were serving more than 190,000 pharmacies, a number consistent with our goal of reaching 230,000 pharmacies by the end of 2019.

Second, we enhanced customers picking us. During the quarter, we processed 193,000 orders, which was 52,000 more than last quarter and a new high. Furthermore, we noticed our existing pharmacy customers placed orders more frequently. This attributed an additional 114 million RMB to revenue, representing 24.9% revenue growth compared with Q1.

Third, on slide eight, we further deepened and widened our cooperation with upstream pharmaceutical companies by strengthening an increasing efficiency and transparency through our advanced proprietary technology.

We believe the 4+7 pilot scheme over the centralized urban pharmaceutical procurement policy will be rolled out across the board and many pharmaceutical companies will be facing a series of challenges, including lower prices, restrictions on existing distribution channels, and so on. They will have a genuine need to develop new distribution strategies and channels. To help them succeed in their diversification efforts, we have developed a highly effective suite of services that will help us grow our client base. I will describe this more a little later.

As of June 30th, 2019, we were sourcing directly from 124 domestic and international pharmaceutical companies, which was up 100% year-over-year. Specific examples are our recent strategic partnership with Tong Ren Tang Technologies, which is listed in Hong Kong under the ticker 1666, and with Harbin Pharmaceutical Group Holding Co. Limited, which is listed in Shanghai under the ticker 600664. The partnership with Harbin Pharmaceutical for exclusive online sales of its OTC product is based on a new supply chain service model, which delivers effective channel and price management.

Now, let's take a look at our B2C business, starting with slide nine. In the recent past, we have deliberately decided to move away from the traditional way of B2C by burning marketing dollars to acquire online traffic and grow the business. Instead, we have decided to focus on building a sustainable business. For instance, we started to focus on medical-type users rather than consumer-type users and we shifted money-losing categories to the marketplace, replacing them with high-margin selections.

Further, we're spending more on enhancing our professional medical services to build a better customer experience and have deployed more precision marketing tools. As a result, while revenue decreased by 13.7% to 183 million RMB, gross profit hit an all-time high at 31 million RMB. Gross margin significantly improved to 16.8%, up from 9.5% a year ago and 13.2% last quarter. We're pleased with our progress so far and we will continue to explore growth on a sustainable basis.

I will now take you through our B2C strategy that underpins our long-stated aim of building the largest integrated online and offline healthcare platform. As you can see on slide 11, we leveraged our advanced and proprietary technologies to enable pharmacies, pharmaceutical companies, insurance companies, and doctors to better service end users.

First and foremost, on slide 12, our B2C business model enables pharmacies. As mentioned previously, we are aiming to include 230,000 pharmacies into our virtual network by the end of 2019. In addition to selling products to them, we'll help them solve their critical pain points by providing a series of applications and solutions, included cloud doctors, e-prescriptions, assortment management, CRM, and so on. For example, we provide just-in-time inventory management to reduce their turnover days and improve efficiency.

Because there are hundreds and thousands of transactions occurring on our network every day on both the business and the consumer side, we collect abundant customer and prescription data so that we can tell our pharmacy customers what are the best sellers in our geography and provide them with one quick solution to order those popular products from us.

Second, on slide 13, to fully leverage this data for the benefit of pharmaceutical companies, we have developed an integrated platform for all online sales for providing smart supply chain services, channel and price management, data services, customer insights, marketing, and retail management. For example, the PRS system helps us track prices across this country, which not only helps us form a better price strategy, but also can be a data service to pharmaceutical companies. Third, our B2C business model also enables insurance companies.

Now, let's turn to slide 14. In the second quarter, we have set up an insurance business unit that integrates resources with insurance companies to provide insurance users with online consultation, drug purchase, prescription refill management, insurance payment, health monitoring, and patient management services while we have also strengthened our PBM model. On May 24th, we entered into a strategic partnership with MSH, a world leader in the design and management of international healthcare solutions.

Last but not least, on slide 15, we enable doctors to provide better and more effective care to their patients with a suite of services. For example, we provide multi-site practice opportunities to doctors so that they can serve more patients and build a prescription outflow platform to facilitate patient medication services. We also offer e-medical record and the CRM solutions to enable effective patient management, which helps strengthen patient relationships with their doctors.

By bringing together patients, insurance companies, doctors, pharmacies, and pharmaceutical companies, we are building a powerful, mutually beneficially, and self-reinforcing ecosystem that benefits all parties. It will help us build a stronger and more profitable business that delivers growing shareholder value.

With the continued growth of the business, our core capabilities in smart supply chain, cloud-based solutions, big data, and medical expertise are getting stronger all the time. With a strong conviction of our mission and the foundation we have laid, we're well on our way to build a robust online and offline healthcare platform in China.

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

Luke Chen -- Chief Financial Officer

Thank you, Jungling. Moving to the financials, you can see the details for the second quarter in section three of our presentation on slide 18s to 20. I would like to highlight a few key business and financial measures and focus on year-over-year comparisons. All numbers are in RMB unless otherwise stated.

Let's start with our topline performance -- net revenues increased 109.2% to 838.2 million RMB. Revenue from our B2B segment were up 253.4% to 649.9 million RMB from 183.9 million, and prior revenue from our B2C segment decreased 13.7% to 183 million RMB from 212.1 million RMB.

Turning to slide 19, gross margin in our B2C segment was 16.8%, up from 9.5% in the same quarter last year and 13.2% last quarter. Gross margin in our B2B segment was 1% compared with 0.2% in the same quarter last year and 0.9% last quarter. The improvement in both the B2B and the B2C segments were primary due to improving cost structure and pricing strategy.

Overall, gross profit increased by 72% to 42 million RMB and gross margin was 5% compared with 6.1% in the same quarter last year and 5.1% the last quarter. The decrease was mainly due to the higher proportion of B2B segment revenue, which has a lower gross margin to total revenue. Please turn to slide 20 for a detailed breakdown of operating expenses.

Total operating expenses were up 18.5% to 142.9 million. As a percentage of net revenue, total operating expenses were 17.1%, down from 30.1% in the same quarter last year and down by 410 bps quarter of quarter. Fulfillment expenses increased 62.1% to 27.4 million RMB, primarily as a result of growth in our B2B business and investment in our new fulfillment centers. Fulfillment as a percentage of net revenue was 3.3%, down from 4.2%.

Finally, the marketing expenses increased 20% to 75 million RMB, mainly due to the increase in number of sales staff and expenses associated with extensions of our B2B business. Sales and marketing expenses as a percentage of net revenue were 8.9%, down from 15.6%. G&A expenses increased 18.8% to 28.5 million RMB, mainly due to increase in managerial staff and share-based compensation expenses. G&A expenses as a percentage of net revenue was 3.4%, down from 6%.

Technology expenses decreased 29.7% to 12.3 million RMB, primarily due to improvement of our system development efficiency and implementation of automation tools. Technology expenses accounted for 1.5% of net revenue, down from 4.4%.

Net loss attributable to ordinary shareholder was 100.2 million RMB compared with 86.4 million RMB in the same quarter last year. GAAP net loss attributable to ordinary shareholders were 84.7 billion RMB, up from 74.8 million RMB in the same quarter last year, showing improvement from 96.3 million RMB last quarter.

GAAP net loss attributable to ordinary shareholders accounted for 10.1% of net revenue, down 806 bps from 18.7% in the same period last year and down from 460 bps from 14.7% last quarter. As of June 30th, 2019, we had cash and cash equivalents, receipt of cash, and shorter investment totaled 987.2 million RMB compared with 1.1 billion RMB as of December 31st, 2018.

For the third quarter of 2019, we expect total net revenues to be between 1 billion RMB and 1.05 billion RMB, representing year-over-year growth of approximately 101% to 111%. This forecast is based on current market conditions and reflects our current and preliminary market and operating conditions and customer demand, which are all subject to change.

The company's board of directors has authorized a share repurchase program, under which the company may repurchase its own ordinary shares in the form of American depository shares, ADS, with value of up to $10 million within the next 12 months. The company expects to fund the repurchase from its existing cash balance. The share repurchase program may be limited or terminated at any time without prior notice.

Under the share repurchase program, the company may repurchase its ADS through open market transactions and the prevailing market price in privately negotiated transactions, depending on a number of factors, including but not limited to price, trading volume, and general market conditions along with the company's working capital requirements, general business conditions and other factors, as well as subject to applicable rules, Rule 10b5-1 and our rule 10b18 under the Securities Exchange Act of 1934 as amended.

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

Questions and Answers:

Operator

Certainly. Ladies and gentlemen, we will now begin the question and answer session. If you wish to ask a question, you will need to press *1 on your telephone keypad and wait for your name to be announced. If you wish to cancel your request, you need to press the # key.

The first question comes from the line of Sherry Yin from JP Morgan. Please go ahead.

Sherry Yin -- JP Morgan -- Analyst

Congratulations on the good second quarter results. I have three questions. The first question is about our B2B business. We are encouraged to see the strong same-store growth or the ARPU growth of 25% sequentially. Could you share your outlook for the second half? Can we maintain this above 20% Q on Q growth for ARPU or could you share some guidance about our target ARPU in the next one to two years?

My second question is about the restructuring of our B2C business. We mentioned in previous quarters that we are now targeting the medical users, especially those high-value chronic disease users. Could you share about your latest actions on targeting these clients? We also understand a lot of other online healthcare competitors are also having some initiatives to target the chronic disease patients. How do we differentiate our service versus other competitors?

My third question is about our collaboration with the insurance companies like MSH. Do we expect the PPM type of service to become a key revenue contributor in the next few years? That's all of my questions. Thank you.

Junling Liu -- Co-Founder, Chairman, and Chief Executive Officer

Thank you, Sherry for the questions. I think what I would do is I'll answer the questions one and two. I'll let Luke answer your third question on insurance partnerships. With regard to the B2B business, we're very pleased to see the momentum. As a practice, we don't provide precise guidance for too long in the future. I can share with you here that the business is growing, the momentum is very strong and it is our anticipation that for the second half, we will remain a pretty strong growth rate.

With regard to the B2C business, that's a great question. As a matter of fact, I think that management is very pleased with where things are because we underwent a huge effort to restructure that business. We moved away from the traditional ways of doing B2C, i.e. to burn very expensive marketing dollars to chase traffic. As you can understand today, the online traffic is getting more and more expensive.

If you look into this business, it has its own characteristics. We don't believe that the traditional weight of e-commerce is the right way to do business here. In the traditional way of e-commerce, the consumer is the decision maker and also the payer. Whereas in our situation, the patient is the consumer, but he or she may not be the decision maker. The doctor is likely to be the decision maker. Also, he or she may not be the payer because the social insurance will play a role there.

Therefore, we moved away from that traditional B2C model. We don't want to grow the business for the sake of growing. Many companies can actually buy revenue. So, we moved away from some of the categories and we stopped serving some of the money-losing strategies and focused on more of the lifetime value customers.

So, your question about the model, the chronic patients, we have made a number of initiatives. For instance, we built a doctor's platform, where we could create a private traffic management tool for doctors so over the years, the doctor could accumulate a lot of those patients and those patients could be operated and managed by us on the social media tools and so on. This way, we can actually service the doctors to enable them to better service the end users.

We have also built partnerships with insurance companies, which Luke is going to talk about in a minute. Also, we have built many partnerships with pharmaceutical companies, especially those affected by the 4+7 policy. That policy is likely expected to be implemented this year. There are still customers looking for the original manufactured drugs and so on.

If you look at the difference between our model and all the rest of the players, the real differentiation will be that we are not purely an e-commerce play anymore. What we do is we focus on the customer's lifetime value management.

I'll give you an example -- if somebody's buying a cardiovascular medicine, immediately we'll know this customer is going to have a likelihood of getting into other diseases in future stages of his or her life. Let's say it can get into diabetes. Even when you get into diabetes, there are many stages you have to go through before you can use insulin. We can absolutely intervene the customer's chronic condition management. We have applications out with our technology on patient education on the automatic refill of their drugs and so on. So, with good compliance management, we can better service the consumers.

So, if you look at this healthcare market, we are talking a multi-trillion-yuan market. We just got things started. We believed in our model, which is integrated online and offline. Not only do we acquire customers and service consumers directly, but also, we're working in partnerships with the pharmaceutical companies, the doctors, the pharmacies, and so on. Obviously, that would be our key differentiation from other players in the market. Luke, you may want to address the third question.

Luke Chen -- Chief Financial Officer

Yeah. The partnership with insurance companies is part of our T2B2C model. When you think about insurance companies, they have thousands, even millions of patients. It's our belief that commercial medical insurance will prevail in China if you think about the shortage of government-sponsored medical insurance.

So, for the commercial medical insurance to succeed in this country, client control, cloud usage is extremely important. We are ideally positioned because we deal with pharmaceutical companies, we deal with pharmacies. In the project, we are currently working with Manulife-Sinochem and MSH. The service we provide to them is we are their designated drug purchase platform, especially for their chronic disease patients. They need to refill their drugs time from time and we help them. We also help them to control the drug costs.

We are working to design the new insurance products in terms of the drug adherence, effectiveness, as well as health management for those chronic disease patients. We think the PBM model will work, but we cannot make it happen ourselves. That is why I think we line up pharmacies, line up users, patients, line up insurance companies. We are very positive in talks with other insurance companies as well because we have the online consultation diagnosis capability, but we have the drug prescription and delivery capability, we have house management capability.

I think we can help the patient to get the right drug at affordable prices and we can also help insurance companies to control their costs and help them to manage their chronic disease patient. I think it will be a win-win situation for all the parties. We're not able to make it happen by ourselves alone. We will make it happen all together with all the players in the ecosystem.

Junling Liu -- Co-Founder, Chairman, and Chief Executive Officer

Let me add another point -- another partnership with insurance companies is to design new insurance products based on our big data. That way, we know precisely the customer profile and the behavior and we have statistical data on our customers and we can design specific products for insurance customers.

Sherry Yin -- JP Morgan -- Analyst

Thank you very much. That's very clear.

Operator

The next question comes from the line of [inaudible] from DH Capital. Please go ahead.

Unknown Analyst -- DH Capital -- Analyst

My question is what progress has been done regarding your business model of empowering service through technology? Thanks.

Luke Chen -- Chief Financial Officer

We have done quite a lot. We have built a T2B2C model using technology to enable businesses to serve customers. Certainly, at this point in time, we are not in a hurry to monetize our services. But instead, we use all these technology services to have a deeper engagement with pharmaceutical companies, with insurance companies, have more stickiness with our pharmacy clients.

For example, the pharmaceutical companies use our supply chain service to have a deeper coverage, a broader coverage, deeper penetration, use our marketing service to launch new products to our data service to understand customer profile and behavior. Also, we use our cloud inventory service to help our pharmacy clients to do a selection expansion to better service their customers to speed up their unit returns.

We also collaborate and design new insurance policies for our clients. Those are all based on data service, supply chain service, and our technology services. I can give you an example. Eli Lilly uses our supply chain service to distribute insulin pens to all the diabetes patients.

Operator

The next question comes from the line of Zhiqiang Xing from CICC. Please go ahead.

Zhiqiang Xing -- CICC -- Analyst

Thanks for the management team. The slides mention that T2B2C model to enable doctors. I have one little question on this -- as I know, Ping An Healthcare and Technology has recently launched a new program named Private Doctor, which focuses on providing private doctors for the family, like in many western countries. So, I'm wondering what are the strengths of advantages of our T2B2C model to enable doctors when compared to Ping An's private doctor program?

Junling Liu -- Co-Founder, Chairman, and Chief Executive Officer

We noticed Ping An launching that service and good for them. We take an approach that is very different from other players in the market. So, we have repeatedly stated our model is not a pure B2C model. Nobody in the market has built out a network or footprint of 190,000 pharmacies across the country. Obviously, we have built out as good a practice and technology servicing consumers directly.

Our objective is to enable those pharmacies with our B2C capabilities so that they can better service their consumers. Obviously, we would be in many models out there in the market. It's early days. We have conviction to our mission and strategy and we're going to stick to our own policies. Thank you.

Luke Chen -- Chief Financial Officer

Let me give an example. With our technology based on our data, based on our systems -- for example, our CRM system helps doctors with the refill. With our CRM system, the refill rate reached 50% to 70%. That's tremendous progress by using our systems.

Operator

Once again, if you wish to ask a question, please press * on your telephone keypad and wait for your name to be announced. If you wish to cancel your request, please press # key. Next question comes from the line of Jun Huang from UBS. Please go ahead.

Jun Huang -- UBS -- Analyst

First off, congratulations on the very good results. I hope to ask a question on behalf of Rachel Yang. Could you please briefly talk about the progress on the online sales of prescription drugs and how do you see the progress in the future? Thank you.

Junling Liu -- Co-Founder, Chairman, and Chief Executive Officer

First of all, let me state that we are one of the very few companies out there in China with fully compliant practices in the space. Secondly, we have seen the state council issued many, many policies, including delivering drugs through online channels. As a company, we are very flattered to be invited to participate in the policymaking by CSVA, especially with regard to the online sales of drugs. It is our anticipation that even more favorable policies will be made available to online players like ourselves in the near future.

Operator

One again, if you wish to ask a question, press *1 on your telephone keypad and wait for your name to be announced. As there are no further questions, I would like to hand the call back to Tip.

Tip Fleming -- Christensen & Associates

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

Operator

Ladies and gentlemen, that does conclude your conference for today. Thank you for participating. You may all disconnect now.

Duration: 40 minutes

Call participants:

Tip Fleming -- Christensen & Associates

Junling Liu -- Co-Founder, Chairman, and Chief Executive Officer

Luke Chen -- Chief Financial Officer

Sherry Yin -- JP Morgan -- Analyst

Unknown Analyst -- DH Capital -- Analyst

Zhiqiang Xing -- CICC -- Analyst

Jun Huang -- UBS -- Analyst

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