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; Dr. Junling Liu, Co-Founder, Chairman, and CEO; Dr. Luke Chen, CEO of 111’s Major Subsidiary; and Dr. Haihui Wang, COO. As a reminder, today’s conference call is being broadcast live via webcast. The company’s earnings press release was distributed earlier today and together with the earnings presentation are available on the company’s IR website. Before the conference call gets started, let me remind you that this call may contain forward-looking statements under the Safe Harbor Provisions Act. 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 RMD and all comparisons refer to year-over-year comparison unless otherwise stated. Please also refer to the earnings press release with detailed information of the comparative financial performance on a year-over-year basis. With this, I will turn the call over to 111’s CEO, Dr. Junling Liu.

Good evening and good morning. Thank you for joining our second quarter 2023 earnings call. The information that we’ll be discussing here is also provided in the slides that have been 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. I will begin by providing an overview of the macro environment followed by a review of our recent operational performance. Additionally, I will comment on our continued commitment to industrial digitization, driving revenue, fortifying upstream supply capabilities, enhancing operational efficiency and outlining our future strategies. Subsequently, our CFO, Mr. Luke Chen, will present a detailed analysis of our financial results, ensuring a thorough understanding of our organization’s financial standing. Now let me start with the macro situation in our industry. In the second quarter of 2023, the pharmaceutical retail market faced some challenges. According to statistics, the Q2 sales of retail pharmacies in 2023 reached RMB225.13 billion, marking a decline of 6.82% compared to Q1 of 2023, and a year-on-year decrease of 7.52% compared to Q2 of 2022. Looking at the broader picture, although the total sales volume of Q2 was somewhat more conservative, we feel lucky to be in the right sector. Despite the economic challenges presenting tests to the pharmaceutical retail market, the industry remains optimistic about the future, hoping for a steady rebound in the coming quarters. Amid the sweeping changes and initiatives of 2023, it’s evident that the government’s policies remained staunchly supportive over the digital evolution and the rejuvenation of the healthcare and the pharmaceutical sectors. Specifically, the notice on further improving the integration of designated retail pharmacies into outpatient unified management, issued by the National Medical Insurance Administration underscores a pivotal shift towards harnessing digital avenues to streamline the movement of prescription…

Our top-line and gross segment profit in the second quarter continued to grow. Total net revenues for the quarter grew 14% to RMB3.5 billion, and gross segment profit for the quarter grew 8% to RMB208 million. Top-line growth for the quarter was mainly attributable to our B2B segment revenue growth at 15% to RMB3.4 billion. The gross segment profit for B2B segment has increased by 12%, with gross segment margin at 5.6%. Our B2C segment revenue decreased 13% to RMB88.8 million with gross segment margin at 21.8%. Total operating expenses for the quarter decreased 8% to RMB249.3 million. As a percentage of net revenue, total operating expenses for the quarter were down to 7.2% from 8.9% as we continue to enhance our operating leverage and optimize our operational efficiency. Fulfillment expenses as a percentage of net revenue for the quarter was down to 2.7% from 2.9% in the same quarter of last year. Sales and marketing expenses as a percentage of net revenue for the quarter was 2.6%, down from 3.3% in the same quarter of last year. General and administrative expenses as a percentage of net revenues accounted for 1.1%, down from 1.3% in the same quarter of last year. Technology expenses accounted for 0.7% of net revenue, down from 1.1% in the same quarter last year. As a result, non-GAAP loss from operations narrowed to RMB17.2 million compared to RMB52.8 million in the same quarter of last year. As a percentage of net revenue, non-GAAP loss from operations decreased to 0.5% in the quarter from 1.7% in the same quarter of last year. Non-GAAP net loss attributable to ordinary shareholders was RMB33 million compared to RMB68.3 million in the same quarter of last year. As a percentage of net revenues, non-GAAP net loss attributable to ordinary shareholders decreased…

[Operator Instructions] Our first question today comes from Xipeng Feng with CICC. Please go ahead.

Hi, this is Xipeng from CICC. Thank you for taking my questions. Congratulations on to the company progress. Well, I have two questions actually. And my first question is about policy. There have been many changes in the downstream industry recently, such as national unified medical insurance coverage on retailing pharmacies. So what kind of impact does this policy have on the industry and 111? And this is my first question. Thanks.

Hi, Xipeng, thank you for the question. So obviously, you noticed and we noticed there is suddenly a pretty big change in our general population’s medical insurance. So for those people who do not understand the Chinese Medicare system. So anybody’s Medicare system is divided into two accounts. One account is called the personal account and the other account is called the unified account. And the recent change in the policies that used to be majority of the money is deposited into the personal account. And now it’s reversed. Majority of the money in the account has been distributed to the unified account, which means customers are not able to spend at their own discretion as before. Our understanding of the implications is such that, first of all, more and more pharmacies will be included in the group of pharmacies that can provide reimbursement services to customers. And those numbers will grow. We anticipate that a majority of the pharmacies will be entitled to provide the reimbursement services to their customers. And number two, the consumers’ personal account is reduced. So their ticket size will be somewhat reduced. This will also impact the pharmacy. Those are the negative impacts to pharmacies and to a certain degree to us. But we actually take this as a tremendous opportunity because what this will do is to drive a lot of traffic to pharmacies and because more and more pharmacies will be joining the group that can do the reimbursement services. And therefore, they need to purchase more drugs, they need to purchase more medicines. Furthermore, they have the opportunity to upsell their products and services. So this clearly is going to drive those pharmacies to enrich their offerings. They will have to introduce more categories and more services. So our understanding from the government is that there is a clear trend that the government is intending to separate the consultation from drug sales, which was the fundamental problem of the Chinese healthcare system. And it is not an easy reform as we understand but we are very encouraged to see the government’s determination to head towards this direction, which will be great news for the pharmacy sector and not necessarily the best news for the hospitals. I hope that answers your question, Xipeng.

Okay, thanks for the sharing. And my last question is about financials. As we noticed, the operating expense ratio of 111 has been decreasing. And I just wonder what is the main reason behind this trend and will that continue to decrease in the future or what’s the breakeven point of the company? Thanks.

Yes. That’s a great question, Xipeng. And actually, what drives the operating expenditures is just a few buckets, in a few areas, right? So what we’ve done in the past is we focused on revenue and margin growth. And once the revenue is bigger, and obviously, as a percentage of expenses, they were going to go down. And the other thing we did is really we were relentlessly driving operational efficiency. And your question is, will this continue? Absolutely. It will continue. Not only will it continue, I believe it will even get better. And as to breakeven point, our current projection is that once our revenue can hit RMB20 billion, and our margin stays at 6%, we should be a very profitable business. Thank you.

Okay, that’s very clear and helpful. Thanks for the sharing, and congratulations again on the company’s progress.

Thank you, Xipeng.

The next question comes from Jessie Lu with HSBC. Please go ahead.

Thank you for taking my question. And congratulations on a very solid quarter. So I have two questions. The first question is actually regarding competitive landscape. As Junling has mentioned, because of the recent regulatory changes, we have seen a more emphasis on the out-of-hospital channel, including the pharmacies. But at the same time, we do see a lot of the players mentioned they want to enter into this specific sector. So I want to get your thoughts on the revolving competitive landscape for the sector going forward. And in terms of competitive landscape – sorry, advantage. What competitive advantage does 111 have as compared with other players in the market? Thank you.

Yes. So obviously, any attractive business will attract a lot of competitors here in China. It’s an extremely competitive market. But we feel pretty good about where we are. If you look around the competitive landscape, I think our biggest competitor will have to be those traditional players because they take majority of the share over the past few decades. And – but our advantage is very, very clear. We are a digital player. And furthermore, we actually cover our end customers. We are not simply a distributor. And our digital capabilities would certainly give us the edge, especially when it comes to operational efficiency. As you can tell, our size in this industry is not that big yet. But we – even at this size, we already operate at a pretty efficient way, 6.3% of total OpEx is the current rate. And we believe by RMB20 billion size, we should be operating in the 5 or even sub-5 range of OpEx. And if there are newcomers and we believe there will be even more newcomers and we are very fortunate to enter this space over 10 years ago. We’ve already established ourselves as the leading digital player. And even with the reasonable sized competitors, I think we do a far better job than anybody in the industry when it comes to the small to medium-chain pharmacies. So that’s our bread and butter. And moving forward, of course, we will continue to invest in our digital capabilities, and we believe digital capabilities can drive really operational efficiency. And if we compare to new competitors, old competitors, even our potential future competitors, our clear competitive advantage is going to be our operational efficiency. Thank you.

Thank you. That is all very clear. Actually, my second question is also on the digital capability. I noticed you have started a partnership with Tencent. And at the same time, you mentioned you will be making full use of the medical data and to develop your own AI large language model. I just wonder if management can share more color in this sense, will you be self-developing or also work with Tencent and what kind of product can we look for? Thank you.

Okay. Thank you, Jessie. Let me take that question. First of all, the partnership with Tencent is in very sound progress. Several projects have been defined and been carried out by both teams. And certainly, the merit, the value of the partnership is very clear. We have very complementary strengths, right. Tencent has a very strong decent technology and computing power. And we have – we offer the application platform, all the scenarios and use cases and also we have the customer base. So certainly, these are very complementary in strength, and we certainly hope to create value together. And in these projects, basically we will leverage Tencent technology strength in cloud computing, big data and AI as you mentioned as well as the expertise in consumer internet services. Basically, we will try to support the digitization and upgrade our smart pharmacy retail data center and pharmaceutical sales software. We will also use very advanced technologies such as DSO priming [ph], cloud rendering, credit pharmaceutical retail showcases and management cockpit for 111. As for AI applications, certainly, these will use a lot of AI technology in the background. And we are not going to develop large language models. We are focused on specific applications in the healthcare industry.

I see. That’s very clear. Thank you so much for your answer and congratulations again on the solid results. Thank you.

The next question comes from Steven Lin, an individual investor. Please go ahead.

Thank you, management for the presentation. I have two questions. First, could you please talk more about Quentn [ph] software and the Telescope’s application and the impact? Second, how should I think about 111’s top-line growth in the next few quarters and what are the key drivers? Thank you.

I will take the first one and Haihui will take the second one. So, let me talk about the few products, digital products you mentioned, like Quentn, you mentioned Telescope, etcetera, okay. These are all digital products we developed to serve our customers, okay. For example, Telescope is a SaaS service to pharmaceutical companies. Basically, it’s used to help them monitor the entire supply chain, making the supply completely transparent. They include their product flow through various distribution and retail channels in various regions. The end customer profile, behavior as well as inventory turns and repurchase rates, etcetera, all of those data are made transparent to pharmaceutical companies. And these are used to facilitate their decisions in production, in new product development and in channel allocation. You also mentioned Quentn and Hot Whale [ph]. These are services to our JDP and the marketplace partners. They are used to assist them in more efficient, procurement and logistics. By leveraging these services, we have seen remarkable growth of GMV for these partners, much higher than our overall growth, like more than 40% higher for these partners. So, in turn, they help us to enrich our selection and price competitiveness, so it’s a win-win.

And regarding your second question on growth and also the growth drivers. I think first, from industry-wide as Junling just mentioned, the government strategy of separation of drug sales from the hospitals’ medical treatment is going on, including recently, as you may be aware, and there is also a national-wide anti-corruption in our medical area. So, the execution of the government strategy of separation definitely is very favorable to us as the separation of the drug sales from hospital, meaning it will go to the retail market. And the drug sales in hospital is, we are talking about RMB1.2 trillion, so the overall pharmaceutical retail will get benefits, including us. And also internally, first, we will continue to upgrade our supply chain. We will establish, further strengthen our direct strategy partnership with more and more international and domestic partners to bring more selection with lower and lower cost to our downstream customers. Secondly, we will enhance our digital marketing platform to help pharmaceutical companies to commercialize their new products to pharmacies, clinics and eventually to those patients and customers. So, in my view, our B2B business is becoming the platform to effectively link pharmaceutical companies with pharmacies, clinics and with the end users. Last year, the volume of China pharmacy retail has exceeded RMB600 billion. And as I have mentioned just now, more and more are moving out from hospitals. So, it’s a very, very big market and we believe we have enough room to further expand our business volume with a healthy margin. Thank you.

Okay. It’s very clear. I appreciate your answers.

The next question comes from Francis Juan with VSV Capital. Please go ahead.

Hi. This is Francis from VSV Capital. Congrats again on a great quarter. I have got two questions. The first one is what kind of assistance and impact does your company’s digital capabilities have on the industry. The second one, what will be the company’s operational focus going forward? Thank you.

Thank you, Francis. So, let me take the first question. We define ourselves as the digital enabler in the healthcare industry. We have invested heavily in the digitization of the industry in the areas for supply chain, patient education, medicine availability, patient reach and health management. We set our mission to leverage our digital technology to effectively link patients with the healthcare services, and we are on target – on track to realize that. Junling in his report, mentioned the listing of our 111 information on the Shanghai Data Exchange, that’s a perfect example. So, our master data in the pharmacy industry includes more than 720,000 main product data and 1.2 million company data, currently 99.6% of the whole pharmaceutical market. So, this data will play a very important role in drug flow tracking, drug initial information entry and the compliance for e-commerce pharmaceuticals.

And I will answer Francis’ second question with the operating focus. I would – in a very simple language, it would be two areas. One is to grow revenue and margin. And two is to really drive operational efficiency. If I could elaborate a little bit, how do we grow, as I spoke in my script, obviously, we are going to use JDP to enrich our selections. And for our first-party products, we want to get a much better alignment with customers’ preferences. Internally, we have built up an intelligent system called BeiGene, which collects information from our own internal daily operations and also the intelligence comes from our salespeople on the ground and also from industry-wide sources. And that would ensure that we can have a much better assortment, a much concise and precise assortment for our customers. Therefore, with that, we can provide a one-stop shop experience for our customers. And in terms of growing margin, of course, I spoke about our intelligent pricing system. And of course, in the past, we always used human to do the pricing. And now we are shifting majority of the pricing into machines. Let the machines learn and we feed the machine with all the necessary data and let the machine make the right choice. And if it is wrong, they can learn and readjust. And the other thing I mentioned about driving margin is to really bring cost down. And of course, we are solidifying our supplier base and our procurement team has a very clear specific task on reducing the procurement cost pretty much across the board. And we have internal meetings on a regular basis, at least weekly to look into those numbers. When it comes to drive operational efficiency, of course, we have only literally three buckets of expenses. One is fulfillment. The other one is sales and marketing and the last one is G&A. And obviously, I spoke a lot about fulfillment, and we have really proven the effectiveness of our measures and our fulfillment cost came down to 2.7% versus 2.9%. And obviously, when it comes to sales and marketing, we are doing a fantastic job there, very, very noticeable change in the G&A as well. So essentially, what we are doing is to really invest in technology. We use technology to become much, much more efficient. Once we can operate with sub-6 and sub-5 operational expenditures, we are already the industry’s best. If you look across the board, I don’t see anybody can operate at our rate of operating expenditure today. And we are not going to stop there. We are going to continue to bring the expenditures down. Therefore, we cannot actually be a much more profitable company. Thank you, Francis.

Thank you. Both answers are very clear and we look forward to hearing more.

The next question comes from Jada Wu [ph] with Arbor Group Capital. Please go ahead.

Hi everyone. This is Jada Wu from Arbor Group Capital and congratulations on the company’s success and growth in Q2. Here, I have got two questions. The first question is, what is a reasonable margin level in the next 3 years to 5 years? How can we further expect margin? Thank you.

Yes. Well, regarding margin, our strategy was more and more healthy business model and it has been working well. And we are seeing a significant improvement on our product margin. And there are a couple of initiatives going on in this area. One is to reduce our procurement cost through direct sourcing from pharmaceutical companies. And we are now sourced from over 500 global or domestic, those are big pharmaceutical companies. And we will continue to strengthen our partnership with them. And the second one is – the second lever is we can pull to improve margin is through our product assortment optimization. Currently, with the annual sales revenue of over RMB13 billion, also with the 400,000 pharmacies in our platform, we are now in a position to balance our portfolio of products and fund those high velocity, but low-margin products together with healthy ones. And also we are developing our OEM private-label products. For those product, the margin percentage is as high as 30% to 40%. And the third one is our digitalization part, our digital platform. For example, the Telescope, Junling just mentioned, provides a very comprehensive solution for pharmaceutical companies. And those services module help us to get more marketing dollars from those pharmaceutical companies. And last but not least, from the industry-wide and when I answered the previous question regarding growth, I talked about the revolution of our – the government strategy on medical services, the separation of medical treatment with – from the drug sales, these will bring actual sales to retail market from hospitals. While I believe not only in sales but also it will bring more marketing function to retail market, including patient education, DOT, etcetera. And these marketing functions will be a very good profit for 111 as we already have the very strong capability of digital marketing through our B2C, our B2B, our S2B2C model. Thank you.

Thank you for your sharing, it’s clear and helpful. And one more question. How was the cash flow situation in the second quarter for the company and what is the current cash position? Thank you.

Yes. On the cash position, first of all, we are very pleased to see that our non-GAAP operating loss further narrowed for the quarter to 0.5% of net revenue. But what does that mean, it means that we no longer need to burn cash to support our business. And if you look into deeper, this is a gain of good management on the working capitals, and we believe we are doing a good job and operating with high efficiency. Our accounts payable date is around 42 days to 45 days and our inventory days is about 25 days to 30 days, and our accounts receivable days is about 7 days, which give us like x days of working capital inflow. And while we further build up our business scale, we will be able to negotiate it in better trading terms with suppliers. As of June end, our cash and cash equivalent, restricted cash and short-term investments amounted to RMB736 million and we believe that we have sufficient cash reserves to support our business expansion. Thank you, Jada.

Thanks for the answer. We appreciate for your further performance. Thank you.

Thank you.

The next question comes from Ethan Ling with Iron Harbor Capital. Please go ahead.

Hi. Ethan Ling from Iron Harbor Capital. First of all, thank you for having me Q&A section today. I have a few questions. First is, what are the company’s plans for its OEM products in the future?

Okay. OEM products, there are a couple of private label registered in 111. We have Quentn is for our chain store customers and also Quentn Zhangjiang is for our individual store customers. And also there are also some other dietary supplements, etcetera, we call it [indiscernible]. And by Q2 this year, we already launched 133 private-label SKUs. And also there are much more SKUs have been in our pipeline. Most of these products have been well affected by our customers. And as you know, a majority of our customers are individual stores or those small to medium chain stores, they don’t have the capability to establish their own brand. However, those – the top players, those Kaa, retail stores, every one of them has a very strong performance on their own private label. So, that is a very strong demand from our customers following the private label. So, Zhangjiang [indiscernible] has become a very attractive solution for them for a very stable market and a very stable margin. Thank you.

Thank you for answering. And my next question is, what is the current progress for the company’s privatization?

Yes. We understand the process of privatization is still ongoing. As you may be aware, on July 17th, the company announced the expansion of the Bayer’s Group. So, the special committee formed by three independent directors is now working with the Bayer Group on the privatization proposal. As a public company, we will – we shall make all necessary public announcements according to SEC disclosure rules.

Thank you. That’s all the questions I have today.

This concludes our question-and-answer session. In closing, on behalf of the entire 111 management team, I would 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 111 in Shanghai, China, please let the company know. Thank you for joining us on the call today. This concludes the call. You may now disconnect.