Ladies and gentlemen, thank you for standing by and welcome to the First Quarter 2019 Earnings Conference Call. At this time, all participants are in listen-only mode. There will be a presentation followed by a question-and-answer session. [Operator Instructions] I must advise you that this conference call is being recorded today, the 16th of May, 2019. I would now like to hand the conference over to our first speaker today. Tip, please take over.

Thank you, operator. This is Tip Fleming from Christensen. Hello, everyone and thank you for joining us today for 111's first 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 via the news wires. Also, on the IR website is a PowerPoint presentation that accompanies that comments today. If you have not already done so, please feel free to download it now. It will make it easier for to you follow management’s remarks. 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; and Mr. Barry Zhu, Co-COO. Junling will provide an overview of the company's highlights and business operations, followed by Luke, who will discuss the financials and guidance. They will be available to answer your questions during the Q&A session that follows. I 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 Exchange Act of 1934 as amended as well as defined in the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements can be identified by terminologies such as will, expects, anticipates, future, intends, plans, believes, estimates, targets, confidence, and other similar statements. Among other things, the business outlook and quotations for management in this announcement as well as the company's strategic and operational plans contains forward-looking statements. The company may also make written or oral forward-looking statements in its periodic reports to the U.S. Securities and Exchange Commission and its annual report to shareholders in press releases, in…

Thank you, Tip. Hello, everyone. In reviewing our strong Q1 performance, I'd like to emphasize a few key points. First and foremost, our net revenue was up 98.5% year-over-year at RMB 655.6 million and up 17.6% quarter-over-quarter, exceeding the high-end of our guidance. This growth was driven by a robust performance in our B2B segment. Gross profit improved significantly as well, up 43.9% from the fourth quarter 2018 with improvement in both B2C and B2B segments. Second, let's take a closer look at the growth in our B2B segment on Slide 4. Over the past few quarters, we kept a fast pace, acquiring new pharmacy customers. In the first quarter of 2019, we added 20,000 pharmacies into our virtual pharmacy network and are now serving 170,000 pharmacies. Our goal is to reach 230,000 pharmacies by the end of 2019, about 50% of the total number of retail pharmacies in the domestic market. During the quarter, we processed 141,650 orders with a compound quarterly growth rate of 60.7% since the first quarter of last year. This increase was primarily due to the competitive advantage we have with our Smart Sourcing System and Price Intelligence System. Our Smart Sourcing System proactively tracks products and monitors competitor prices using big data technology. The Price Intelligence System has automatic pricing tracking and the pricing functions to ensure that pharmacy customers are provided with the most cost-effective products. As a result of the expanding number of pharmacies and the increasing total number of orders, our B2B revenue was up 246.5% year-over-year and 39.2% quarter-over-quarter at RMB 459.5 million. Between the first quarter of 2018 and the first quarter of 2019, the compound quarterly growth rate of revenue in our B2B segment was 36.4%. Third, during the quarter, we have made further progress in building our…

Thank you, Junling. If you have not already done so, I would encourage you to download the financial slides we posted concurrently with our press release earlier today in the investor relations section of our website. So moving to the financials, the details for the first quarter 2019 ended March 31, 2019 have been published in our earnings release and you can see them in section two of this presentation in slides 8 to 12. I would like to highlight the key business and financial matrix and our focus on year-over-year comparisons with all numbers in renminbi unless otherwise stated. In the first quarter of 2019, net revenues increase 98.5% to RMB 650.6 million. Product revenue from our B2B segment was up 246.5% to RMB 459.5 million from RMB 132.6 million. Product revenues from our B2C segment decreased 1.1% to RMB 192.3 million from RMB 194.4 million. Turning to Slide 10, gross profit in the quarter decreased by 19.1% to RMB 33.3 million and the gross margin was 4.1% for the quarter as compared to 12.5% in the same quarter last year. The decrease was mainly due to the margin decrease in our B2B segment. Gross margin in our B2B segment was 0.9% this quarter, as compared to 6% in the same quarter last year, which was primarily due to our investment to rapidly expand our B2B business. However, gross margin for both segments has improved substantially this quarter as compared to the previous quarter. Turning to Slide 11 for a detailed breakdown of operating expenses – total operating expenses were up 67.8% to RMB 139.8 million. As a percentage of net revenue, total operating expenses were 21.2%, down from 25.4% in the same quarter last year. We have seen this scaling effect. Fulfillment expenses increased 48.4% to RMB 21.2…

Certainly, sir. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] We have our first question coming from the line of Erdong Hua from 6 Dimensions. Please go ahead.

Thanks, Junling and Luke for an update. This is Erdong Hua from 6 Dimensions Capital. I have two questions, actually. Number one is what is your views of the private and commercial health insurance development in China and what role can 111 play? Number two is as Junling just mentioned, in terms of the healthcare delivery, China is in the process of transforming from a hospital and doctor-centric model to a patient-centric model. So, could you please elaborate on your comments about the patient-centric model? Thanks.

Thank you, Erdong. And let me just address the first question on the private or commercial health insurance in China. I think one can safely bet that this will be experiencing a rapid growth in the next few years as we have spoken to many different healthcare insurance providers because the state will primarily want the Medicare or the state-run Medicare to provide the most basic care and primary care to its citizens. And there are many incentives out there from government policy, including tax reductions if you purchase commercial insurance. And obviously, we are very uniquely positioned in the space given the capabilities we have today. Every single insurance provider we have spoken to all require or would like to look for partners who can help them to do expenditure management. And we're in the position to be able to provide a transparent full visibility from drug purchasing to the prescription appropriateness to the individual patient management, lifecycle management. And I think this is going to be a major area for us to focus in the foreseeable future. And we are very bullish on the development in this space and we have already made that investment with a dedicated team. So, we want to take advantage of this rapid growth opportunity. With regards to your second question, what I mean by a patient-centric model. As everybody understands in China today, the only way for you to receive Medicare or healthcare is to visit the hospital to queue up to get a registration number and you see a doctor who will spend a few minutes with you and then give you the prescriptions or give you a whole bunch of tests and then eventually give you prescriptions and so on. That is basically the only way. There aren't that many…

Thank you, very clear and helpful.

[Operator Instructions] We have our next question coming from the line of Leon Chik from JPMorgan. Please go ahead.

Hi. Congratulations on the results. So can you just walk us through the marketing expenses? It's up 82% year-on-year. However, I believe that you're not really adding to your salesforce. So, just trying to look toward the rest of the year and going forward, how should we expect marketing sales to grow – marketing expense to grow in the next few quarters and also next year? Thanks.

Thank you, Leon. Yes, the sales and marketing expenses for the quarter is around RMB 75 million. If you’re looking back for quarter three last year, the sales and marketing is around RMB 77 million and quarter four, it’s RMB 78 million. Although, if you compare year-over-year with first quarter last year, it seems to increase substantially, but if you recall that in the first quarter last year, we just kicked off the B2B business expansion, right. So we believe our team is expecting there and we will be able to continue to keep that level of investment and then continue expansion on the topline. As a percentage of net revenue, sales and marketing will continue to go down. But we don’t expect to adding more and more marketing expenses in this regard.

Great. If I may just add a follow-up, so I roughly estimate your annual ARPU, like revenue per drug store as about RMB 12,000. So that’s a pretty big improvement from the same period last year. Can you just walk us through maybe after you sign a new drug store, typically what happens? As they get used to your platform, how does the growth per customer can be achieved over time? Thanks.

Sure. Our COO, Harvey is going to take on this question.

Thanks for the question. For a typical customer, for example, like path on that all once as long as they register in our ATP and we need to exchange a couple of certificates, and so which is required by the law. And after that, normally, they will place a small order. The order volume is about RMB 1,000 to RMB 1,500 as the first order. Normally, it’s about 3 to 4 SKU. And after that, the next – in about two days or even less than two days, probably the next day, they will receive the goods and after that, normally within the next week, they will continue to place the second order. And the order quantity, as well as the volume of the order will continue to increase up as the time goes on and as they familiar with our platform, familiar with our product. So we are seeing the typical customer, their ARPU will increase about two to three times in two months.

How about like a year after? I mean what – I mean like from the first two months to, say, a year later, I mean what typically happens to the – is it still a very small part of the purchase, right? So we just want to see how they ramp up in terms of buying more stuff from you guys.

For very early stage, I think about one year ago, actually, we haven’t really saw the so called single-store pharmacy business. At that time, they were chain stores. And as I remember, based on the record, in about six months, for a typical one job more customer, they are purchase on a ARPU about four to five times compared to their first month.

Leon, that’s a good question. And in the real world, obviously, we are in the very aggressive mode of acquiring new customers. There will be attrition because once we finish the initial order paperwork to clear all the obstacles to have an order placed or to have an order fulfilled, they will forget about us and our sales team would have moved on. Obviously, we have a pretty good CRM system and we track some of the customers who went dormant. We need to have wake up programs and so on. So our anticipation is not on the quarter-over-quarter basis at a grand scheme of pictures. The [indiscernible] will grow on a quarter-over-quarter basis. Even though, let’s say, Q1 versus Q4 is a down quarter, we still showed a pretty strong growth from Q1 over Q4, given we have almost a month off in Q1 during the Chinese New Year. Obviously, at a grand scheme level, we expect growing very nicely. We’re anticipating that will continue to grow. Once we finish the acquisition priority by the end of this year, we will have 230,000 and obviously, we’re going to be turning back to make sure that all of those who have signed on, we need to make sure that every single one of them get activated. Our focus by then will be making sure that all of them are going to be active and also, we need to look into different geographies and how we can gear up their [indiscernible] In other words, we would rather use a terminology like shared wallet to measure how we are progressing in relation to whatever they need and whatever services we’re providing. Thank goodness we have all the technology to actually get a better view of what they truly need and how technology can give us the guidance on what type of assortment management we need to have based on the customers in different geographies.

Great. Well, hopefully we can continue to see growing. Thanks.

Thank you. We have our next question coming from the line of [indiscernible] from Citibank. Please go ahead.

Hello. Can you hear me.

Yes. Go ahead.

Hi. This is John call from Citi. Thanks for the presentation. I have just a few questions. Let’s start with the first two easy ones and then I have two follow-up questions on the business model. And thanks for taking my question. First of all, could the management clarify a little bit on what are the medical-type customers? Could you give me a granular breakdown on these customers? Who are they, really? Because I actually want to see what is the breakdown of pharmacies and hospitals. And please elaborate on that. The second clarification that I have is what is the room for the operating leverage? I’m seeing a good trend that the margins are getting better. What should we expect from the future trend from now and on? And that’s the second question. And two follow-up questions on the business model. Could you please compare the rest of the market competitors? Do any of them specifically have a similar integrated B&C platform they are using right now, business plus consumer? Could you please elaborate on what’s the difference between the competitors and us? Beyond that, I would like to ask a follow-up question on our business end. On our business, I see the smaller retail pharmacies are facing competition from larger retail pharmacy chains and they have the choice to actually collaborate with us or get themselves consolidated. When they make the decision to either get acquired or work with us, what is actually on their mind? Please elaborate on that. Thank you.

Thank you, John. Great set of questions. Maybe I'll have a shot first and then see if my team has other comments. So with regard to your first question on the typical customer profile, we don't really work to service the biggest chains. If you take away all the big guys out there in the market who has pretty much all the capabilities they think they needed to have, a typical customer would be a small chain, would be a stand-alone store. Because if you look at their challenges today, they have to have a sales team. They have to buy from a whole heap of distributors. The prices they buy usually are fairly lousy because they simply do not have the reach to even get to the Tier 1 or Tier 2 distributors, let alone the pharmaceutical companies. And their inventory days on hand is actually pretty high. Based on our research, if you have a 180 days, that is actually pretty good because we have seen 300 days, 400 days, et cetera. And the service we actually offered to those pharmacies, the first service we offered to them is actually inventory on demand. Basically, we move all the inventory over the cloud. It's just like companies like us, today, we don't actually have our servers anymore. We put all of our servers, our storage into Ali Cloud and Ali buys all the servers and all the storage and so on. So, it's a similar concept except we actually do it in a harder way and we've got to have our supply chain to support us in doing that. By having access to that service, we create tremendous value for those little guys. And if you look at the market landscape, there are 450,000 pharmacies out there. More than…

John, let me add on to the operating leverage. So the total expenses as a potential net revenue for this quarter is around like at 21.2%. If you look at our top line growth quarter-over-quarter is around 36%. So, we believe we will continue that trend. Internally, we think as a potential of net revenue, the total operating expenses will continue down, hopefully every quarter by 1% or 2%. Then we will probably stay at like fourth quarter, something around 15%. That’s a rough estimate. So, we will see because in the past, we already see very significant leverage when the revenue is up. The operating leverage is very clear in this business model. Back to your first question, I know you’re talking about, because our B2C business, we continue to put a lot of emphasis on our B2C business, but the way we do it is very different from the previous. We focus more on those high-quality medical-type consumers. Where we took medical types. We’re looking at disease type, we keep them on disease type and we offer them the chronic disease management. We’re not doing those like price promotion, online marketing, you want to try those consumer-type they’re shucking [ph] one time. So that’s the difference we’re talking about.

John, thank you for your questions.

Very clear. Thank you very much.

Thank you. We have our next question coming from the line of Rachal Yang from UBS. Please go ahead.

Hello, Hello, sorry I was muted. Thanks for taking my questions. Actually, I have three questions. The first one is related to the regulatory change. As we know, the GPO practice has been in place for at least two months. So, as per management, do you see any change on the retail market as we are into the GPO practice? What is the impact on our business? My second question is on fulfillment cost, which is extremely low. It looks extremely low to me. So maybe can you elaborate a little bit about how we achieve such a low fulfillment rate? And last question is a much bigger question. So what do we want to be like five years from now? Thanks.

Great questions, Rachel. I think probably, I’ll take the first question and then I’ll leave the second question to our COO to talk about and then we can come back to the five-year big question. In terms of a regulatory change, that’s a great question. We have lots of regulatory movements, especially in the last two years and the buzzword in the industry today is really the 4+7, which means the 11-cities trial on the bulk purchase. So, the state authority for Medicare insurance is taking charge. And obviously, they want to replace all the generic drugs with cheap suppliers. And we can see the effect is very, very obvious. And the first batch of SKUs, between GPO had discounts ranging from minimum in the mid-50s, even as high as to 93%-94%. That is bad news for a lot of those original manufacturers in that space because many of them will face the challenge that their drugs will be delisted from the hospital. Even if the doctor want to give that prescription, it’s not even available anymore. Obviously, they’ve been looking for ways of selling those drugs outside of the hospital space. Where can they go? Obviously, there are only a number of places they can go to. First of all, the offline pharmacies and the other clinics, other private hospitals, and also, online pharmacies – this is ideally the place where we play. Not only do we service consumers directly, we also have this [indiscernible] platform. That’s our B2B platform, precisely built to help those little guys to find good products to sell. Obviously, we love that policy. And we have been chased by various different pharmaceutical companies to work with them. As a matter of fact, we put team together just to specifically target that opportunity. All those big pharmaceutical manufacturers will also need to relook at their retail strategy. That’s where we believe we can actually be of great help to them. So, maybe, Harvey, you want to take on the fulfillment question.

Yeah. The fulfillment costs [Technical Difficulty].

Pardon me. Shall we move to the next question, sir? Pardon me for interruption. This is the audio operator, our speaker is experiencing a technical difficulty. Kindly hold on until we address the situation.

So, Rachel, did you hear the answer to question number three?

Sorry. I actually lost audio from the second question. For the sake of time, actually we can take it offline.

Maybe I’ll just quickly address the last question.

Okay, sure. Thank you.

So, obviously, I want to make two statements. Statement number one is that the Chinese healthcare system is broken today. The second statement I want to make is that in less than 10 years’ time, China is going to have one of the most efficient healthcare systems in the world. If you look at 111, we have a mission statement, which is to build the largest integrated online and offline healthcare platform in China powered by technology. We’re in the space of delivering care to patients. With the capabilities we have built, if you ask me where we want to be in five years time, we want to be one of the most important players in the Chinese healthcare system, the reason being we’re the only one today who has built the capabilities of B2C, of B2B, and we’re the only one with the largest virtual pharmacy network. We have a footprint across the whole country. We play the role of being an enabler of the overall healthcare ecosystem. So, we have every opportunity in the world to do well in that space. So, we’re excited to be where we are and we are looking forward to updating the progress over the next quarters, years. Thank you.

Okay. Thanks. So for – my understanding is we will continue to cover more stand-alone pharmacies to increase our share in the retail market, I mean the B2B market?

Indeed, yes.

Okay. Thank you.

Thank you. We have our next question from the line of [indiscernible] from CICC. Please go ahead.

Hi, this is [indiscernible], hear me.

Barely.

Okay. Congratulations on the financial results of our Q1 results. And I’ve just got one little question. As I noticed in the Slide Page 4, the number of orders each quarter is smaller than the number of pharmacies each quarter. Does this mean that some of the pharmacies contributed zero orders each quarter and will this trend continue?

Yes, you are right. It’s a good catch. Now, we are serving 130,000 pharmacies. Last quarter I mean – this quarter, the first quarter of 2019, we fulfilled 141,000 orders. So, there are some pharmacies not placing orders in the quarter. Like Junling mentioned before, to get all those pharmacies doing business, we need to do a lot of logistic work, like changes certificate, permits, et cetera and get them going. But of course those – some pharmacies, they are also shopping around. They’re comparing pricing, comparing selection, et cetera. Also, we need our field team to kind of reach out to some pharmacies. That’s the work we continue doing. That’s the way we look at our business. One is we – of course, we are incorporating more pharmacies into our network and we estimate by the end of this year, there will be 230 of them. At the same time, we want all the pharmacies in our network placing orders more frequently with more SKU purchased from us. Of course, we need to provide them with better selection. But you are right, some pharmacies did not place orders in the quarter and we are – the team is working very closely with them to make sure that they are satisfied with our selection, the pricing and service, et cetera. It’s a lot of work to do. Thank you.

Okay thanks.

Thank you, sir. Thank you. We have no further questions at the moment. I would like to hand the conference back to Tip. Please take over.

Thank you very much, 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 do let us know. Again, thank you for joining, this concludes the call.

Thank you, sir. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. To end this phone call, kindly hang up your lines. Thank you.