111 trades on the NASDAQ under the ticker YI, and I would like to add that for 111 Safe Harbor statements, please refer to the company's filings with the SEC. So let me welcome Junling Liu, CEO and co-founder of 111. It's great to see you again.
Hi, Robert. Good to be here.
Great. You recently reported your results for the third quarter, so can you start by giving us the key takeaways from that earnings report?
Yeah, I was very pleased with our results. You know, despite the tough economic environment, we achieved profitability at a Non-GAAP and GAAP level for three consecutive quarters. In the meantime, we also achieved positive cash flow for three consecutive quarters, and the amount of the free cash flow is about 110 million RMB. And also, our operating expenses decreased 160 basis points. You know, considering that, you know, we were still making over 80 million RMB loss from Q3 last year, we have made tremendous progress, and I'm pretty proud of what our team has accomplished.
Great. And that was a performance in the context of macro headwinds that will continue to impact your partners at both ends of the supply chain ecosystem. Can you provide insights into how and to what extent they are affecting your upstream and downstream partners and the impact on your operations?
Yeah, at a macro level, it's been very challenging economically the last few quarters while China is sorting out some structural issues. Our industry is impacted as the household spending on healthcare is not as generous, and the people are cutting back on non-essential healthcare spending. And the anti-corruption campaign across the hospitals in China is creating lots of challenges for our upstream customers as, you know, their traditional methods on promoting their drugs will have to change. And the volume purchase from the government program could mean, you know, 60, 70, you know, sometimes 80% discount, in some cases even more. It seems that, you know, this situation will continue for some time. You know, when we talk about our downstream pharmacy customers, they're also experiencing challenges.
Because of the shortage of funds, the government shifted the majority of the money from the consumers' personal accounts to government-run accounts, which means, you know, the money at their own discretion in the personal account became much less. So this is the money they usually spend mostly in pharmacies. What's worse is that, you know, most of the pharmacies are busy checking back their respective history and trying to clean up cases which they may have, you know, claimed more Medicare than necessary in the past, as there has been a high-pressure crackdown, and if they were found, you know, guilty of such actions, that will result in some serious consequences. From you know the public market information, we can tell that, you know, the pharmacies will experience some near-term difficulties.
You know, examples are that, like Yixint ang, one of the biggest chains in China, reported that over a 90% decline in profit in Q3. Jianz hij ia is down 68%, Laob aix ing is down 37%, and Das henl in is down 22%. You know, those are the better-run larger chains in China, which can tell more or less what's happening in the overall industry. You know, from our perspective, we take a quite positive view as, you know, those measures that are happening today will clean up the industry, and the ecosystem will become much more transparent, and the companies will have to rely on clean, transparent, and efficient business models to survive. That is precisely the space where we want to play.
Even if we have to continue to operate, you know, under the unfavorable environment in the short term, it is worthwhile for the industry to go through this transformation.
How, when you say the transformation, it's a very important thing. How quickly do you think that can occur? Really, I'm leading to your question of what are your expectations for the market in 2025?
Yeah, you know, that's a very good question, Robert. You know, so, you know, we can tell right now the consumer spending last quarter is pretty weak, and the sentiment is not what we would like to see right now. You know, I'm sure the new regime in the U.S. will make life even harder for China. 2025 will be, you know, full of challenges. You know, as entrepreneurs, we're not afraid of challenges. The tough environment will call for more efficiency and the digital transformation. You know, hopefully we can find, you know, spaces where we can create value for both our upstream and downstream customers. You know, it's hard to put an exact timeline, but, you know, we would expect that, you know, 2025 is going to be a year full of challenges.
So how does that impact the development of your B2B and B2C platforms next year? And can you identify, be more specific, and identify the main challenges and opportunities that lie ahead for you?
Yeah, you know, we've been looking for what will transpire with all those, you know, challenges we just talked about. First and foremost, we want to maintain profitability and cash flow positive. You know, then we must understand, you know, under the tough operating environment, you know, what do our customers really want and what we can do to help them to generate a better customer experience. You know, we have a 100% pure digital operating system, you know, which enabled us to set the industry benchmark in terms of operational efficiency. We must take advantage of our digital capabilities to help our upstream and downstream partners so, you know, they can get the benefit and become more efficient.
So with that.
You know, whatever changes are taking place, you know, the core fundamentals of the business in our industry won't change. You know, our philosophy of the core fundamentals are pretty simple, and they include, you know, selection, prices, and services. You know, we will never lose focus over those, and we'll endeavor to ensure that, you know, we can provide the richest selection with competitive prices, and, you know, customers are happy with our post-sale services. You know, we will win if we are able to create a better shopping experience for our customers than our competitors. Quite a few industries in China are going to face unprecedented challenges. You know, we feel extremely lucky as the demographics in China are undergoing structural changes. You know, the aging population will demand much more healthcare spending.
You know, one of the popular terminologies in China today is silver economy, you know, which means when people are getting old, they are going to grow gray hair or white hair in Chinese, and we call that the silver population. And therefore, there's going to be a silver economy. You know, China's healthcare spending is about 7% of GDP, whereas the United States is about 20%. You know, I read different numbers, 17%-20%. There is a lot of headroom here for China to grow. You know, frankly speaking, I would rather be in this industry than any other ones.
Right. And so really, the focus though initially in this period of uncertainty in terms of the macro picture is to focus on profitability and cash flow rather than growth. Would that be fair to say?
Yes, indeed. You know, obviously, you know, if there are meaningful opportunities for us to grow, we will never, you know, let that opportunity to pass by. But, you know, whatever happens, we won't lose focus on, you know, making sure that company stays profitable.
Right. So in the current quarter, you've opened four new fulfillment centers across the country, and the plan is to open at least another five over the next year. So can you tell us what you assess are the incremental benefits of this expansion to 111's revenue-generating capacity and operating cost structure?
Right. In the past, we have relied on 100% first-party fulfillment centers, you know, which is capital-intensive, and it usually takes a long time to ramp up. You know, people may think that, you know, innovation only happens at the customer-facing areas in the operation, but we want innovation across all segments of our business. I must compliment our team for coming up with ideas in the supply chain side. You know, today, in addition to our super hubs, we also blended in the models of joint venture fulfillment centers and franchise fulfillment centers, you know, which we use our partners' existing infrastructure, including the warehouse, the regulatory approval, existing inventory, and so on. So, you know, we will export our systems to ensure a consistent customer experience.
You know, this way, we can ramp up a fulfillment center in a much faster fashion with, you know, very little capital outlay, and this will cut down the ramp-up time substantially. You know, it goes back to what I just talked about, you know, providing our customers the richest selection with the, you know, competitive prices. You know, by adding franchise fulfillment centers, you know, we can add both the breadth and depth of selection. Of course, it is, you know, still early days, but we have already seen some encouraging signs. You know, this will help us scale our operations. You know, franchised fulfillment centers may not add much revenue as the transactions will be invoiced by our partners, and we won't be able to recognize that as revenue, but it will increase our GMV and our gross margin.
More fundamentally, you know, it creates a better customer experience, you know, without us spending much money. It's a much more cost-effective way for us to scale our business.
Right. Excellent. So OpEx as a % of revenues has been trending down from around 10% in 2021 to around 6% this year. And you have said that your target is to get the ratio down to below 5%. So what has to happen for you to achieve that target?
That's a great question. For that to happen, we just need to keep growing our business scale, you know, with, you know, greater order density. And I believe once our revenue reaches RMB 20 billion annually, we should be able to scale down our OpEx to 5% or even lower.
Right. And do you have a sort of a timeline for when you could achieve that 20 billion RMB?
As I said, you know, our short-term focus is profitability, but it will happen. You know, like if we really, you know, drill down the fundamentals to build up the selection to, you know, offer competitive prices to our customers, the experiences on our platform are superior to other platforms, it will happen.
Right. Okay. So one of the questions that I often get from clients is the disconnect between the operational and financial achievements of 111 and the share price value, which seems to give little credit or no credit at all to a company generating about $2 billion of revenue and is on track to deliver its first full year of operating profit and positive operating cash flow this year. Furthermore, the sub-$1 share price elicited in late September notification as of non-compliance to listing rules from NASDAQ. What do you believe are the things that are of most concern to investors, and how will you address those concerns and the NASDAQ non-compliance issue?
You know, quite frankly, you know, this bothers us a great deal as it makes no sense whatsoever, you know, for a company in one of the major markets with about $2 billion in sales and, you know, profitable to be worth only, you know, a mere $60 million. I understand that there is a concern of the redeemable shares, you know, but I want to, you know, make it clear that the redemption has no impact on the operations of the company at all. You know, we have built a firewall between the listco, which is 111, Inc., and the domestic entity where the redemption obligations lie. Whatever happens in this entity, you know, will have no impact on 111, Inc., which is the listco. You know, we have negotiated a new three-year term for the redeemables, which is very well supported by the investors.
We also have taken measures to make sure that we will be NASDAQ compliant, and this will happen quite soon. You know, let me say this, Robert. You know, since the founding of the company, we have come a long way. You know, it cost us billions and billions of RMB to build out the infrastructure and getting over, I would say, 70% or more pharmacies onto our platform. The macro policies are all tailwinds for us, you know, long-term-wise. The demographics are getting more and more favorable for 111. You know, sure, we have challenges with this and that, you know, but we finally turned the business around and achieved profitability this year. It'll be, you know, just a matter of time for people to realize that, you know, this is a very valuable business.
We hope that, you know, our value can be truly reflected in the market.
Thank you for that candid answer. I think we'll wrap it up there. If there are any more questions for Junling, please send them to me, and I'll pass them on. You can check out our analysis of the company, so you can refer to our open access website at www.watertowerresearch.com. The views expressed in this fireside chat may not necessarily reflect the views of Water Tower Research, and we're just providing it for informational purposes only. Finally, thank you, Junling, and everyone for joining us, and have a great day.
You're welcome. Bye.