Long Chen; Chairman of the Board, Chief Executive Officer; ZKH Group Ltd
Chun Lai; Chief Financial Officer; ZKH Group Ltd
Leo Chiang; Analyst; Deutsche Bank
Ella Ji; Analyst; China Renaissance
Sophie Jiang; Analyst; CICC
Presentation
Operator
Ladies and gentlemen, good day, and welcome to ZKH Group Limited's third-quarter 2024 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ji Lin, Head of Investor Relations. Please go ahead.
Li Jin
Thank you, operator. Thank you, everyone. Welcome to our call today. Joining me today on the call are Mr. Eric Chen, our Founder, Chairman and Chief Executive Officer; and Max Lai, our Chief Financial Officer. During this call, we will discuss our future performance, which are forward-looking statements made under the safe harbor provision of the US Private Securities Litigation Reform Act. Such statements are not guarantees of future performance and are subject to certain risks and uncertainties. Some of these risks are beyond the company's control and could cause actual results to differ materially from those mentioned in today's press release. A number of potential risks and uncertainties are included in ZKH Group's public filings with the Securities and Exchange Commission. ZKH Group does not undertake any obligation to update these forward-looking information, except as required by law. During today's call, we will also discuss certain non-GAAP financial measures for comparison purpose only. Please see the press release issued earlier today for a destination of non-GAAP financial measures and a reconciliation of GAAP to non-GAAP financial results. Eric and Max will share our business updates, operating highlights and financial performance for the third quarter of 2024. After the prepared remarks, we will have a Q&A section. With that, I will turn the call over to Eric. Eric, please?
Long Chen
(interpreted) Hello, everyone. Thank you for joining ZKH's third-quarter 2024 earnings conference call. We are pleased to report continued improvements in our business structure, quality and resilience during the third quarter, driven by our proactive efforts throughout the year to optimize and withdraw from certain business areas that did not align with our long-term competitiveness. While these optimization initiatives affected our overall revenue growth in the short term, this strategic approach will ultimately foster ZKH's long-term health and sustainability. Looking at our financials, we achieved a GMV of RMB2.69 billion and a revenue of RMB2.28 billion in the third quarter. Despite a slight year-over-year decline in GMV, a deeper analysis of our business structure reviews that in our core customer industries, both large key account customers and SME customers continued to deliver steady growth. Excluding the impact of our business optimization initiatives, our third quarter GMV maintained double-digit year-over-year growth. In terms of profitability, both our gross profit and gross margin continue to grow, with gross margin rising from 16.3% to 17% year over year in the third quarter. Notably, the gross margin of our product sales business and the take rate of our marketplace business on the ZKH platform, both improved significantly. Additionally, we substantially narrowed our adjusted net loss with the adjusted net loss margin improving from 4.4% in last year's third quarter to 2.9% this third quarter, marking another quarter of year-over-year improvement. Notably, we achieved these positive outcomes while maintaining our commitment in investing in the future growth of our company, including products, IT capabilities and global expansion. On the business front, we have consistently emphasized our commitment to doing the right things that position our business for long-term success. Creating value for our customers and partners has always been at the core of our mission. Through advancements in digital and intelligent technologies, enhanced product capabilities and supply chain efficiency optimization, we empower our customers to sustainably reduce costs and improve operational efficiency. We have a large potential customer base. We see businesses of all types, industries and sizes as potential customers as long as they are well managed, comply with procurement requirements and have solid payment capacity and commitment. Large enterprises represent a key segment of our customer base. They not only help drive the development of our supply chain capabilities, but also as leading state-owned enterprises, multinational corporations and private enterprises, they stand as influential role models for SMEs. However, company size is not the only factor in our customer selection, and it's not the most critical one either. In fact, for us, SMEs with sound management practices, compliance, strong payment capacity and willingness and the focus on improving overall management efficiency also constitute a high-quality core customer group. Effectively engaging these high-quality core customers and in providing them with exceptional service will drive our long-term business growth. To achieve this, we've implemented the following key strategies: First, we strategically allocate personnel and resources focusing on high-quality customers and crucial regions. Our key account sales team continues to strengthen its customer acquisition capabilities. At present, we serve over 600 group enterprises out of China's top 1,000 group enterprises in the manufacturing industry with around 400 in the pipeline for potential future engagement. Meanwhile, we consistently strive to deepen our cooperation with these key account customers. Currently, our average share of their procurement spending remains relatively modest, leaving substantial room for further deeper engagement and growth. Given China's vast number of SMEs, we center our resource allocation strategy on a region-based service approach and a grid-based staffing approach to enhance on-the-ground services and accelerate regional factory coverage, market reach and customer acquisition. We have strategically selected Shanghai, Shenzhen and other high-quality regions to establish a competitive edge in regional coverage. We also leverage our GBB platform to serve SMEs and micro enterprises through an e-commerce-only model. Moreover, online marketing has emerged as a key customer acquisition channel, yielding impressive results. From January to September this year, we successfully catered to more than 75,000 customers, a year-over-year increase of over 30%. Recently, we also entered into a strategic partnership with Taobao and Tmall MRO division to further enhance our coverage and service for SMEs. Our second strategy involves refining product pools and supply chain management and deepening supplier collaboration to transition from a sales-driven to a supply-driven model. To achieve this, our product team will continue to streamline and manage our product pools for key industries and customers, proactively driving product development and inventory planning to improve cost and delivery efficiency. In addition, we'll deepen our strategic partnerships with suppliers at the manufacturing source fostering long-term, stable and mutually beneficial relationships to further enhance product quality and reduce costs. Currently, the vast majority of our procurement is conducted directly with original manufacturers or their authorized agents, ensuring that our procurement cost remain highly competitive. We will further ramp up our investment in bolstering our product design, R&D, testing and selection capabilities. To that end, we recently decided to set up an innovation and R&D center at our Taicang facility in Suzhou, Jiangsu province, where we plan to establish a proprietary development system for our private label products, strengthening our R&D, testing and technical analysis capabilities. Ultimately, this will enable us to provide our customers with more professional product selection and recommendation services across product benchmarking, selection, optimization and more, while also driving the development and sales of our private label products. From January to December, from January to September this year, the GMV of our private label products reached RMB490 million, up 24% year over year, accounting for 6.3% of our total GMV. Our long-term goal is for our private label products to generate over 30% of our total GMV. As the third strategy is to elevate operational efficiency and workforce productivity through AI empowerment. As a digital MRO service platform, ZKH is dedicated to leveraging AI to address pain points in the MRO procurement and sales process. Through continuous data accumulation and AI model optimization, we aim to achieve intelligent automation across various procurement scenarios, improving our operational efficiency, enhancing compliance and rationality in decision-making and increasing value at reduced costs along the industry value chain. Recently, following the launch of the AI Assistant and the RPA robot, we also unveiled an array of new AI offerings, including the AI Material Manager, which is China's first generative AI tool for material management. The AI price comparison assistant, which can quickly identify the best prices among tens of thousands of suppliers quotes, and the AI product recommendation brain, which helps customers select products faster and more accurately. Finally, regarding our overseas strategy and progress, we believe mature and developed industrial countries represent ideal markets for our business model. As such, we chose the United States as our first overseas destination and have already set up a local team to provide high value-for-money products online catering to US-based manufacturing SMEs. Of course, we also have opportunities to serve larger US customers, leveraging our existing relationships with the China operations of such multinational cooperations. Our US stand alone site is scheduled to go live on December 1, and our product selection testing, validation and inventory preparations are almost complete. In this initial phase, we will launch more than 1,000 SKUs, focusing on categories, including personal protective equipment, hand tools, packaging materials and measuring instruments, with plans to gradually diversify into other categories. Once our US business model matures and stabilizes, will expand into Canada, Mexico and Europe. In Southeast Asia, our strategy is to follow our key account customers in China to offer localized services for their factories in that region. Recently, we established a subsidiary in Thailand to support these business operations. China's MRO market is vast and becoming increasingly stable with leading companies strengthening their competitive positions and benefiting from their market dominance. In this environment, product and supply chain capabilities as well as digital and AI capabilities are key to success. As China's leading digital MRO service platform, we have built a solid customer base and an industry-leading product pool and supply chain system. Moving forward, we'll continue to invest in elevating our core competitiveness and expanding into overseas markets while strengthening our financial foundation to propel the company's long-term sustainable development. Now I will turn the call over to our CFO, Max Lai, to present our financial results. Thank you, everyone.
Chun Lai
Thank you, Eric, and thanks, everyone, for making time to join our earnings call today. I will now provide an overview of our 2024 third quarter financial results. In the third quarter, we continued to deliver solid performance with further improvements in profitability and strong GMV growth based on a framework that excludes the impact of the optimizer business. However, our overall GMV decreased by 7.2% year over year to RMB2.7 billion from RMB2.9 billion with the optimized business accounting for approximately 20% of GMV in the first quarter last year. As the automated business was primarily generated by the marketplace model, the proportion of GMV generated from marketplace model was about 17% in the third quarter of 2024 compared with 24.7% in the prior year period. Our total net revenues in the third quarter of 2024 were RMB2.28 billion, representing a slight year-over-year increase of 0.7%, mainly due to an increase in the number of customers, partially offset by effect of business optimizations. Looking at the breakdown of our total net revenues. Net product revenues were RMB2.21 billion, an increase of 2% from RMB2.16 billion in the prior year period. Net service revenues amounted to RMB57.7 million, a decrease of 27.8% from RMB79.9 million in the prior year period, primarily due to a lower proportion of GMV generated by the marketplace model on platform due to the reason I mentioned above. Other revenues were RMB15.7 million compared with RMB21.7 million in the prior year period, mainly due to a lower revenue from operating lease services for certain types of machinery and equipment. Gross profit in the third quarter of 2024 grew by 5.1% year-over-year to RMB388.4 million, resulting in gross profit margin of 17% compared with 16.3% in the prior year period. The increase in gross profit margin was driven by an improved gross profit margin of product sales model, which rose from 13.9% to 16% year over year and a higher take rate of marketplace model, which increased from 11.2% to 12.6% year over year on the ZKH platform. The overall improvement in the gross profit margin was largely due to the expanding proportion of GMV contributed by our private label products, which typically have higher gross profit margin and changes in our business mix as a result of our business optimization. Operating expenses in the third quarter of 2024 were RMB493.8 million. Operating expenses as a percentage of net revenues were 21.6% compared with 21.7% in the prior year period. Fulfillment expenses in the third quarter of 2024 were RMB100.2 million, a decrease of 11.8% from RMB113.6 million in the prior year period. The decrease was primarily attributable to lower employee benefit costs, warehouse rental costs and distribution expenses. Fulfillment expenses as a percentage of revenues were 4.4% compared with 5% in the prior year period. Sales and marketing expenses in the third quarter of 2024 were RMB168.2 million, a decrease of 7.7% from RMB162.3 million in the prior year period. The decrease was primarily attributable to lower marketing and promotion expenses and travel expenses. Sales and marketing expenses as a percentage of net revenues were 7.4% compared with 8% in the prior year period. Research and development expenses in the third quarter of 2024 were RMB49.8 million, an increase of 12.2% from RMB44.4 million in the prior year period. The increase was primarily attributable to higher employee benefit costs and expenses related to technology and information services such as cloud services. Research and development expenses as a percentage of net revenues were 2.2% compared with 2% in the prior year period. General and administrative expenses in the third quarter of 2024 were RMB175.6 million, an increase of 16.6% from RMB150.7 million in the prior year period. The increase was primarily attributable to higher share-based compensation expenses and allowance for credit losses, which were partially offset by decreased employee benefit costs and travel expenses. General and administration -- administrative expenses as a percentage of net revenues were 7.7% compared with 6.7% in the prior year period. Net loss in the third quarter of 2024 were RMB81.8 million compared with RMB97.7 million in the prior year period. Non-GAAP adjusted net loss in the third quarter of 2024 was RMB66.2 million compared with RMB98.7 million in the prior year period. Non-GAAP adjusted net loss margin was 2.9% in the third quarter compared with 4.4% in the prior year period, showing that we continue to advance along the path to profitability year over year. Our cash position also continued to strengthen. We generated net cash from operating activity of RMB160.5 million in the third quarter of 2024 compared to net cash used in operating activity of RMB9 million in the prior year period. Before I conclude, I would like to reiterate our commitment to delivering value to our shareholders. Throughout this quarter, we continued to execute our share repurchase program as announced in June. This ongoing effort underscores our strong confidence in the company's growth prospects and reflects our dedication to create a long-term value for our shareholders. With that, I would now like to open the call to Q&A. Operator, please go ahead.
Question and Answer Session
Operator
(Operator Instructions) Leo Chiang, Deutsche Bank.
Leo Chiang
(spoken in foreign language) I will translate myself. I have two questions. My first question is management can share with us of the performance by product and industry verticals in third quarter? My second question is commencement an update on recent China's and old procurement service market and outlook for 2025 and may increase economic stimulus policies and the company's business outlook for 2025.
Long Chen
(interpreted) Thank you very much for your questions. From the perspective of industries, when it comes to EVs, electrical and equipment manufacturing, food, medication, agriculture, communication electronics and property management. These sectors have maintained -- maintain pretty high growth on our platform. But when it comes to traditional ICE cars, mining, coal and construction, including cement and steel, these sectors have seen year-over-year decrease in terms of their procurement on our platform. In terms of products, we have seen pretty high year-over-year growth for categories such as spare parts, MRO fasteners, electrical automation products, pneumatic and hydraulic products. In chemicals, we saw high year-over-year growth for workshop chemicals and chemical reagents. For manufacturing, there's grinders, abrasives, nice measuring tools. And also for general consumables, there's PPEs, power tools, welding, tapes and labels and also office suppliers for administrative materials. All these things have seen pretty high year-over-year growth on our platform. And these categories tend to have pretty high gross margins as well. And for categories that are seeing year-over-year decreases are cables, wires, renovation products, apparel, furniture, renovation furbishing materials and administrative procurement. To your second question, I don't think the overall MRO market in China has fundamentally changed, meaning it's still a vast market with very inelastic demand has always been strong and there's lots of customers looking to buy. The market is very fragmented, and it's also going through a transition from procuring offline to procuring online. Specifically, when it comes to competitive landscape, I think it has also entered a new phase characterized by three things. Firstly, when we compare ourselves with competitors, it comes down to whether you're able to manage your products, warehousing and delivery capabilities? Or are you entrusting those things to a third party to do? So I think being able to do everything in-house is one of our core competencies. And secondly, the ability to develop our own private label has become extremely important as a metric of competency. As our share of private labels keeps rising, it will not only help our customers achieve cost downs, but also it will drive up our gross margins significantly. Thirdly, overseas markets are becoming increasingly important in terms of our exploration of those markets and our product R&D locally. So this has become an extremely important source of growth for us. And the current competitive landscape has pretty much stabilized. So for companies who do not have a need to finance, to do more financing rounds or companies who have already become listed companies, there's more of an opportunity to focus on developing their own business and to drive value creation for their customers. And ZKH is definitely one of them. So under today's circumstances, it is a very good tailwind and important opportunities for us to grab. As long as we focus on doing the right things, we will definitely achieve better results. Looking to the future, we are embracing the future with lots of confidence and optimism. Because over the past several years, we have built ourselves out as a platform company, but that alone will not help us succeed and thrive. Because being in the B2B MRO space, just being a platform is simply not sufficient. We have to build out this vertical three-dimensional ecosystem, where we develop our products in-house and also reach out -- reach upstream to acquire manufacturing capabilities as well. So these capabilities are the determinants of our success down the road. So that was my answers to these two questions.
Operator
Ella Ji, China Renaissance.
Ella Ji
(spoken in foreign language) So I just wanted to hear management's comments regarding a potential higher tariff between the US and China. What could be the potential impact? And what are the company's measurement to help deal with the situation?
Long Chen
(interpreted) So thank you very much for that question. When it comes to the US MRO market, it is a very large and also very lucrative market, even though there has been several big players around, the market overall is still pretty fragmented. So our strategy in the US is to break into it and compete with those conventional players with new business models. Meaning we are intending to become the Costco for the industrial sectors by way of selecting and cherrypicking the best products. So basically, we are minimizing the volume of SKUs with better product quality. So with lower costs and fewer SKUs, we are better serving our customers. The US MRO market has already become a pretty transparent one, meaning whatever products are needed or their ASPs, everything is available and visible. So they can be studied and prepared in advance. Everything is basically on the table. So as long as we keep improving our capabilities and keep our products competitive, we will be able to grow very quickly. Like I said in the prepared remarks, we will be launching our first independent shop on December 1 this year. It will go live with more than 1,000 SKUs before we will gradually expand that SKU base. And for this initial preliminary phase, we will be relying on 3PLs or third-party logistics providers to provide logistical services. So we could focus our energy on validating and improving our product capabilities first, before we go out to build out our own logistical capabilities. As for your question regarding geopolitical factors and the potential tariffs that we will be faced with, we are tackling those by trying to diversify our supplier base by reaching out to a global pool of suppliers in order to avoid those risks. So we have been pushing for that diversification of suppliers very hard, and we believe our efforts will pay off. And eventually, we will be able to circumvent those geopolitical risks. With my answer to this question. Thank you.
Operator
Sophie Jiang, CICC.
Sophie Jiang
(spoken in foreign language) Could you please give us more details on the strategic cooperation with Tmall, please?
Long Chen
(interpreted)So thank you very much for that question. We know that in China, they have -- there's a lot of SME manufacturers and their procurement habits are no different from those of individuals, namely they all like the e-commerce model buying online. And the Taobao MRO has already been generating RMB100 billion plus of annual GMV. So they have covered large quantities of small- and medium-sized customers. So we believe there is a complementarity when it comes to the capabilities between our platform and the Taobao. So we can leverage Taobao to help our suppliers to cover our long-tail SME customers because for our suppliers to develop those long-tail customers themselves, the cost of customer acquisition is simply too high to make any economic sense. So for those two reasons, we are working with them. And for Taobao and Tmall, they are running like a platform. And when it comes to MRO, it takes warehousing and the delivery capabilities, which we have. So that is what I meant by complementarity. And so by working with the Taobao and Tmall MRO, we can help their suppliers and our suppliers to serve the brands, to open flagship shops on Taobao and Tmall MRO to better serve the SMEs. And also, there are still -- there are still counterfeits in the MRO space. Counterfeits are still an issue. So by working with the suppliers Tmall MRO, we can help solve that issue to a very large extent, which will certainly create lots of value for SMEs. So my expectation of this collaboration is that there's a lot of headroom for growth, and it's going to be a win-win collaboration. It will help Taobao develop their customer base to better serve their customers, and it will also help our business grow. That was my answer to your question.
Operator
And that concludes the question-and-answer session. I would like to turn the conference back over to management for any additional or closing comments.
Li Jin
Thank you, operator, and thanks once again for everyone joining us today. You can find the webcast of today's call on ir.zkh.com. If you have any further questions, please feel free to contact us. Our contact information can be found in today's press release. Thank you, and have a great day.
Operator
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
Portions of this transcript that are marked (interpreted) were spoken by an interpreter present on the live call. The interpreter was provided by the company sponsoring this event.
