ZKH Group Q2 2024 Earnings Report

ZKH Group EPS Results

• Actual EPS: -$0.06
• Consensus EPS: $0.03
• Beat/Miss: Missed by -$0.09
• One Year Ago EPS: N/A

ZKH Group Revenue Results

• Actual Revenue: $309.61 million
• Expected Revenue: N/A
• Beat/Miss: N/A
• YoY Revenue Growth: N/A

ZKH Group Announcement Details

• Quarter: Q2 2024
• Date: 8/22/2024
• Time: Before Market Opens
• Conference Call Date: Thursday, August 22, 2024
• Conference Call Time: 8:00AM ET

ZKH Group (NYSE:ZKH) Limited develops and operates a maintenance, repair, and operating (MRO) products trading and service platform that offers spare parts, chemicals, manufacturing parts, general consumables, and office supplies in the People's Republic of China. The company provides MRO procurement and management services; digitalized MRO procurement solutions; and logistics and warehousing services. It also engages in the production and sale of intelligent warehousing equipment. ZKH Group Limited was founded in 1998 and is based in Shanghai, the People's Republic of China.

ZKH Group Q2 2024 Earnings Call Transcript

Key Takeaways

• In Q2, ZKH Group delivered GMV of RMB2.75 billion (up 5.6% YoY) and revenue of RMB2.25 billion (up 8.5% YoY), while gross profit rose 14.3% to RMB380 million, lifting the gross margin to 17%.
• The company narrowed its non-GAAP adjusted net loss by RMB95 million to RMB34.9 million, marking its ninth consecutive quarter of year-over-year improvement in adjusted net loss margin from 6.2% to 1.5%.
• Enhanced working capital management drove a net operating cash inflow of RMB120 million in Q2, and ZKH initiated a US$50 million ADS share repurchase program to underscore confidence in future value creation.
• ZKH is deepening its MRO leadership through upstream integration and private-label R&D, with private label GMV up 27% YoY and a new Taichung innovation center set to open by year-end.
• The platform served over 48,000 customers in Q2 (up 25.8% YoY) and more than 63,000 in H1 (up 32.7%), as it expands focus on SMEs and launches efforts in developed overseas markets.

Presentation

[Operator]

Ladies and gentlemen, good day, and welcome to ZKH Group Limited second quarter and fiscal year 2024 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Jin Li, Head of Investor Relations. Please go ahead.

[Jin Li, Head of Investor Relations at ZKH Group Limited]

Thank you, operator. Thank you, everyone. Welcome to our call today. Joining us today on the call are Mr. Eric Chen, our Founder, Chairman, and Chief Executive Officer, and Mr. Max Lai, our Chief Financial Officer. During this call, we will discuss our future performance. These are forward-looking statements made under the safe harbor provisions of the U.S. 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 this forward-looking information, except as required by law.

[Jin Li, Head of Investor Relations at ZKH Group Limited]

During today's call, we will also discuss certain Non-GAAP financial measures for comparison purposes only. Please see the press release issued earlier today for a definition 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 second quarter of two thousand and twenty-four. After the prepared remarks, we will have a Q&A session. With that, I will turn the call to Eric. Eric, please go ahead.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

Hello, everyone. Thank you for joining ZKH's second quarter 2024 earnings conference call. Our exemplary teamwork and effective execution yielded strong results during this quarter.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

Despite the ongoing macro headwinds, we remain steadfast in our commitment to do the right things that position our business for long-term success. We strategically stepped back from business that did not align with our sustainable competitive edge. While this may impact our short-term growth, it has led to an improvement in the quality of our business. Importantly, even with these recent optimizations and business adjustments, we still achieved solid revenue growth, profitability increase, and significantly improved cash flow in the second quarter. Let's delve into these.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

Our second quarter GMV reached RMB 2.75 billion, up 5.6% year-over-year. This brought our second quarter revenue to RMB 2.25 billion, up 8.5% year-over-year. Our gross profit in the second quarter increased by 14.3% year-over-year, reaching RMB 380 million. Our gross margin, based on revenue, increased to 17% in the second quarter, up from 16.2% in the same period last year.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

Driven by higher business quality, effective cost control, and improved efficiency, we substantially narrowed our adjusted net loss by RMB 95 million to RMB 34.86 million in the second quarter, compared to RMB 130 million in the second quarter of 2023. Notably, the second quarter marks our ninth consecutive quarter of year-over-year improvement in our adjusted net loss margin from 6.2% in the second quarter of 2023 to 1.5% in the second quarter of 2024.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

I'd like to add that despite the controls that we achieved on management cost, we did not lower our investment in product capabilities as well as our digital capabilities. And that is to say, the improvement in profitability is not at the price of a lower investment in these core competencies.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

Our substantial profitability improvements, coupled with optimized management of accounts receivables, accounts payable and inventories, resulted in a net operating cash inflow of RMB 120 million in the second quarter of 2024. This positive cash flow further strengthens our cash position.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

Recently, we've undertaken comprehensive discussions and initiatives with the primary goal of reaffirming our development direction and strategic objectives, as well as aligning our entire team's mindset to ensure strategic consistency and effective execution.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

I'd like to add a few words here, in terms of what I mean by our development direction and strategic objectives. First, we are deeply committed to the MRO industry, and we are making deep investments into product capabilities, and that means that we are not just choosing products for our customers, but we are now actively engaged in the research and development of products, as well as in the coordination of manufacturing. Secondly, we are not just covering our key account customers, but now expanding our focus more to small and medium customers, and we are also developing our overseas business, starting with developed countries.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

Thirdly, we're increasing our focus on the management of accounts receivable, inventories, and cash flow. In this macro environment, we believe that this management is of extreme importance.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

Our goal is to become a MRO service platform of choice for our customers globally, that can create value for our customers. More specifically, I will explain this in three areas.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

In terms of our organizational structure and team capabilities, as we enter a new growth stage focused on lean operations and advancing IT and digital capabilities, we are upgrading our team capabilities and synergy, and this includes bringing together and empowering our teams for customer operations, product operations, and business development, as well as enhancing the management of human resources and finance. This means that we are creating a team with mature experience in the industry, with great synergy in collaboration, and with the ability to take on new tasks competently, and this will help us lay a solid foundation for our further growth, which is going to be more healthy and more long-term.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

We aim to further increase our data assets and enhance our digital and intelligent service capabilities through product and customer operations, including improving digitalization in our internal operations.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

We aim to strengthen our business development team to attract more high-quality third-party marketplace suppliers, fostering both competition and synergy with our first-party product sales and private label offerings, thereby enhancing our supply competitiveness.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

In terms of product capabilities, we believe one of our differentiators versus our competitors is that we are moving further upstream in the supply chain, as we actively engage in product R&D, design, and smart manufacturing to grow the research and development of our private label offerings to achieve true cost savings and high price performance. By the end of this year, our plant in Taicang, Jiangsu Province, will be built, and our MRO Innovation Center there will be opened. In the second quarter of 2024, the GMV of our private label products increased by 27% year-over-year. Additionally, by deepening our industry and customer insights and enriching our data assets, we're well-positioned to deliver curated product pools, offering industry-specific features and meeting the diverse needs of our customer segments.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

This strategy will expedite our transition from a sales-driven to a supply-driven model, reducing our reliance on sales generated from ad hoc inquiries and requests for quotes. Instead, we'll focus on increasing the sales of our readily available products with a competitive advantage, particularly our private label offerings and the ZKH Selection product line. This transition is poised to enhance customer experience and boost repeat purchases, ultimately improving our operating efficiency and expanding our gross margin.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

On the sales front, by enhancing customer operations and accumulating more customer-related data, we aim to assess solutions that can help our customers reduce costs and improve efficiency, ultimately leading to better and more effective online customer acquisition, particularly small and medium-sized customers. Additionally, through our localized service organizational design, we aim to further enhance on-the-ground services and accelerate our efforts to cover, engage, and onboard regional customers. At the same time, our grid-based staffing strategy is designed to boost the efficiency and effectiveness of customer visits, fostering deeper customer engagement and loyalty. As a result of these initiatives, we served over 48,000 customers in the second quarter of 2024, and more than 63,000 customers over the first half of this year, representing year-over-year growth of 25.8% and 32.7%, respectively.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

We are committed to becoming a leading digital platform for MRO service, with a strong focus on creating value for our customers. We firmly believe that the strategies and initiatives outlined here are critical to enhancing our product supply chain capabilities, digitalization, and lean operations, all of which are key to long-term business development and growth. Therefore, even though we have recently optimized and adjusted certain areas of our business, and despite the challenging external environment, we are continuing to invest in our product and digital capabilities, which may have a short-term impact on the growth of revenue and profitability. Even despite all of this, our long-term outlook remains unchanged... and we believe that this will help us further strengthen our core competitiveness. Ultimately, we are confident in our ability to achieve sustained, steady growth and continuously unlock profitability over time.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

With that, I'll turn the call over to our CFO, Max Lai, to discuss our financial performance. Thank you.

[Max Lai, CFO at ZKH Group Limited]

Thank you, Eric, and thanks everyone for making time to join our earnings call today. I will now provide an overview of our 2024 second quarter financial results. We are pleased with the solid performance in the second quarter, driving further profitability improvement despite macroeconomic headwinds. In the second quarter, our GMV increased by 5.6% year-over-year to RMB 2.8 billion. By platform, GMV generated from ZKH platform increased by 4.4% year-over-year to RMB 2.5 billion, and GMV generated from GBB platform grew 17.8% year-over-year to RMB 274.7 million. The proportion of GMV generated from the marketplace model was about 20.7% in the second quarter of 2024.

[Max Lai, CFO at ZKH Group Limited]

Our total revenues in the second quarter of 2024 were RMB 2.25 billion, representing an increase of 8.5%, mainly due to the strong increase in our customer numbers and continued growth in MRO market demand. We enhanced our customer coverage and service capabilities by optimizing the sales team structure to foster closer customer engagement. As a result, we had over 48,000 customers transacted on our platforms in the second quarter of 2024, representing year-over-year increase of 25.8%. As a result of business quality improvement, gross profit in the second quarter grew by 14.3% year-over-year to RMB 383 million, resulting in gross profit margin of 17%, compared with 16.2% in the prior year period.

[Max Lai, CFO at ZKH Group Limited]

The increase was driven by higher gross margin of product sales, 1P model, increased from 13.7% to 15.5%, and increased takeaway of marketplace 3P models, increased from 11.4% to 12.2%, partially offset by slightly lower gross margin of GBB platform. Operating expenses in the second quarter of 2024 were RMB 454.2 million. Operating expenses as percentage of net revenues were 20.2%, compared with 22.1% in the prior year period, demonstrating our improved operating efficiency and also effectiveness of our cost control measures. Fulfillment expenses in the second quarter of 2024 were RMB 99.1 million, a decrease of 7.1% from RMB 106.7 million in the prior year period.

[Max Lai, CFO at ZKH Group Limited]

The decrease was primarily attributable to lower employee benefits costs and warehouse rental costs, partially offset by higher distribution expenses. Fulfillment expenses as percentage of net revenue were 4.4%, compared with 5.1% in the prior year period. Sales and marketing expenses in the second quarter of 2024 were RMB 157.7 million, a decrease of 6.5% from RMB 168.6 million in the prior year period. The decrease was mainly attributable to lower travel expenses and employee benefits costs. Sales and marketing expenses as percentage of net revenues were 7%, compared with 8.1% in the prior year period. Research and development expenses in the second quarter were RMB 38.4 million, a decrease of 16.4% from RMB 46 million in the prior year period.

[Max Lai, CFO at ZKH Group Limited]

The decrease was mainly attributable to lower employee benefits costs. Research and development cost expenses as percentage of net revenues were 1.7%, compared with 2.2% in the prior year period. General and administrative expenses in the second quarter of 2024 were RMB 159 million, an increase of 16.1% from RMB 136.9 million in the prior year period. The increase was primarily attributable to higher share-based compensation expenses and partially offset by decrease in employee benefit costs. General and administrative expenses as percentage of net revenues were 7.1%, compared to 6.6% in the prior year period. Our Non-GAAP adjusted net loss in the second quarter of 2024 was RMB 34.9 million, compared with RMB 129.5 million in the prior year period.

[Max Lai, CFO at ZKH Group Limited]

Non-GAAP adjusted net loss margin was 1.5% in the second quarter of 2024, compared with 6.2% in the prior year period, making our ninth consecutive quarter of year-over-year improvement. As of June thirtieth, 2024, we had cash and cash equivalents, restricted cash and short-term investments of RMB 2.04 billion, compared with RMB 2.12 billion as of December 31st, 2023. Net cash generated from operating activities was RMB 122.1 million in the second quarter of 2024, compared with net cash used in operating activities of RMB 236.2 million in the prior year period. In June this year, we initiated share repurchase program, under which we may repurchase up to $50 million of ADS over a 12-month period ending in June 2025.

[Max Lai, CFO at ZKH Group Limited]

The program underscores our confidence in our business growth and future value creation potential. Moving forward, we will continue to execute our share repurchase program from time to time on the open market and market prices, and we may focus on sustaining growth and delivering long-term value to our all shareholders. With that, I would now like to open the call to Q&A, and operators, please go ahead. Thank you.

[Operator]

Thank you. We will now begin the question and answer session. To ask a question, you may press star, then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star, then two. Again, it is star, then one to ask a question. For the benefit of all participants on today's call, if you wish to ask your question to management in Chinese, please immediately repeat your question in English. At this time, we will pause momentarily to assemble our roster. The first question comes from Leo Chiang with Deutsche Bank. Please go ahead.

[Leo Chiang, Equity Research Analyst at Deutsche Bank]

[Foreign language] I will translate myself. So thanks management for taking my questions. We saw that GMV growth slowed down due to macro challenges and business adjustment. On this, I have three questions. The first question, could management give us an update on customer spending by industry verticals and product categories in second quarter?

[Leo Chiang, Equity Research Analyst at Deutsche Bank]

My second question is, could management share with us the updates on China's MRO consumer service market outlook and the competition landscape in second half 2024? My third question is, could management give us an update on the business optimization progress? It is largely complete, or should we expect a continuous impact in second quarter? Thank you.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

Thank you very much for your question. So yes, from the industry perspective, indeed, some industries were doing really well, or at least relatively stable, but some industries have been impacted by cycles. So if you look to industries like EVs, chemicals, electric and equipment manufacturing, and communications electronics, their procurement on our platform has been growing very strong. Not because the downstream demand has grown significantly, but because these industries are growing at a pretty healthy pace, and their digitized procurement, their migration of procurement from offline to online has been going pretty smoothly. Specifically for EV, Q2 growth has been 36% year-over-year. For chemicals, the growth of procurement was 36% also, year-over-year. Electric and equipment manufacturing, 30% year-over-year growth.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

Communications, electronics, 29% year-over-year growth. So for these industries, barring the risks of receivables and payment collection, the growth will usually be pretty quick. But on the contrary, for example, for traditional, you know, ICE vehicles, mining, steel, and coal, these industries, their procurement on the platform has been pretty flat year-over-year. Specifically for ICE cars, Q2 has been down procurement-wise by 2% year-over-year. Steel has been down by 1% year-over-year.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

And from the product perspective, chemicals, factory automation, fasteners, grinders and abrasives, and PPEs or personal protective equipment, have been growing pretty quickly year-over-year. Specifically for chemicals, year-over-year growth was 40%, 25% for factory automation, 26% for fasteners, 45% for grinders and abrasives, and 23% for PPE.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

From the customer's perspective, GMV from SMEs has been growing very rapidly. Specifically, the GBB platform that serves SMEs has recorded a GMV of 270 million RMB with a year-over-year growth of 17.8%. However, KA customers are still the key to us deeply cultivating the market and growing our market share. In terms of the number of our customers, this number grew by 32.7% in the first half this year, meaning we're covering more and more clients and customers due to our increasing product competitiveness.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

So to your second question, despite the macro headwinds like you referred to, the Chinese manufacturing sector is still the largest in the world. And when it comes to MRO, it remains an inelastic demand by the manufacturing sector. That's why the market potential for MRO is huge.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

Currently, if you look at the penetration of the digitized procurement on the part of the companies, the penetration is still pretty low. This trend of companies moving to online to do their procurement is only accelerating, and this trend is irreversible. During economic hardships, the companies will have even a stronger need to minimize their costs and maximize their proficiency, or efficiency rather. That's why more and more companies are willing to adopt e-commerce as their way to procure their items.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

And, competition-wise, it's getting increasingly rational. The fierce competition in the past is now non-existent. And, as a leader in this space, and leaders in this space will have even more marked position, and their advantages will become even more conspicuous. And of course, competition not only exists in China, it also exists in overseas markets, especially developed markets. And I would say that, developed markets offer better opportunities for Chinese MRO. And, in this sense, our presence and foray into the US market will give us, even a better edge or better leg up.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

And to answer your third question, so I would like to further explain what we mean by optimization and how we go about it. So firstly, we would like to optimize business where there's a payment collection risk. So we do that in order to better guard our cash flow, so we manage that kind of business in advance. And also, when it comes to 3P or platform type of business, and especially, in cases where products are not competitive, either, price-wise or quality-wise, we're determined to optimize and let go of those. Because in the short term, even though those kinds of products will add to our GMV, in the long term, we don't think they offer much value to our customers.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

We believe an important way to create value for our customer is to offer better quality and lower costs for them.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

So in terms of impact and the duration of it, I think, you know, the first two quarters have been impacted, and I gauge it, the third quarter will also be impacted to some extent. Then the impact will gradually start to fade away. And because we have already replaced those, you know, those products, with less advantage and competitiveness, with our advantage and competitive products, so we have effectively infused fresh blood into the system. So we believe, going forward, Q4 and beyond, the quality of the business will definitely improve.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

So that was my answers to your three questions. Thank you.

[Operator]

The next question comes from Colin Liu with China Renaissance. Please go ahead.

[Colin Liu, Global Tech Analyst at China Renaissance]

[Foreign language]

[Colin Liu, Global Tech Analyst at China Renaissance]

Thanks management for the opportunity. So I have three questions and mainly about the outlook. The first one is about second half outlook. So really appreciate management can provide some guidance on top-line growth of second half, potential break-even timing, and what are the drivers behind the revenue growth and the breakeven of profit growth? And my second question is about GBB platform, and I would like management to provide some updates, if there are any, on GBB platform outlook. And then my last question is about 3P model. Well, management just explained, you know, the revenue decline, sorry, the revenue contribution declined from 3P model in the quarter. So I want to ask about how should we think about the revenue contributions from this model going into next few quarters?

[Colin Liu, Global Tech Analyst at China Renaissance]

Thank you very much.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

So in terms of the whole year growth and profitability outlook, excluding the optimized portions of our business, the rest of the business remained a growth of 15% in Q2, and July continued this trend. It's estimated that for the whole year our growth will be either high single digit or low double digit, and the gross profit will continue to improve, the whole year growth will be 15%-20%, and specifically, the whole year gross profit will be about RMB 1.45 billion. And sorry, the RMB 1.45 billion referred to gross profit in 2023. And we expect this year to break even with some slight profits.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

So, second question regarding GBB growth in terms of their GMV in Q2 this year was 17.8% year-over-year under the existing model. And with regards to its outlook, we did a hard and thorough look at GBB, and we have made a very firm determination, which is we are determined to turn GBB into a truly digitized platform dedicated to serving the SMEs.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

And in order to better support the growth of GBB, we want to become a truly technological company. And to that end, we recently recruited the former head of the MRO platform on Taobao to become the head of GBB. And hopefully with this person at the helm, GBB can truly become a MRO platform that serves large quantities of SMEs under the backdrop of this smart era we are in.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

So when it comes to 3P, it has to do with our intentional optimization that I referred to earlier. So the 3P, mind you, the 3P business we are trying to get rid of is, for example, typical trading companies that are neither original manufacturers nor formal agents of any brands, and for those, we will eliminate gradually. But for 3P business that is original manufacturer and that can guarantee the competitiveness of their products and has quality assurance, those we will keep. So the decrease from 3P is primarily from those non-original manufacturer 3Ps, and where this year the share of 3P for our GMV will be about 20% long term, longer term, it will be about 30%.

[Operator]

Colin, did that answer your questions?

[Colin Liu, Global Tech Analyst at China Renaissance]

Yes. Thanks to the management. You know, that's really helpful.

[Operator]

The next question comes from Liping Zhao with CICC. Please go ahead.

[Liping Zhao, VP at CICC]

[Foreign language] Good evening, management, thanks for taking my questions.

[Liping Zhao, VP at CICC]

We noticed that the gross margin saw a year-over-year expansion in both first quarter and second quarter. And what's the gross margin outlook for the whole year? And what is the key drivers of the margin expansion? And second question, could you please give us latest updates on company's U.S. expansion? Thank you.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

Sure! To your first question regarding margin. We believe that for this year, our gross margin will increase by about 1.5 percentage points, and we are confident that in the years to come, we will continue to grow our gross margin at this rate. This margin growth will be driven by three main sources. First, the continuous expansion of our business scale means that we have greater bargaining power with our upstream suppliers. We will receive further support from our suppliers as we aggregate more demand, despite the fact that quantity tends to be smaller in the MRO industry for different types of items.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

We are already past that initial stage of smaller quantities, and now we are enjoying the benefits brought by this aggregated larger demand, and we believe that in the future, this advantage will only increase. The second margin driver comes from our efforts at integrating the upstream, which means that we are sourcing directly from manufacturers, turning them into our strategic partners. That will help us further reduce cost. The third margin driver comes from our private label offerings. It is now helping us to further increase our gross margin by reducing cost.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

[Foreign language]

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

Regarding your second question, on our overseas business strategy. Our strategy is very clear. It is two-pronged for the developed markets such as the U.S. and Europe. Our approach is to establish our companies, our entities locally, and use a localized business approach. Whereas in developing markets such as those in Southeast Asia, our approach is to collaborate with existing companies in the local region and establish joint ventures or create agents to facilitate local sales. These two different approaches is based on the level of transparency and compliance in different markets. We made this decision based on that difference. Specifically for the U.S. market, we have already won our first client in the U.S., and I believe that in the U.S., we will be working with two main types of customers.

[Eric Chen, Founder, Chairman, and CEO at ZKH Group Limited]

One is larger key account customers, who will be U.S. companies who are already our customers in the China market, and we will be able to now continue to provide for them in their home market. The second type of customers will be small and medium enterprises. Our approach for warehousing and supply chain will be very asset light, meaning that we'll be using a 3PL model, whereas we will heavily invest in our product capabilities and digital capabilities to improve our online customer acquisition and product competitiveness. I hope that answers your question.

[Liping Zhao, VP at CICC]

Ah, yes, thanks. That's very helpful. Thank you.

[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.

[Jin Li, Head of Investor Relations at ZKH Group Limited]

Thank you, operator, and thanks everyone for 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. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

Participants

Executives

• Eric Chen, Founder, Chairman, and CEO
• Jin Li, Head of Investor Relations
• Max Lai, CFO

Analysts

• Leo Chiang, Equity Research Analyst at Deutsche Bank
• Liping Zhao, VP at CICC
• Translator
• Colin Liu, Global Tech Analyst at China Renaissance