Kingsoft Cloud Holdings Limited (KC) Q2 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. And welcome to the Kingsoft Cloud's second quarter 2020 earnings conference call. [Operator Instructions] Please be advised that this conference is being recorded today. I would like to hand the conference over to your speaker today, Ms. Nicole Shan, Investment Relations Manager of Kingsoft Cloud. Thank you. Please go ahead.

Thank you, Operator. Hello, everyone. And thank you for joining us today. Kingsoft Cloud's second quarter 2020 earnings release was distributed already today and is available on our website at ir.ksyun.com as well as on global newswire sources. On the call today from Kingsoft Cloud, we have our CEO, Mr. Yulin Wang, and our CFO, Mr. Haijian He. Mr. Wang will review business operations and company highlights followed by Mr. He who will discuss financials and guidance. They will be available to answer your questions during the Q&A session that follows. Before we begin, I'd like to remind you that this conference call contains forward-looking statements within the meaning of section 21E of the Securities Exchange Act of 1934 as amended and as defined in the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements are based upon management's current expectation of current market and operating conditions and relate to events that involve known or unknown risks, uncertainties and other factors all of which are difficult to predict, and many of which are beyond the company's control. Which may cause the company's actual results, performance or achievements to differ materially from those in the forward-looking statements. Further information regarding these other risk uncertainty factors are included in the company's filings with the U.S. SEC. The company doesn't undertake any obligation to update any forward-looking statements as a result of new information, future events or otherwise except as required under applicable law. Finally, please note that unless otherwise stated, all figures mentioned during this conference call are in RMB. It's now my pleasure to introduce our CEO, Mr. Yulin Wang. Please go ahead.

[Foreign Language]

Thank you. And thank you all for joining our second quarter 2020 earnings call. During this quarter, we continued to focus on using technological innovations to improve our operational and financial performances. Growth of China's cloud market continued to gain momentum fueled by supportive government policies, to broader digitalization trends and technology developments. According to an IDC report published in May 2020, the size of China's public cloud market is expected to reach USD18.05 billion in 2020, up 45.5 percent year-over-year. As a leading independent cloud service provider, we will further solidify our leading position in the industry leveraging the growing demand for cloud services and the trend towards multi-cloud deployment. We'll further [Indiscernible] internet industries such as video and games and traditional industries such as public service, financial service and health care. With our [green] customers' focus and select vertical expansion we are well positioned to capture the opportunities in cloud service market.

[Foreign Language]

Now I will show you with some updates across [indiscernible] verticals. I will first touch on the internet sector. During the quarter, overall usage of our public cloud service by existing customers grew steadily. In terms of technical innovation, we integrated VR and 8K technologies into our recently launched live streaming solutions, our leverage in our delivery network and cutting edge live-streaming technologies. Our one stop solution provides VR video encoding, storage, distribution and many other functions. Combined with smart HD technologies, this solution effectively lowers bandwidth usage without compromising image quality and results in significant bandwidth cost savings. We have already partnered with certain well known live streaming platforms to improve their users' VR video experience. In addition, we released match mirror platform in June. It assimilates a user's actual living experience and provides further suggestions from experienced advisors. Through the dashboard, customers can evaluate and improve image quality. The platform has been widely used by video editing applications.

[Foreign Language]

We continue to expand our foothold across various sub sectors in the internet industry including education and e-commerce. Our one-stop cloud solutions for e-commerce enable customers to access low latency, high definition and smooth audio and video services. During the 6.18 Carnival, the largest media online shopping festival in China, we provided a large capacity and the security solutions to a number of customers including Xiaomi Corporation ensuring a robust operational continuity of their campaigns. Game sector, we accelerated business development of our cloud-based game platform in June. We signed a partnership agreement with [Megu] Neubie Interactive Entertainment, the exclusive digital content game platform and [Indiscernible] mobile. The partnership allows Megu and us to conduct in depth development around cloud based games in terms of 5G technology, distribution channels and other areas. Kingsoft Cloud will provide advanced technologies at both plus and add levels. In addition, at a recently held 2020 APAC content delivery conference, our advanced edge computing technology won the best edge computing platform awards. In leveraging full scale of [Indiscernible] network and scheduling management capabilities, our edge computing technology provides customers with efficient and stable computing services and has won recognition of customers and the APAC city and industry alliance.

[Foreign Language]

In relation to financial service sector, we launched dedicated cloud solutions, big data solutions and distributed database solutions to meet the digitalization demands in the sector. During the second quarter, we successfully implemented our galaxus stack cloud system at [Zhejiang Xingye] Commercial Bank. This helped the bank rapidly deploy cloud solutions to user management and network security management providing the bank with flexibility and scalability that matches the performance of public cloud solutions. We also entered into a strategic agreement with Hauxia Bank a leading bank with total size of RMB3.0 trillion to build a joint line. Our big data and database products will be incubated and deployed at Hauxia Bank. Now moving to the public sector. We continue to invest in the sector and execute our flagship projects. In March 2020, we collaborated with major municipal government of Guangdong Province to kick off the construction of cloud based industrial internet platform. In May, the [Indiscernible] note project for its ID resolution system launched successfully. The system focused on file applications including device management, intelligent applications, big data analysis, collaborative office and robotics helping enterprises to transform to intelligent manufacturing. In addition, we won two bids for two central ministry projects in the area of artificial intelligence further demonstrating our technology and service capabilities.

[Foreign Language]

To sufficiently meet the growing demand for cloud based services, we continue to upgrade our infrastructure. In the second quarter, we got approval on the energy consumption [Indiscernible] government for our own data center. The new data center meets [Indiscernible] and the national E-level standards and has a capacity of up to 6,600 [Indiscernible] racks, which will supplement our rack resources in Beijing. Going forward, we will continue to focus on public service, financial service and healthcare industries and enhance our technology and human resources to develop more in depth solutions. We will further optimize our technology and expertise in cloud computing to provide high quality services to our customers and continue to improve our operational efficiency to achieve sustainable growth.

[Foreign Language]

I will now pass the call to our CFO, Henry, to go over our financials of the quarter. Thank you.

Thank you, Yulin. Thank you, Nicole. Hello, everyone. I will now discuss our financial performance of the second quarter. Please be reminded all the numbers quoted here are in RMB. Please also be referred to our earning release for the detailed financial results. I would like to highlight the following three points. First of all, our previous guidance for the second quarter ranged from RMB1.5 billion to RMB1.54 billion. The total revenue during the quarter came in at the top end of the previous guidance at RMB1.535 billion, representing an increase of 64.1 percent year-over-year. Our enterprise cloud service revenue were RMB246.1 million. Despite the impact of the second wave of the pandemic in June, enterprise cloud service revenue achieved a significant growth of 259.3 percent on a year-over-year basis and 35.5 percent on a quarter-over-quarter basis. Second, we generated a positive gross profit for the fourth consecutive quarter and our adjusted gross margin has now improved for eight quarters in a row. In particular, the adjusted gross margin increased from negative 1.8 percent in Q2 2019 to 5.5 percent in Q2 2020 representing an improvement of 7.3 percentage points. Third, excluding the one-time IPO-related expenses our normalized adjusted EBITDA margin increased from negative 12.6 percent in Q2 2019 to negative 1.7 percent in Q2 2020 representing an improvement of 10.9 percentage point. Adjusted EBITDA margin has now steadily improved for eight consecutive quarters. Despite uncertainties in the macro-economy, we are pleased to see that we are consistently delivering faster revenue growth than the general public cloud market in China and are continuing to improve the bottom line performance as we are achieving greater economics of scale. It demonstrates our ability to provide quality services to our customers even in very challenging market conditions. Now I will go through the detail of financial results. Our public cloud service revenue increased by 48.6 percent year-over-year to RMB1.287 billion. Although people returned to work in the second quarter, the usage of our public cloud customers kept growing. The performance of our premium customer space remained very strong and we expanded into online education, e-commerce and the remote work verticals. Enterprise cloud service revenues accounted for 16 percent of our total revenue in the second quarter up from 7.3 percent in the same period of 2019. Cost of revenue increased by 52.2 percent year-over-year to RMB1.454 billion. IDC costs increased by 31.6 percent year-over-year to RMB978.4 million. But as a percentage of total revenue decreased from 79.5 percent during Q2 last year to 63.8 percent in the second quarter this year. Depreciation and amortization costs increased by 59.1 percent year-over-year to RMB217.5 million. As a percentage of total revenue, D&A costs decreased from 14.6 percent during the same period last year to 14.2 percent in the second quarter of 2020. Other costs consist of third party software purchase, outsourcing costs and the channel costs associated both public cloud and enterprise cloud as well as other equipment costs in relation to enterprise services. Other costs were RMB244.9 million and the staffing costs were RMB13.2 million. As we continue to improve efficiency of the IT resources, we expect IDC and the D&A cost as a percentage of total revenue will gradually decline. Adjusted gross profit was RMB83.8 million compared with adjusted gross loss of RMB16.5 million in the same quarter of 2019. The adjusted gross margin began to break even from the third quarter of 2019 and it continued to improve to 5.5 percent in the second quarter this year. Thanks to economics of scale and operating leverage, we are pleased to see that our profitability improved. Total operating expenses increased to RMB511 million, up 80.4 percent from the same period 2019. The increase was mainly due to a one-time IPO-related share based compensation expenses. Total share based compensation in operating expenses was RMB172.1 representing a 289.7 percent increase year-over-year. Our share based compensation help us retain and attract talents. Excluding the impact of share based compensation operating expenses as a percentage of total revenue continue to decline from 25.6 percent in Q2 last year to 22.1 percent of this quarter. Our operational efficiency continued to improve. Excluding share based compensation adjusted R&D expenses as a percentage of revenue declined from 13.5 percent of last year, Q2, to 12.3 percent this quarter. Adjusted selling and marketing expenses as a percentage of revenue decreased from 6.8 percent for the same period last year to 5.1 percent this quarter. Adjusted SG&A expenses as percentage of revenue decreased from 5.3 percent for the same period last year to 4.8 percent this quarter. Excluding the one time IPO-related expenses and other non-GAAP adjustments, our normalized adjusted EBITDA reached negative RMB26.8 million compared with negative RMB117.6 million in the same period of 2019. Normalized adjusted EBITDA margin also improved steadily reaching negative 1.7 percent in second quarter last year from negative 12.6 in the same period of 2019. As of June 30 2020, we had cash equivalents and short term investments of RMB5.76 billion. We will continue to be very prudent in managing capital expenditures and maintaining healthy balance sheets. During this quarter, capital expenditure were RMB432.2 million. In addition, we were granted RMB750 million, a line of credit by a Beijing commercial bank and other banks. Moving to outlook. We are currently expecting net revenue for the third quarter of 2020 to be between RMB1.67 billion and RMB1.74 billion, representing a year-over-year increase of 67 percent to 74 percent. However, this outlook is based on the current market conditions and reflects the company's preliminary estimates which are all subject to change as we all understand the uncertainties as a result of COVID-19 are still in effect.

This concludes our prepared remarks. Thanks for your attention. We are now happy to take your questions. Operator, please go ahead.

[Operator Instructions]The first question's from the line of Alex Yao of JPMorgan. Please go ahead.

Thank you, management, for taking my question. I have two questions. Number one is regarding the second half revenue outlook. Based on your revenue guidance, the third quarter revenue growth rate will accelerate versus the second quarter. What is the key driver leading to the acceleration in top line growth? Second question is regarding the development of cloud gaming in China. In your view, what is the development stage of cloud gaming in China? What have you done to position yourself in the industry development? And then lastly, when do you expect the commerciality of cloud gaming will hit the inflection point in China? Thank you.

[Foreign Language]

As Henry has said, we have read our outlook for the third quarter at RMB1.67 going to RMB174 billion. Now we also see some some seasonality in our revenue growth. For the quarter on quarter revenue increase we are very consistent during the past several quarters. And we also see detailed number of last year, the circle of last year is a little bit slow. So we grow from comparatively low base into the third quarter this year. And we believe the revenue growth will maintain stable quarter over quarter in the future. Our revenue growth mainly contribute to the cloud market development and also, thanks to our premium customer focus and selective industry focus, we believe we can deliver a higher than -- higher revenue growth than other peers in this industry. And for your second question, we believe Kingsoft Cloud, our cloud based game solution is among of the cloud based technologies. And we have already developed -- well-developed cloud based solutions. The cloud based game market is in the second phase. For the first phase, most of the [Indiscernible] providers are still in the testing phase and for now we have seen some small games has transformed to the cloud. We have already cooperated with most of the top game providers to derive into this industry. However, we think the commercialization of the cloud based games still takes time. We're thinking, generally, it takes six to 18 months to make a game available to the public. So the cloud [Indiscernible] games, we think it's still under research and will be go public in one year. However, the cloud based game industry is growing from a comparatively low base so the growth rate is very fast. And we think the [Indiscernible] of cloud based games will come in -- compare a longer time from [Indiscernible]. Thank you.

Thank you. Next question is from the line of [Fauston Wu] of UBS. Please go ahead. Please ask your question.

My first question is how should we think about the impact of Microsoft and TikTok's situation right now in the U.S. on your China business? And two, should we expect some impact from COVID on the third quarter guidance?

[Foreign Language]

Well, for the first question. We think that TikTok even has no directing power over the business as we haven't cooperated with TikTok in America business. However, we'll keep all eyes on the macroeconomic and the geopolitical issues to see if there will be further impact on our potential or see opportunities. And for the second quarter -- for the second question, we have talk about the issue last quarter. We think the pandemic has a good trend for our online business as people spend more time at home. The video consumption and e-commerce consumption has increased which is [Indiscernible] public cloud service usages. But for the offline business there is still some impact on their own business. The digitalization trends is huge. However, there is some [Indiscernible]. There is second level -- second level with the pandemic in Beijing, we can't deliver some of the projects offline. However for now, we haven't seen meaningful impact on our work in our business in this quarter but we will keep our [Indiscernible] macro-economy trends to see if there will be direct impact on the economy by the pandemic. Thank you.

[Operator Instructions]Next question is from the line of Kyna Wong of Credit Suisse. Please go ahead.

My two questions, actually because we also expect around 20 to 30 premium clients in the quarter, to add in the quarter. But can we identify how much is actually from enterprise or like from the public cloud, which was actually driving the fast growth? And the second question is about the multi-cloud strategy that we see that getting more popular and how much of the new clients actually that's from the multi cloud and they're already using [Indiscernible] cloud for new customer gains.

Thank you, Kyna, for the question. Happy to address that. But regarding the first question about the premium custom strategy. We are pleased to see that we very robustly continue to execute our premium customer strategy. Although you understand that we are not planning to disclose a number of premium customer on a quarterly basis but based on our internal management counts, we are happy to see that on a year-over-year basis as well as on the quarter-over-quarter basis, the number of the premium customers from both public cloud as well as enterprise cloud has continued to improve. And I would say probably in terms of the quality maybe the number of premium customers is increasing to a kind of probably greater level compared with the number you just mentioned. So in addition, when we track our net dollar retention number as well as the attrition number, I think there's two important internal KPI to measure how the premium customer perform on a both quarterly and year-on-year basis has been robust and improving as well. The second question regarding the verticals. I would say, especially in the prepared remarks, we mentioned that in the public cloud market we are seeing the great potential in online education, remote work collaboration as well as the different diversified e-commerce space. In those verticals, these are the three major verticals who attracting new premium customers as well. So to your second question. So to your second question regarding the multi cloud. As you know, the few verticals I just mentioned they have been kind of growing in a very attractive rate in the past few years. As you can expect that. Many of our customers they have been working with different players in the public health space. And the way we're engaging with them is -- not only we're engaging them as new premium customers but also we continue to expand our wallet sharing to those customers. Which means that we are one of the multi cloud provider into those premium customers. And I think especially when you look at a premium customer, many of them they already at the top tier clients in their own verticals. Which means the technology requirements and the technology and the technology [Indiscernible] regarding the stability and the data security also pretty high in their own measure. So that's why the multi cloud provide very natural routes for them to resolve the technology standard and deliver the business performance they require. So I think that's probably a few color for the question you asked. Thank you, Kyna.

Thank you. Next question is from your line of [Libnin Yao] of [CICC]. Please, your question.

I'll translate by myself. I have two questions here. My first question is about the market competition. We noticed some smaller players in the market also started to expand their cloud delivery service. Will this bring pressure on our pricing and what's the G.P. margin level for our delivery business segment right now and our future strategy on this segment? My second question is in regards to the CapEx plan for this year. Because we noticed the company had planned to build up their self operated IDCs in Tianjin District. And also due to the U.S. and China tension, will the company change the server CapEx [Indiscernible] for this year and next year? Thank you.

[Foreign Language]

We have noticed some small cloud storage providers they have launched their IPO programs. However, as we have already been top of the cloud storage providers we've solidified our positions in terms of the skill and also the premium customers' relations. There is little impact from the small players in the market. And we think the price of our CDN business is very stable in the recent years. For the top cloud service providers, they all [Indiscernible] consider their profitability in the recent quarters. And for our own we have delivered our profitability improvements as we schedule in the IPO. And for the second quarter, our Tianjin data centers have been planned for a while and the investment and the investment, also the capital expenditure, has been included in our budget. And for the servers. We haven't see significant impact from the geopolitical issues on the supply chain but we will keep an eye on the policies to see if there will be further impact on our business. In this quarter as the public cloud service increased very fast, we [Indiscernible] which is most of our system we expect before have -- you can see the meaningful impact on our financials. We still delivered the results as we scheduled. Thank you.

Thank you. Next question from the line of [L.C. Chang] of Goldman Sachs. Please ask your question.

Thank you, management, for taking my question. And just to follow up in terms of the product categories, if we look into the[Indiscernible] and past products, can management share a little bit more color into the revenue mix change and outlook in this space? Thank you.

[Foreign Language]

For the ISAN [Indiscernible]. So it's a different work code to have [Indiscernible] featured. For internet industries, as we had mentioned, in the video sectors we have launched our VR and AK technologies. Also our encoding technology is very popular and widely used by our customers. As we also mentioned that our arch computing has been recognized by the APAC edge alliance, city and alliance and our customers. For other past products the performance maintains at a normal level. The usage keeps increasing -- keeping increasing rapidly. And for other sectors. The service are not quite [Indiscernible] and the ex-levels. We provide our one stop solutions to the customers, especially in the financial service sectors and internet -- industry internet sector and healthcare sectors. They integrate most of our enterprise technology into their solutions. So in different sector we provide different feature products.

Got it. Thank you very much.

Thank you. Next question is from the line of Dan Wong of Macquarie. Please go ahead.

[Foreign Language] So, thanks, management for taking the question. Our first question is so we heard that ByteDance is actually using GDS for their own data centers. Do management expect any negative impact from the move of your largest clients? And secondly, can management share some colors on which sub sector is going to be -- provide the most, majority of the new key customers in in one year forward? Thanks.

[Foreign Language]

For the ByteDance [Indiscernible]. It has always had their own IDC corporation. They have rent some computing services and their own IDC. So there is no direct impact on their corporation. ByteDance, as our largest customers, we have maintained [Indiscernible] stable relation with [Indiscernible] a long time. And for your second question, we haven't discussed the numbers of customers in different sectors. But overall, all the sectors have delivered good performance. The number of customer has increased steadily. [Indiscernible] small numbers beyond our annual reports. But to sum up, there is no significant change in the sector that was [Indiscernible]. Thank you.

Thank you. There are no further questions at this time. I would now like to hand the conference back to the presenters. Please continue.

Thank you, everyone, [Indiscernible]. This concludes our conference call. See you next time.

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.