Kingsoft Cloud Holdings Limited (KC) Q2 2023 Earnings Report, Transcript and Summary

Good day and thank you for standing by. Welcome to Kingsoft Cloud's Second Quarter 2023 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I'd now like to hand the conference over to your speaker today Nicole Shan, IR Manager. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining us today. Kingsoft Cloud's second quarter earnings release was distributed earlier today and is available on our IR website at ir.ksyun.com, as well as our GlobalNewswire services. On the call today from Kingsoft Cloud, we have our Vice Chairman and CEO, Mr. Tao Zou; and our CFO, Mr. Haijian He. Mr. Zou will review our business strategies, operations and the Company highlights; followed by Mr. He, who will discuss the financial guidance. They will be available to answer your questions during the Q&A session that follows. There will be consecutive integration, our integrations are for your covenants and reference purpose only. In case of any discrepancy in management statement in our original language will prevail. Before we begin, I would 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 expectations and current market and operating conditions and related to on that well 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 this and other risks, uncertainties or factors are included in the Company's filings with the U.S. SEC. The Company does not 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 financial figures mentioned during this conference call are denominated in RMB. It's now my pleasure to introduce our Vice Chairman and CEO, Mr. Zou. Please go ahead.

[Foreign Language] Hello, everyone, and thank you all for joining Kingsoft Cloud second quarter 2023 earnings call. During the quarter, we continued to uphold the principle of high quality and sustainable development, build success based on technology and innovation and forge our reputation throughout the entire business process with customer centricity. We have enhanced our operations management and proactively embraced the new AI era. This quarter, our profitability further improved. Total revenues reached RMB1.84 billion. Adjusted gross margin increased steadily for the fourth consecutive quarter to a new record high of 11.3%. Adjusted gross profit reached RMB207 million, more than three times the amount for the same quarter last year. Normalized adjusted EBITDA margin was negative 3.3%, which represents a significant improvement of 5.3 percentage points from the same quarter last year and 2.6 percentage points from the previous quarter. So in terms of public cloud services revenues were RMB1.16 billion with a gross margin of 5.2%, significantly higher than and turning positive from the negative 2.4% gross margin in the same quarter last year. We continued to focus on three priorities for public cloud services, namely the Xiaomi and Kingsoft ecosystem, customer mix and cost reduction. First of all, we continued to serve Xiaomi and Kingsoft ecosystem well. In particular, total revenues from Kingsoft Group increased by approximately 15% year-over-year. Second, we continued to optimize our customer mix. The revenue share of our largest customer dropped further to around 16% while signing up more than 20 new medium-sized customers. Meanwhile, we also resolutely withdrew from long-term loss-making projects and customers, achieving a more balanced and healthier revenue mix. Third, we have made cost reduction and efficiency improvement and ongoing initiative. We established a dedicated cost optimization team to tackle redundancy including the cancellation, relocation, consolidation, reuse, and disposal of such resources and assets yielding remarkable results. Moving on to Enterprise Cloud Services. Total revenues were RMB675 million with a gross margin of 21.7%, a significant improvement from 15.3% in the same quarter last year. In public services space we opted to focus on core areas of public service cloud and state on asset clouds executing a differentiated approach with not only build cloud for customers but also developed an end-to-end cloud service model covering cloud migration, cloud usage and cloud management. We have forged our core competitiveness of standardized the Public Services Cloud operation capabilities applicable to both public service cloud and state-owned asset cloud. For example, we have been the partner for the Beijing Public Service Cloud for nine consecutive years, winning a strong reputation to deliver secure, reliable, and easy-to-use systems and services, resulting in a virtuous cycle of increased cloud adoption by more than 50 public services departments. In digital health space, we have maintained a steady and sure approach, first consolidating our strengths, then expanding in scale. Our proven capabilities and the leadership in super large ultra-complex landmark cloud projects have provided a solid foundation for further growth. On one hand, we are horizontally replicating our regional healthcare cloud model to more regions. Our model features an innovative architecture recognized by China's National Health Commission and industry associations and has been promoted to more than a dozen provinces as an industry-referenced framework, allowing us the opportunity to engage more deeply in the construction of the national public health systems and medical digitalization platforms, producing remarkable economic and social benefits. For example, we completed the first phase of the Jiangsu medical image cloud project integrating image data from over 1,300 hospitals across the province with estimated annual savings of RMB2.4 billion from reduction of duplicated medical images. Building upon our successful experience of this landmark project, we have replicated our imaging cloud projects in Chongqing province. Meanwhile, we are working on the plan for the second phase of Jiangsu imaging cloud projects which upon completion is expected to connect all the public hospitals across the province to the cloud platform. On the other hand, we are also vertically penetrating our business to hospital level. We are partnering with a number of top-tier hospitals to facilitate cloud-based next-generation digital transformation. Our solution addresses a number of pain points, including high maintenance costs, server instability, and slow response to user requests. For example, we helped the ZhongAn hospital of Wuhan University, a Grade A tertiary hospital, transform its modular system with micro service architecture, developed an innovative data structure for Dongxing hospital creating a loosely coupled horizontally integrated architecture for its platforms and applications enabling business process optimization and Unified Data Management. In the financial services space, we completed and delivered a batch of big data projects for leading financial institutions, as well as the second phase of China constructing banks' cloud infrastructure development project. We are now in the process of deploying the third phase of this project. Turning to Camelot. During the quarter, Camelot achieved a solid business performance signing up six new customers while maintaining robust relationships with existing major clients, it's profitability remained at a healthy and stable level. In terms of products and technology, we uphold our principle of building success based on technology and innovation by delivering best-in-class customer experience across our core product offerings. In storage space, we launched a deep ultra-called data archive product particularly well suited for data management use cases, including medical imaging, financial documents, and compliance and archive. In big data space, our big data product was recognized for its overall strengths and ranked among the top three leading Chinese companies by IDC, a premier international institution in its Data Lake House Platform Technology Assessment Report 2023 in terms of its comprehensive capabilities such as data management, storage, development, and security. In database space, we entered into strategic partnership with EnCap leveraging our respective strengths to jointly provide fully managed distributed cloud database services. In enterprise cloud space, we upgraded our Galaxy stack management system, a unified platform facing operation and maintenance personnel and the cloud user-facing cloud manager adding dozens of new features to solve cloud management and usage pain points for enterprise cloud customers. In 2023, trusted cloud summit, an authoritative and prestigious event that promotes the best practice of cloud industry standards in China and hosted by China Academy of Information and Communications Technology and China Communication Standards Association. Our Galaxy Stack won two milestone awards, namely best practice award for Technology and best practice awards for Public Services Clouds validating our outstanding technical strength in the domain of dedicated cloud. On-shoring the new AI era, we are beginning to see results from our rapid response to and comprehensive embrace of AIGC leveraging our neutral positioning. We have gained the preference of independent AI companies and signed a dozen of new AI customers. As the sole of strategic cloud platform in the Xiaomi and Kingsoft ecosystem, we're working closely with Kingsoft Office on WPS AI enabling model training and inference business deployment. Partnering with industry leading large language model and vector database providers, we launched our mass mutual trust for dedicated zone solution to bridge the trust the gap in AI to be use cases. We also carried out AI targeted upgrade to our container and storage products to support InfiniBand technology and the multimedia processing in AIGC use cases. In addition, we are collaborating with the Xiaomi and Kingsoft ecosystem to purchase or lease AI service from various channels conducting test and evaluations of domestic GPUs or alternative contingency plans. To develop and grow our Wuhan R&D center is our significant strategic initiatives, which will help us nurture new talents for maintaining our technological leadership in the medium to long run. In less than a year since its inception in last October through voluntary reallocation of key R&D staff from Beijing and Wuhan local recruitment, our Wuhan team has quickly grown to approximately 400 people, accounting for more than one-third of our total R&D team and 50% of the Wuhan team hold a master's degree. We also organized star training camp at Wuhan center to provide aspiring university graduates with a fast track to transition from campus to workplace and attract the talents from Wuhan's top universities by fostering a sense of belongingness in our corporate family. In summary, the continuous and rapid improvement in our profitability over the past few consecutive quarters has strengthened our belief in the strategies and the directions we have chosen. Looking ahead, we will nimbly uphold the principle of high quality and sustainable development and focus on technology, reputation, and management to drive progress thereby creating value for our customers, shareholders, employees, and the society. I will now pass the call over to our CFO, Henry, to go over our financials for the second quarter 2023. Thank you.

Thank you, Mr. Zou and I welcome, everyone for joining the call. Now, I will walk you through the financial results for the second quarter 2023. Uphold strategy of high quality and sustainable development, we are pleased to deliver another quarter of steady profitability improvement. Our adjusted gross profit continued to grow for the fourth consecutive quarter and achieved record high of RMB206.8 million increased by 202% year-over-year representing adjusted gross margin of 11.3%. Along with our strict expense control, our normalized adjusted EBITDA narrowed from negative RMB163.7 million in the same period of last year to negative RMB59.9 million this quarter. As a result, normalized adjusted EBITDA margin further narrowed from negative 8.6% in the same period of last year and negative 5.9% in the last quarter to negative 3.3% this quarter. Thanks to the operational efficiency improvement, the quarter-over-quarter narrowing of normalized adjusted EBITDA margin outpaced increase of adjusted gross margin. Our total revenue were RMB1,835.4 million this quarter of which revenue from public cloud services were RMB1,159.5 million, representing a decrease of 10.1% compared with RMB1,289.1 million in the same period of last year as we steadily adjusted our revenue mix and proactively scaling down services to our top CDN clients. Revenue from enterprise cloud services were RMB675.2 million, representing an increase of 9.5% from RMB616.6 million in the same period of last year. The year-over-year increase was mainly driven by our continued to focus on selective verticals and quality projects, recovery from COVID-19 impact, our investment into flagship products bearing fruits, enhancing our capabilities to replicate solutions and services to different regional customers. We continued to enhance our cost-control measures. Total cost of revenue decreased by 11.5% year-over-year to RMB1,628.8 million. IDC costs decreased significantly by 16.4% year-over-year from RMB1029.1 million to RMB860.7 million this quarter. Depreciation and amortization costs decreased by 18.8% from RMB249.1 million in the same period of last year to RMB202.1 million this quarter. Solution development and services costs decreased by 7.4% from RMB489.1 million to RMB452.9 million this quarter. Fulfillment costs and other costs were RMB71.7 million and RMB41.3 million this quarter, respectively. Adjusted gross profit of this quarter increased by 202% to RMB206.8 million representing adjusted gross margin of 11.3% this quarter compared with 6.6% in the same period of last year. The significant margin improvements testify to be the effectiveness of strategic adjustments of revenue mix, improvement of our infrastructure efficiency based off of loss-making customers and optimize enterprise cloud projects selections and efficient cost control measures, demonstrating our strong commitment to improve our profitability and delivering high quality and a sustainable development. Each our business achieved margin improvements. Gross profit of public cloud services was RMB59.7 million, which was significantly improved from the gross loss of RMB 30.7 million in the same period last year. Gross margin on public cloud services was 5.2% compared with negative 2.4% in the same period last year. The improvement was mainly due to our proactive scaling down our CDN services and adjustment of our client mix. Gross profit of our enterprise cloud services was RMB146.7 million compared with RMB94.6 million in the same period of last year. Gross margin of enterprise cloud services was 21.7% improved from 15.3% in the same period of last year. The improvements were mainly due to our rigorous enterprise to our project selection. In terms of expenses, excluding share-based compensation and impairments of long-lived assets, our total adjustments operational expenses were RMB538.1 million, decreased by 9.7% from RMB595.8 million last quarter, of which our adjusted R&D expenses were RMB182.3 million, decreased by 10% from last quarter. Adjusted selling and marketing expenses was RMB128.3 million compared with RMB104.2 million last quarter. Our adjusted SG&A expenses decreased, largely by 21.3% from RMB289.1 million last quarter to RMB227.5 million. We have been taking strict expense control over the period such as reduction of several expenses and screening of other discretionary expenses and others. As of June 30, 2023, our cash and cash equivalents and short-term expenses, investments amounted to RMB4.8 billion, providing us with sufficient working capitals and liquidity for operations. The capital expenditures for this quarter was RMB89.0 million, which primarily consists of payments for service. We have been taking prudent control of our procurement of traditional CPU service such as the ones used for CDN business. We've been saving our funds for high-performance AI service and we are working very closely with the top leading global CPU server provider and their OEM partners. To fulfill the orders, we expect the capital expenditures may increase in the second half of this year but subject to timelines of delivery. Our operating cash flow once again recorded a net inflow after last quarter fluctuation, reached RMB65.2 million and resulted from our margin improvements as well as our internal cash control enhancements. Lastly, we are honored to see that we have been listed in the first edition of the sustainable year for China by S&P Global. The selection assessed almost 1,600 Chinese companies and out of those 88 outstanding companies across 44 industries included in the 2023 sustainability yearbook China of S&P Global. We would like to send S&P global recognition of our ESG efforts where we will continue our commitment to improve our governance decreasing our footprints of carbon emissions and making positive impact to the whole industry and side. Looking ahead, we will continue to pursue our high-quality and sustainable development strategy and unlock synergies within the Xiaomi and Kingsoft Group ecosystems while staying agile to capture new opportunities in a new era of AI technology. Thank you.

This concludes our prepared remarks and it's for your attention and we are now happy to take questions. Please ask your questions in both Chinese, Mandarin and English if possible. Operator, please go ahead. Thank you.

[Operator Instructions] Our first question comes from the line of Xiaodan Zhang from CICC. Please go ahead.

[Foreign Language] So thanks management for taking my questions. And I got two questions here. First of all, the company has been proactively scaling down the CDN business in the past year or two. So when do you expect structural optimizations for your public cloud business to be completed? And is there any chance that your public cloud segment will return to positive growth in the upcoming quarters? And secondly, what do management think of the prospects of incremental revenue contribution from large language models and generative AI related business? Thank you.

Okay, so to respond to your question, you mentioned the structural adjustment we have been conducting in the public cloud services sector segment and this can be broken down into two parts. One is the CDN business and the other is the other public cloud services business. Now for the CDN part, actually since I took the role of CEO last year, we have communicated with the market and I would have to say that. In general, the development for this adjustment of this business has been in line with what I have communicated in the past quarters, but due to the changes in the overall market situation, the speed has been a little bit faster than what we had expected. However, in general, the pace and the direction is consistent. We would expect the adjustment for the CDN business to continue for a while and we expect to complete that within half a year to one year, and for the non-CDN business part of the public cloud services business, the business adjustment has been going through rather smoothly and we have done an excellent job in terms of cost reduction. As can be shown in our financial performances, the gross margin for the public cloud services business has improved from negative 2.4% in the second quarter 2022 to positive 5.2% in this quarter, which we are reporting. So this also relates to the second question that you have about the AI business. We expect that this round of AI opportunity has the potential opportunity to bring us more growth to the public cloud services business. So to answer your question, we do believe that this round of new AI opportunities will bring a lot of opportunity for us. As you can see, after the Chinese Spring Festival, the GPT concept started to explosively grow. The demand for AIGC has been particularly strong. And as mentioned, our neutral positioning has enabled us to win in the favor of the vast majority of venture AI companies in China and we are in the process of signing up contracts with dozens of such companies and so this is about the -- in terms of supporting their computing power. In addition, as mentioned, we are also providing companies with mass models of service business. We're also making progress in that front, for example, we have launched the MassMutual Trust dedicated zone solution and we're also collaborating very closely with Xiaomi and Kingsoft. So in general, in summary, basically what we have been seeing is, on the demand side, the demand is particularly strong. However, on the supply side, there is significant bottleneck in particular in terms of NVIDIA's supply chain to supply of GPU chips and we believe that our bottleneck is relatively difficult to resolve within the short period of time. So in short, the supply far exceeds -- the demand far exceeds the supply in the market. And that is not the situation for us as one company, it is a general situation for the industry. As a result of that, we had originally expected the revenue from AI to be shown in our financials in the third quarter and that is likely to be delayed due to the shortage of supply of GPU servers through the fourth quarter or even the first quarter of 2024. However, I would say in terms of our overall deployment and response to this new era of AIGC, the results that we have achieved, including the contracts that we have signed, including the models, the solutions that we have launched are quite successful. In the longer -- in the even longer term, we believe this will become -- embracing the AI wholeheartedly will actually become the most of poor direction for Kingsoft Cloud and Kingsoft Group.

Operator, next question please.

Thank you. We'll now move on to our next question. Our next question comes from the line of Timothy Zhao from Goldman Sachs. Please go ahead.

[Foreign Language] Thank you management for taking my questions. I have two questions, one is regarding the gross profit margin as I see the gross margin of public cloud, enterprise cloud has been upward trend over the past few quarters and especially for enterprise cloud, the gross margin has achieved above 20% for the past two quarters. Could management further elaborate on the drivers for the gross margin behind that? And what is our updated view on the gross margin target for this year and in the mid-term? And secondly, and also regarding the enterprise cloud and the question is regarding the revenue, as I see the potential for the revenue has been in the declining mode slightly in the second quarter. Just wondering if there is any specific reason behind that and how should we look at the revenue trend into the second half this year. Thank you.

Thank you, Tim, this is Henry. Happy to take on the first question and our CEO, Mr. Zou will take on the second one. So actually acknowledge the improvement of the gross margin of enterprise cloud business. Actually, there are few things we actually discussed this earlier about, you eventually see that trend, actually kept very stable and you see that improvement expansion, a few things, first of all is we talk about, is the right client selection process. So I think that actually the first and the beginning point that do the right business with right people and if you do look at our average revenue mix from enterprise cloud, we used to have some kind of heavyweights on the top clients with over RMB30 million or RMB40 million per contract. But right now, we're focused on the sweet spot around like RMB8 million to about RMB10 million per contract. So working on that range of the right clients, we have a better ability to control the cost and to make sure that all the receivables and cost control measures kind of actually finally deliver, I assume this is the first point. The second one is really about the repeating sales for the more standardized products. So we're working very closely with our sales team and our R&D team as well. We will make sure that we not only work with one client or one product, but we want to -- working with different clients with the same product. So I think that percentage, obviously, we didn't disclose the number from last year to this year, the standardization of the products, services and solutions has been very important driver, that's the second part and the third one is really about, I appreciate all the comments from the research analysts and our shareholders. We're actually moving up from the ICE TO PaaS level of services and in some cases, we're actually working with client from SaaS level products, especially given the AI drivers and a new phenomenon. Hopefully we can actually go up a little bit, obviously it depends on different verticals on the right penetration of the PaaS and SaaS level product which actually never carry with some higher margin. So as a conclusion, Tim, we do believe we have a capacity and willingness to keep gross margin above 20% of the enterprise cloud services, including both Kingsoft and Camelot as well and given the right incentives for our solution and delivery team to control their own costs, which were actually embedded into their own budgeting and a bonus calculation, we hopefully have more internal measures to make sure this pressure has been moving down the chain, and make sure everyone working in Kingsoft Cloud actually pay attention on the bottom line. So going forward, hopefully, we can keep above 20% our gross margin of enterprise cloud as well as we are hoping after the AI eventually unfolded, our enterprise, our margin even higher hopefully can -- above the three handles in the mid-term. So I think that give you -- hopefully give you some color. Thank you, Tim. And the second question, I will pass over to Zou

[Foreign Language] So before I answer the details of your question, I would like to give you an overview of how we think about the enterprise cloud business. The real thinking is that we have been becoming more focused on high-quality products -- high-quality projects in terms of selecting high-quality projects and also for the projects that are more sustainable for us. So in terms of project quality, in terms of reputation, in terms of deployment capabilities and services we offer to customers, we have been working very hard on those fronts and that is why you have been seeing in the consecutive quarters we have been experiencing improving profitability levels. I now ask your question of why the slight decrease for the revenue of enterprise cloud from the second quarter versus the first quarter. The answer is really just the seasonality because the revenue recognition for enterprise cloud projects, they generally delay from the time of the signing of those projects to the revenue recognition for some -- for several quarters to one year, some -- and in some other cases can be as long as two years. And therefore the financial results you see in one single quarter is the -- added is the combined results of different projects signing a different time points and the different delays in the overall revenue recognition cycle and therefore, I wouldn't say that a slight decrease for the financial of the revenue for enterprise cloud for the second quarter versus the first quarter is a reflection of the -- of our business performance for the enterprise cloud, on the contrary, we feel that the fundamentals of the enterprise cloud business have been going quite well and in some future quarters. For example, in the Fourth quarter, you might be also seeing a sudden surge of our enterprise cloud revenue. However, that's -- not necessarily reflect equivalent search of the business fundamentals. So that's the general idea I would like to give you. In fact, we have also been in communication with the auditors, hoping to find a metrics that would provide real-time reflections of our fundamental business situation and the alignment with that of the financial performance, we're still exploring that, we hope to find that metrics soon. thank you.

Thank you. That's helpful.

Operator, next question please.

Thank you. We'll now move on to our next question. our next question comes from the line of Allen Li from JPMorgan. Please go ahead.

[Foreign Language] Thank you management for taking my question. I have a follow-up question on gross margin. So for public cloud services, if we exclude CDN business, what's the gross margin trend for core computing and storage in past few quarters? And how do we think the trend into the second half? And also Henry, you just mentioned you have increasing revenue contribution from higher margin SaaS and PaaS services and could management share some color on how should we think about the long-term revenue contribution from these two business? Thank you.

Thank you, Allen. This is Henry. Happy to share some color. So first of all, again, while we're talking about the structure challenge of the client and revenue mix, CDN versus non-CDN. But I want to point out that the CDN business itself is not really problematic business. The point is a concentration risk together with the CDN products to certain clients is really a high-risk flat for us. So that's why we did some changes in the past few quarters but putting that aside, as you mentioned, there are two things we can share why we haven't disclosed in detail on that numbers. First of all, the marketing of the CDN business does have certain fluctuations, depends on the season, depends on time mix. And while we're cutting down certain client penetration and the client concentration, we do need to switch and reallocate certain resources, especially on the DNA and the bandwidth, we need to change and cancel and renew, those actions will take out some fluctuations. But I will say that in the old days, let's say, last year, a year before as you mentioned, there are certain quarters, our CDN business gross margin was negative in certain regions, certain notes. But right now, we do have relatively stable positive gross margin of the CDN business where it's really not as high as a public cloud product. The second part is gross margin of the cloud -- public cloud services including computing network and storage definitely higher and I think CDN products are much higher than CDN products in terms of the gross margin and we're trying to improving the percentage of their revenue from their products, so if you're putting that everything together, I think in few quarters when we're looking ahead given that we do have a lot of efforts on the resource management and cost control, hopefully, the spread between the computing and storage versus the CDN will be expanded and the computing and storage database and network products will deliver even higher gross margin going forward given the changes we have. So I don't want to provide a detailed guidance on the gross margin by product, as I mentioned, is really a dynamic and really kind of fluid in certain situation but overall I can tell you that from a management perspective, we're aiming for a relatively expansion for the public cloud gross margin as a whole and we try to manage on that. And one more point is you don't have to split that out because one client they will use multiple product lines and in one IDC centers, we may deliver different products, and one resources we're trying to and provide more utilization as well. So it's not really from the very single, straightforward line of calculation. So hopefully you can understand. On the second point is, I think the earlier question from Tim was really regarding enterprise cloud. It's not really about the PaaS or SaaS within the public cloud, really two different [indiscernible] put this way. So the enterprise cloud side, as I mentioned, our PaaS and SaaS level, they are packaging with solution and our services and we do see that service convert to a higher margin and on the public cloud. I don't want to provide a detailed guidance because as I mentioned, once AI is coming, all the business new model is changing. When we're talking about the most and other things was mentioned, we don't want to kind of develop and divided by the -- got a traditional concept of ICE and ICE products, but we are aiming for the mass products and services as a whole package. And as a whole, I think the margin will be much higher than the traditional ICE and computing service going forward. Thank you, Allen.

Thank you.

Thank you. Due to time constraints, this concludes our question-and-answer session. So I'll hand the call back to you for closing remarks.

Thank you, operator. Thank you all once again for joining us today. if you have any further questions, please feel free to contact us. Look forward to speaking with you again next quarter. Have a nice day. Thank you.

This concludes today's conference call. Thank you for participating. You may now disconnect.