Earnings Call Transcript - KC Q2 2024

Operator, Operator

Good day, and thank you for standing by. Welcome to the Kingsoft Cloud's Second Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Nicole Shan, IR Director of Kingsoft Cloud. Please go ahead.

Nicole Shan, IR Director

Thank you, operator. Hello, everyone, and thank you for joining us today. Kingsoft Cloud's second quarter 2024 earnings release was distributed earlier today and is available on our IR website at ir.ksyun.com, as well as on GlobalNewswire services. On the call today from Kingsoft Cloud, we have our Vice Chairman and CEO, Mr. Tao Zou; and CFO, Mr. Haijian He. Mr. Zou will review our business strategies, operations and company highlights, followed by Mr. He who will discuss the financials and the guidance. They will be available to answer your questions during the Q&A session that follows. There will be consecutive interpretations. Our interpretations are for your convenience and reference purposes only. In case of any discrepancy, management's statement in the 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 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 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. Thank you.

Tao Zou, CEO

Hello, everyone. Thank you for joining Kingsoft Cloud's second quarter 2024 earnings call. I am Zou Tao, CEO of Kingsoft Cloud. Reflecting on the last two years since August 2022, our team has effectively implemented a high-quality and sustainable development strategy, leading to a complete transformation of the company. Profitability has significantly improved, with gross margins increasing from low single digits to 17%. The adjusted EBITDA margin rose to 3% after turning positive in Q1, and we are well-positioned to achieve positive operating and net profits. We have swiftly adapted to AIGC opportunities, with AI services contributing to public cloud revenue rising from 0% to 26%, making us a leader in the industry. We are also phasing out low-margin businesses, reducing CDN services revenue contribution from about 40% to 20%, which has alleviated risk from customer concentration. We've implemented refined management practices in procurement, assets, and operations, resulting in a decrease of approximately RMB300 million in quarterly costs and expenses, reflecting 15% of our quarterly revenues. As we take a long-term perspective, our Wuhan R&D center has rapidly grown to host about 30% of our workforce, establishing a solid foundation for ongoing technological leadership. We've also completed our dual primary listing on the Hong Kong Stock Exchange and were included in the Hang Seng Composite Index and Hong Kong Stock Connect, reinforcing our capital markets structure. These initiatives have laid the groundwork for high-quality and sustainable future development. I want to express my sincere gratitude to our customers, shareholders, and employees for their long-term support. Now, let me share the business highlights for the second quarter of 2024. Kingsoft Cloud has achieved significant breakthroughs in revenue scale, profitability, and operating cash flow this quarter. Our revenues reached RMB1.89 billion, reflecting sequential growth of 6.5% and year-over-year growth of 3.1%. Revenue from high value-added products and services grew, offsetting pressures from our proactive adjustments to CDN services. Adjusted gross profit reached RMB323 million, a year-over-year increase of 56.4%. Adjusted gross margin increased to 17.1%, marking eight consecutive quarters of improvement. Adjusted EBITDA reached RMB60.59 million, with an adjusted EBITDA margin of 3.2%, a sequential improvement following our Q1 positive milestone and a year-over-year increase of 6.5 percentage points. We recorded a net operating cash inflow of RMB150 million, demonstrating our ability to generate cash from operations. The improvement of our financial performance indicators indicates that our high-quality and sustainable development strategy is effective, positioning us for long-term healthy growth in 2024 and beyond. In public cloud services, revenues reached RMB1.23 billion this quarter, representing a 6.5% year-over-year increase and a 4% quarter-over-quarter increase. We have seen positive results from our three primary areas for public cloud services: the Xiaomi and Kingsoft ecosystem, AI businesses, and supply chain. As the sole strategic cloud platform within the Xiaomi and Kingsoft ecosystem, we leverage cloud business opportunities effectively. This quarter, revenue from Xiaomi and Kingsoft reached 20%, amounting to RMB370 million, with a year-over-year increase of 36.9%. Our AI business continued to thrive, with AI revenue surging to RMB326 million, doubling the first quarter's amount and constituting 26.3% of public cloud revenues. Our AI customer base now includes large language model companies and self-driving applications, and we have built a substantial computing resource pool, leading industry standards in large-scale network capabilities. We have developed a comprehensive supply chain system, ensuring a stable and intelligent computing resource pool while managing procurement costs by utilizing data centers in central and western China more efficiently than those in core eastern cities. We also expand our supplier coverage to find the best price-to-quality combinations. In enterprise cloud services, revenues amounted to RMB657 million. We have pursued opportunities in public service cloud and state-owned enterprise cloud, implementing standardized operations and maintenance. Leveraging our core components like models, big data, and workspace collaboration, we target use cases in these domains. According to CCID’s June 2024 report, we are ranked in the leaders quadrant of the China e-government cloud market, and IDC ranks us among the top six companies in the e-government cloud operations service market, reflecting our recognition for product capabilities and market share. This quarter, we promoted a benchmark project implementing large language models in the public service sector, assisting the Beijing Municipal Commission of Housing and Urban-Rural Development in various initiatives, thereby enhancing service quality and response times. In healthcare, Changzhou Health Cloud has launched its fifth phase expansion to address new business requirements. Kingsoft AI, our invested subsidiary, has begun promoting its business in enterprise AI software applications. We also initiated strategic cooperation with Dentons law firm to establish a joint laboratory focusing on Legal Artificial Intelligence, advancing digital transformation in the legal industry. We prioritize technology and innovation to deliver an exceptional customer experience. In the AI space, to meet increasing data cleansing demands, we integrated products like Bare Metal and object storage into a comprehensive solution for data cleansing, addressing various media types. In enterprise cloud space, we launched the Galaxy Stack platform, a low-cost, high-density proprietary cloud platform, achieving significant reductions in cost per instance and substantial increases in instance density. In conclusion, after two years of effective implementation of our high-quality and sustainable development strategy, Kingsoft Cloud has transformed its fundamentals. Looking ahead, we will continue to improve profitability and cash generation, deepen cooperation with the Xiaomi and Kingsoft ecosystem, enhance the Wuhan Research Center, and explore new AI opportunities. Our aim is to continually create value for our customers, shareholders, employees, and stakeholders. I will now hand the call over to our CFO, Haijian, to discuss our financials for the second quarter of 2024. Thank you.

Haijian He, CFO

Thank you, Mr. Zou, and welcome everyone for joining the call. Now I will walk you through our financial results for the second quarter of 2024. We would like to highlight three key areas of progress. First, we are very pleased with the ongoing improvements in our financial metrics. By applying first principle thinking, we are committed to a profit-focused approach that has led to consecutive increases in our gross profit, gross margin, EBITDA profit, and EBITDA margin over the past several quarters. This quarter, our adjusted gross margin reached 17.1%, marking eight consecutive quarters of steady growth, while adjusted gross profit hit RMB333.4 million. After turning a profit in adjusted EBITDA margin last quarter, we continued this positive trend with RMB60.6 million in EBITDA and 3.2% in EBITDA margin, demonstrating our successful execution of a high-quality sustainable development strategy. Second, this quarter our revenue reached RMB1,891.8 million, showing a positive trend with a 3.1% year-over-year increase and a 6.5% rise quarter-over-quarter. By strategically adjusting our revenue mix in line with our high-quality and sustainable development strategy, we have allocated more resources to develop high-value services. This quarter, our AI revenues grew to RMB326 million, accounting for 26% of our total public cloud services revenue, which is double the amount from last quarter. We have established a resilient supply chain, scalable computing power, and a long-term partnership with customers to support our growing AI revenues. In response to cost pressure and low margins, we have strategically reduced the proportion of our CDN services to 19% of total revenue, down from 23% last quarter. Third, we reported a net inflow of operating cash flow amounting to RMB151.2 million. We also secured various financial channels to support our AI business, including loan facilities from Kingsoft Corporation, financial leasing, and other bank loans. Here are the details of our financial results. Total revenues for this quarter were RMB1,891.8 million, a 3.1% increase year-over-year, of which revenues from public cloud services were RMB1,234.5 million, up 4% from RMB1,187.4 million last quarter, primarily driven by the growth in AI-related revenues to RMB326 million. Revenues from enterprise cloud services reached RMB657.2 million, up from RMB588.2 million last quarter, due to accelerated project deliveries this quarter. We have continued to enhance our cost control by expanding our supply base to improve service quality and procurement prices. Total cost of revenue decreased by 30.4% year-over-year and remained stable quarter-over-quarter at RMB1,573.4 million. IDC costs dropped significantly by 14.4% year-over-year from RMB860.7 million to RMB728.2 million this quarter, reflecting the strategic scaling down of our CDN services and optimizing rack usage. Depreciation and amortization costs increased from RMB202.1 million in the same period last year to RMB265.9 million this quarter, mainly due to the depreciation of newly acquired servers. Solution development and services costs increased by 8.4% year-over-year from RMB452.9 million to RMB491.1 million due to personnel expansion in Camelot, which was aligned with revenue growth. Fulfillment costs and other costs were RMB37.6 million and RMB50.6 million this quarter, respectively. Our adjusted gross profit for the quarter was RMB323.4 million, a 56.4% increase year-over-year with an adjusted gross margin of 17.1%. This marks a new record and the eighth consecutive quarter of steady margin improvement, up from 11.3% last year and 16.8% last quarter. In terms of expenses, excluding share-based compensation and impairments of long-lived assets, our total adjusted operating expenses were RMB555.3 million, slightly up by 3.2% year-over-year and 18.3% quarter-over-quarter. Our adjusted R&D expenses were RMB200.1 million, a 3.7% increase from last quarter due to personnel costs. Adjusted selling and marketing expenses were RMB117.5 million, up from RMB97.9 million last quarter, representing 6.2% of total revenues. Adjusted G&A expenses were RMB237.7 million compared to RMB178.7 million last quarter. As of June 30, 2024, our cash and cash equivalents totaled RMB1,837.8 million, providing strong liquidity for operations and AI investments. Capital expenditures for this quarter were RMB654.8 million, reflecting our investment in infrastructure to support our sustainable AI business. Looking ahead, we remain committed to high quality and sustainable development. We will continue to enhance revenue quality, reduce costs and expenses, and improve profitability. Thank you.

Nicole Shan, IR Director

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

Operator, Operator

Thank you. We will now take our first question. This is from the line of Xiaodan Zhang from CICC. Please go ahead. Your line is open.

Xiaodan Zhang, Analyst

Thank you, management, for taking my questions. I have two inquiries. First, could you update us on your CapEx guidance for the next two quarters? Second, can you provide some insight into the ROI of your AI investment and your expectations for AI revenue contribution for the full year? Thank you.

Haijian He, CFO

Regarding the CapEx, I believe you're right in noting that this year we are increasing our investment in promising areas of financial business growth. Most of our CapEx, over 95% or possibly even more, is focused on AI investments, which we see as a significant opportunity for us. While we can't provide complete guidance for our full-year CapEx, we can highlight a couple of key points. Firstly, in this quarter, we reported a net cash inflow from operations of approximately RMB151 million. This indicates that our CapEx investments are translating into positive operational cash flow. Secondly, we have broadened our financing channels. For instance, last year we obtained financing from Kingsoft Group and explored leasing options with Xiaomi Group. This year, particularly in the last two quarters, we have received substantial support from national policy banks and state-owned financial institutions, including banks and leasing companies. As a result, we are not limited by our current cash balance when considering CapEx investments. The additional financing opportunities allow us to enhance our capability to support AI investments significantly. Furthermore, since our investments are long-term, we assess the profitability and sustainability of these initiatives carefully. Most of our AI clients are reputable names in the market, and we have secured long-term contracts that ensure a steady cash flow and recurring business opportunities with these clients. A few quarters ago, we discussed the importance of recurring revenue for our profitability, and we now see that recurring revenue percentages from AI are much higher compared to our previous IaaS services model. In conclusion, we are not constrained by our current cash reserves and can increase our investments. Every dollar we invest now is expected to generate long-term returns and secure stable recurring cash flow. Additionally, we have the capacity to engage with a diverse range of clients, particularly in the AI sector within China. We believe we are well-positioned to lead in revenue generation and financing capabilities, allowing us to align these aspects for sustainable growth. Lastly, Xiaodan, as you requested a ballpark figure, I can say that our total CapEx this year is likely several times greater than last year’s, which should translate into accelerated revenue growth in the upcoming quarters. Thank you.

Tao Zou, CEO

Okay. Let me just translate what Mr. Zou said. In terms of AI, I want to take this opportunity to share my overall thoughts. It's really about three dimensions. First is the supply of computing power. Second is inference, which is the application of artificial intelligence. The third is training, which you can see from the current financials shows tremendous growth, for example, 10 times year-over-year growth and two times the AI revenue growth compared to the first quarter. However, most of these numbers currently come from the supply of computing power. I believe that in the future, there is much more potential for revenue and business in terms of training and application of the models. Regarding ROI, I must say that the GP margin for the AI business is significantly higher than that of other business parts, which contributes to the company's overall GP margin improvement. Looking ahead, I want to discuss it from two dimensions: the supply of computing power and the application of AI capabilities. In the first dimension, two areas offer many opportunities. One is electric vehicles, particularly the autonomous driving demand in the EV market. Since the launch of Tesla's FSD, we have engaged with many EV firms, all of which have a strong intention to implement and train their own autonomous driving models. This presents substantial business opportunity for us. The second area is robotics, which enhances robots with artificial intelligence. We believe there are many opportunities in this space. Notably, one company has recently secured RMB3 billion in financing, indicating strong confidence in this sector. The second dimension concerns inference and the use cases for model capability. As mentioned in our prepared remarks, we are implementing some projects in collaboration with our partners, deepening these collaborations and achieving significant progress. This will establish a solid foundation for the mass model as a service offerings we aim to provide. In summary, we believe that our overall strategy of focusing on AI since June last year has been very fruitful, and we look forward to continuing our investments and development in this area. Thank you.

Nicole Shan, IR Director

Thank you.

Operator, Operator

Thank you. We'll now take our next question. This is from Timothy Zhao from Goldman Sachs. Please go ahead.

Timothy Zhao, Analyst

Thank you, management, for taking my question. I have two inquiries. The first pertains to the revenue contribution from Xiaomi and the Kingsoft Group. I've observed significant revenue growth in the last quarter, with their total contribution reaching 20% of overall revenue. Could you explain what is driving this growth and detail the AI-related revenue contribution from Xiaomi and Kingsoft Group to Kingsoft Cloud? Looking ahead to the second half of this year and beyond, especially with more Xiaomi cars on the road and WPS monetization from Kingsoft Group, what is your revenue outlook from this point? My second question concerns the CDN revenue. With the ongoing proactive downscaling of CDN revenue, could you provide your perspective on the future outlook for this business line? Thank you.

Haijian He, CFO

Thank you, Tim. The first question about the revenue contribution from related parties highlights some encouraging signals regarding future revenue growth. First, we are strengthening our business connections, particularly with Xiaomi and the Kingsoft Group. We have allocated more resources to prioritize revenue and client demand from our internal clients. A few months ago, we mentioned that this is a significant opportunity for Kingsoft Cloud. In this quarter, revenue from Xiaomi and Kingsoft Group grew by approximately 36.9% year-over-year, contributing around RMB370 million for this quarter alone. This is a positive indicator of our ability to serve important internal clients such as Xiaomi, Kingsoft, and WPS. Additionally, the advancements in auto-driving and AI-related SaaS services are crucial drivers for this opportunity. Looking ahead, we may ask shareholders to approve an increase in the cap on related party revenue by the end of this year as we enter a new financial year. We aim to propose a higher ceiling for revenue cap in upcoming shareholder meetings to demonstrate our strong visibility on revenue from related parties. Regarding AI revenue contribution, most of the incremental revenue from internal parties is linked to AI-related services. Approximately half of the total AI revenue this quarter came from related parties, with the rest coming from external clients. This balance shows our capability to serve both internal and external clients effectively, with many of our external clients being top-tier AI model companies in the Chinese tech landscape. The increasing visibility of potential revenue growth is encouraging. Lastly, it's worth noting that our gross margin has been steadily improving, and the added gross profit primarily stems from our AI-related business. We are making careful selections of AI clients and believe that this revenue will be sustainable and visible moving forward. We will also learn from past experiences to manage business contracts and models effectively while being aware of potential risks associated with these revenues. We aim to maintain a balanced return and risk profile for the profits and contracts we engage with in the AI sector. That concludes my response to the first question.

Tao Zou, CEO

I think it's important to differentiate between two types of CDN business. One type is the standard CDN business, which typically has lower profit margins, while the other type, such as live broadcasting acceleration and dynamic acceleration, generally offers higher margins due to their added value. Therefore, for the standard CDN business, we aim to maintain a minimum quarterly revenue of RMB300 million, and I don't anticipate it going lower than that since it serves as a foundation for our overall business. We will also continue to invest in and expand the higher margin aspects of the CDN business. That wraps up my response.

Nicole Shan, IR Director

Thank you, operator. This concludes our Q&A.

Timothy Zhao, Analyst

Thank you.

Nicole Shan, IR Director

Thank you, Tim Zhao. This concludes our Q&A.

Operator, Operator

Thank you. There are no further questions at this time. So I will now hand back to Nicole Shan for any closing remarks.

Nicole Shan, IR Director

Thank you, and 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 all. Bye.

Operator, Operator

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