Earnings Call Transcript - KC Q1 2024

Operator, Operator

Good day, and thank you for standing by. Welcome to Kingsoft Cloud's First 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 that today's conference call is being recorded. I would like now to turn the conference over to 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 first quarter 2024 earnings release was distributed earlier today and is available on our IR website at ir.ksyun.com as well as on GlobeNewswire services. On the call today from Kingsoft Cloud, we have our Vice Chairman and CEO, Mr. Zou Tao; and our CFO, Mr. Henry 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. All interpretations are for your convenience and reference purposes only. In case of any discrepancy, the 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, Vice Chairman and CEO

Hello, everyone, and thank you for joining Kingsoft Cloud's first quarter 2024 earnings call. This quarter, Kingsoft Cloud's focus on high-quality and sustainable development has yielded positive results. After over a year of continuous optimization and adjustments, along with a steady increase in gross profit margin, we have achieved the significant milestone of turning adjusted EBITDA positive for the first time since Kingsoft Cloud was established. This marks a demonstration of our profitability and sustainable growth potential, signifying the start of a new phase in our development. It lays a solid foundation for our long-term progression into 2024 and beyond. Now, I will discuss the business highlights from the first quarter of 2024. This quarter saw improvements in both revenue and profitability. Our total revenues hit RMB1.78 billion, marking a 3.1% increase quarter-over-quarter. The adjusted gross profit for the quarter was approximately RMB300 million, reflecting a 54% year-over-year growth. The adjusted gross margin also saw a notable increase of 1.6 percentage points quarter-over-quarter, reaching 16.8%, which represents seven consecutive quarters of improvement. Adjusted EBITDA stood at RMB33.19 million, with an adjusted EBITDA margin of 1.9%, a substantial improvement of 8.9 percentage points year-over-year. In public cloud services, revenues reached RMB1.19 billion this quarter, a 12.9% increase quarter-over-quarter. Excluding the CDN business, public cloud revenues increased by 9% quarter-over-quarter. We have observed positive developments across our three core areas for public cloud services, namely the Xiaomi and Kingsoft ecosystem, AI business, and CDN strategic adjustments. As the exclusive strategic cloud platform within the Xiaomi and Kingsoft ecosystem, we maximized cloud business opportunities, particularly following the launch of Xiaomi SU7 and the commercialization of WPS AI, which drove demand for computing power in autonomous driving and AI office applications. This quarter, revenues from the Xiaomi and Kingsoft ecosystem accounted for 19%, representing a 4 percentage point year-over-year increase. Additionally, we proactively pursued opportunities arising from the current AIGC boom and made significant advancements in our AI business. AI revenue surged to RMB160 million, a 93% increase quarter-over-quarter, contributing to 13.5% of public cloud revenues and further diversifying our customer industry distribution. On one hand, we continued to invest heavily in infrastructure, with capital expenditures exceeding RMB1.2 billion this quarter, building a large-scale high computing cloud resource pool. On the other hand, recognizing the historic opportunity presented by AI's role in various industries, we established Kingsoft AI as a wholly-owned subsidiary, focusing on opportunities in the intelligent digital transformation of enterprises and professional services. We also moved forward with strategic adjustments in our CDN business. CDN revenue remained stable compared to the previous quarter, constituting 23% of total revenues. We are dedicated to enhancing CDN profitability through the promotion of high-value product sales externally, strict internal procurement cost management, expanding supplier coverage, and optimizing market pricing and service offerings. In enterprise cloud services, revenues were RMB590 million. In the public service sector, we actively pursued opportunities within public service cloud and state-owned assets cloud. By implementing standardized operations and maintenance, we leveraged our core components, including model capabilities, big data, and workspace collaboration, to target applications in public service and enterprise domains. This quarter, we initiated a trial operation for the Wuhan Optics Valley cloud we constructed, providing a centralized computing and storage platform for the entire Wuhan East Lake High-tech Development Zone, which has facilitated data collection, sharing, and offered public cloud infrastructure services for technology innovation enterprises in the high-tech zone. Furthermore, we are attentive to the trend of including data assets on balance sheets. Recently, we held a seminar on data assets and data elements, engaging experts and scholars from various institutions to discuss topics such as policy interpretation, data assetization, and practices related to state-owned enterprises, closely following data assetization business opportunities. In healthcare, our DaaS platform, medical imaging cloud platform, and integrated electronic medical record platform have all passed evaluations and been selected as part of the first batch of high-quality digital medical products and services by the China Academy of Information and Communications Technology, showcasing our achievements in product innovation and service capabilities in the medical AI industry. In financial services, we provide object storage expansion services for a leading joint-stock bank, utilizing comprehensive storage capabilities such as object storage, file storage, and big data gateways. Turning to Camelot, this quarter experienced stable and healthy revenue and profitability, with four new prominent customers signed while maintaining strong relationships with existing major clients. From an overall ecosystem perspective, Camelot has launched a specialized cooperation service plan with customers in the Xiaomi and Kingsoft ecosystems to explore new business models. Focusing on product and technology, we adhere to our belief in achieving success through technology and innovation, delivering the best customer experience across our core offerings. In the AI domain, we have built substantial expertise in deploying large-scale clusters, achieving automation in deployment and maintenance management. In enterprise cloud services, we released an updated version of the Galaxy Stack operations and maintenance platform, incorporating 84 new monitoring capabilities for performance monitoring to assist customers in effective management. To summarize, our high-quality and sustainable development strategy has been steadily implemented, leading to our first-ever positive EBITDA. Additionally, we have seen continuous revenue growth over the past two quarters, with seven consecutive quarters of improved gross profit margin. Looking ahead, we are committed to our long-term strategy, focusing on high-value products and services, embracing AI opportunities, advancing technological progress, and enhancing profitability. We aim to create value for our customers, shareholders, employees, and stakeholders by increasing management efficiency, controlling costs and expenses, enhancing talent development, and expanding our Wuhan R&D center. I will now turn the call over to our CFO, Henry, to review our financials for the first 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 the financial results for the first quarter of 2024. We are very pleased to see our adjusted EBITDA margin turn positive for the first time, with our adjusted gross margin improving consecutively for seven quarters, confirming our well-executed strategy focused on high-quality and sustainable development. Having achieved a profitable EBITDA margin, we want to emphasize three key efforts that contributed to our results. First, we strategically adjusted our revenue mix in line with our high-quality and sustainable development strategy. Over the past year, we proactively reduced our CDN services, which have a low margin profile. This quarter, CDN services contributed approximately 23% of our total revenue, down from over 50% at peak times in 2020. Simultaneously, we grew our revenue from the high-margin AI business, which reached RMB160 million this quarter, accounting for around 13% of our public cloud revenues. Second, both our public cloud and enterprise cloud services enhanced their margins in 2023 and for the quarters to come compared to 2022. Since last year, we focused on high-margin products and services and selected our clients carefully, resulting in an improved margin profile. Third, we implemented strict measures and a supply chain strategy aimed at reducing costs and expenses. We streamlined our procurement process and expanded our supplier base to achieve better cost efficiency. We also closely monitored daily operating expenses. These key initiatives paid off this quarter with recorded EBITDA profit, and we believe there is still potential for further improvement in the future. We are committed to enhancing our profitability. Our adjusted gross profit rose to RMB299.1 million, a 53.8% year-over-year increase, representing an adjusted gross margin of 16.8%, a record high for the company, and an improvement of 1.6 percentage points from the last quarter. Our adjusted EBITDA improved from negative RMB130.5 million in the same period last year and negative RMB27.7 million in the previous quarter to positive RMB33.2 million this quarter. The adjusted EBITDA margin also changed from negative 7% in the same period last year and negative 1.6% in the last quarter to positive 1.9% this quarter. Total revenues for this quarter were RMB1,775.7 million, up 3.1% sequentially. Revenues from public cloud services were RMB1,187.4 million, a 12.9% increase compared to RMB1,052 million in the last quarter, primarily driven by growth in AI-related revenues and a relatively stable CDN business. Revenues from enterprise cloud services were RMB588.2 million, down from RMB670.3 million in the last quarter, as fewer projects were scheduled for delivery during the Chinese New Year holiday. We continue to strengthen our cost control measures, broadening our supplier network to improve service quality and procurement prices. The total cost of revenue fell by 11.2% year-over-year, remaining stable quarter-over-quarter at RMB1,482.4 million. IDC costs dropped significantly by 11.9% year-over-year from RMB872.4 million to RMB768.5 million this quarter, consistent with our reduced CDN services. Depreciation and amortization costs decreased by 18.3% from RMB224.6 million in the same quarter last year to RMB183.5 million this quarter, mainly due to previous asset impairments offset by the depreciation of new services we acquired. Costs for solution development and services rose by 5.3% year-over-year from RMB423.6 million to RMB446.0 million this quarter, primarily due to personnel expansion within Camelot. Fulfillment costs and other costs were RMB36.1 million and RMB48.3 million this quarter, respectively. Adjusted gross profit for this quarter jumped by 53.8% year-over-year to RMB299.1 million, corresponding to an adjusted gross margin of 16.8%, compared to 10.4% in the same period last year and 15.2% last quarter, marking another record high and the third consecutive quarter of steady margin improvement. Regarding expenses, excluding share-based compensation and impairment of our long-lived assets, total adjusted operating expenses were RMB469.6 million, down 21.2% year-over-year and 5.1% from last quarter. Our adjusted R&D expenses were RMB193.0 million, an 18.8% increase from last quarter, mainly due to our ongoing investment in technology. Adjusted selling and marketing expenses fell to RMB97.9 million, down 8.3% from RMB106.7 million last quarter, while adjusted G&A expenses decreased by 20.8% from RMB225.6 million last quarter to RMB178.7 million, largely due to strict control over daily operational expenses and reduced bad debt provisions. As of March 31, 2024, our cash and cash equivalents totaled RMB1.8 billion, providing us with the liquidity needed for operations and investments in AI. Capital expenditures for this quarter amounted to RMB1,212.2 million as we invested in infrastructure to support a sustainable AI business. In April, we released our ESG report for 2023, offering an in-depth review of the company's progress over the last year in its ESG practices, encompassing business ethics, responsible operations, talent development, green development, a sustainable supply chain, and corporate responsibility. In 2023, we were awarded as a member among the top 88 companies in the first edition of S&P Global's Sustainable Yearbook China Edition. We also received a single A rating in MSCI ESG rating, leading among all ADR stocks in China. We are committed to fulfilling our social responsibility and creating value for our customers, employees, shareholders, suppliers, and society as a whole. Looking ahead, based on our core principle of high-quality and sustainable development, we will continue to implement initiatives to enhance our revenue quality, reduce costs and expenses, and improve profitability. The breakeven of EBITDA represents a strong beginning for us, and we anticipate a more balanced and healthy business performance and financial results in the future. 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 questions in both Mandarin and English, if possible. Operator, please go ahead. Thank you.

Operator, Operator

Thank you. Our first question comes from Xiaodan Zhang with CICC. Your line is now open.

Xiaodan Zhang, Analyst

I have two questions. First, what are your expectations for the pace of improvement in the adjusted EBITDA margin for the upcoming quarters? Second, how do you plan to address the increasingly aggressive pricing strategies from IC and large language model vendors? Thank you.

Haijian He, CFO

I will address the first question. We are pleased to announce that during our 12 years of operation, this is the first quarter that we have achieved breakeven on our EBITDA margin. The key drivers behind this achievement are straightforward. We believe these factors will continue to generate value and profit in the coming quarters, including an improved revenue mix from various business units, significant contributions from our AI business, and a revamping of our supply chain strategies to maintain competitiveness in costs. We have also enhanced our internal operational efficiency by streamlining certain processes. While other companies may pursue similar initiatives, we believe our approach is more committed and sustainable. We expect that the benefits from these initiatives will persist in the upcoming quarters. Moreover, we anticipate positive trends that will support increased growth on our top line, which should enhance our bottom line profitability as well. To summarize, we do not view the EBITDA margin improvement as a one-time occurrence. We expect it to be consistent and to carry forward in the subsequent quarters. Additionally, we see that an improving gross margin will also play a role in enhancing the EBITDA margin. We believe we will see a sequential improvement in gross margin and a reduction in the gap between gross margin and EBITDA margin. Therefore, we anticipate a faster trend of EBITDA margin improvement. While we will not provide specific numeric guidance regarding the EBITDA margin going forward, we assure you that our breakeven EBITDA margin this quarter will not be an isolated event. We are confident that both gross margin and EBITDA margin will continue to show improvement in the quarters ahead. Thank you.

Tao Zou, Vice Chairman and CEO

To summarize and translate, we had anticipated this situation. People have noted the price reductions of large language models from various providers, indicating that development in China has reached a relatively mature phase marked by competition that may eliminate some participants. It's crucial to clarify that Kingsoft Cloud's role is distinct from those of large language model creators; we supply services and computing resources to these players but do not develop large language models ourselves. Our focus is on monitoring the survival and market presence of our customers, the independent large language model providers. Many of them have recently secured significant funding, and we view their situation as relatively strong for at least the next one to two years, aligning with our contract timelines. Long-term, we recognize that not all players can sustain their operations in this developing market. However, we see promising opportunities for vertical application models, with many likely establishing their own niches in the competitive landscape.

Nicole Shan, IR Director

Operator, could you please go ahead?

Operator, Operator

Please stand by for the next question. The next question comes from Timothy Zhao with Goldman Sachs. Your line is now open.

Timothy Zhao, Analyst

Thank you management for taking my question. My question is about AI and relevant investments. I noticed that AI revenue showed strong quarter-on-quarter growth both in absolute numbers and as a percentage of revenue. Can management provide any insights into what is driving this significant increase in AI revenue? Additionally, regarding capital expenditures, you mentioned that you have already spent around RMB1.2 billion. Do you have any guidance on the total capital expenditures for this year? Thank you.

Haijian He, CFO

Thank you, Tim. I’ll take on part of the question, and our SVP will probably provide more color on the business side. Regarding the investments, I think we are still in the early stages and there are numerous opportunities ahead. We want to invest in the right clients. As mentioned, we want to carefully select our clients, but after we commit to a client, as we get to know them better, we will continue to invest more. The RMB1.2 billion spent this quarter reflects only a segment of the demand we've received from our clients, and we expect to invest more in the following quarters, which we believe will result in higher revenues. On the other hand, since the AI business carries a better margin, and the supply/demand trend in the market is more balanced, we are changing the way we allocate our resources. Not only are we utilizing our equity capital, but we are also leveraging various sources, including financial leasing, operational leasing, bank borrowing, and other partnerships that provide certain credits to us. Therefore, we do not intend to limit our AI investments solely based on the cash we currently hold. As for guidance on total CapEx for 2024, the total investment, including CapEx and R&D expenses for the AI team, along with different partnerships with suppliers, will be several times this quarter's number. This would be the ballpark figure I can provide. We believe this will yield significantly higher AI revenues in the subsequent quarters. Additionally, the demand for the AI business spans a diversified array. It is not limited to large model companies; as AI continues to grow, more clients from various sectors, including Internet, financial services, legal, auditing, and public sector clients, will leverage AI computing power, ultimately contributing to our revenue.

Tao Liu, SVP

Yes. As mentioned, we are receiving income from various types of companies, including AI firms that are currently building base clusters on our cloud. As stated in the report, we have established about 256 or even 512 clusters. Many of these companies will be expanding their clusters on the cloud, leading to better revenues in the upcoming quarter. Furthermore, all cloud companies require not only hard drive technologies but language model technologies. We have customers from the Internet sector creating their own language models. We are not only providing cluster services to them, but also assisting them in training their models and managing new data. Additionally, we see emerging demands from companies focusing on images and videos. This demand is expected to rise significantly.

Nicole Shan, IR Director

Thank you, operator.

Operator, Operator

I show no further questions at this time. I would now like to turn the call back over to Nicole Shan for closing remarks.

Nicole Shan, IR Director

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

Operator, Operator

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