Earnings Call Transcript
Kingsoft Cloud Holdings Ltd (KC)
Earnings Call Transcript - KC Q2 2020
Operator, Operator
Ladies and gentlemen, thank you for standing by. And welcome to the Kingsoft Cloud's second quarter 2020 earnings conference call. 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.
Nicole Shan, Investment Relations Manager
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.
Yulin Wang, CEO
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.
Nicole Shan, Investment Relations Manager
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. The growth of China's cloud market continued to gain momentum fueled by supportive government policies, 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 will further penetrate internet industries such as video and games and traditional industries such as public service, financial service, and healthcare. With our customer focus and selective vertical expansion, we are well positioned to capture the opportunities in the cloud service market.
Yulin Wang, CEO
As a leading independent cloud service provider, we will further solidify our leading position in the industry by leveraging the growing demand for cloud services and the trend towards multi-cloud deployment. We will further penetrate internet industries such as video and games, as well as traditional industries like public service, financial service, and healthcare. With our customer focus and selective vertical expansion, we are well positioned to capture the opportunities in the cloud service market.
Nicole Shan, Investment Relations Manager
Now I will share some updates across various 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, leveraging 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, resulting 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 the 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.
Yulin Wang, CEO
We have already partnered with certain well-known live streaming platforms to improve their users' VR video experience. In addition, we released the 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.
Nicole Shan, Investment Relations Manager
We continue to expand our foothold across various subsectors 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 online shopping festival in China, we provided large capacity and security solutions to a number of customers including Xiaomi Corporation, ensuring robust operational continuity of their campaigns. In the gaming sector, we accelerated the 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. 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 the platform and application levels. In addition, at a recently held 2020 APAC content delivery conference, our advanced edge computing technology won the best edge computing platform award. By leveraging our full-scale network and scheduling management capabilities, our edge computing technology provides customers with efficient and stable computing services and has garnered recognition from customers and the APAC City and industry alliance.
Yulin Wang, CEO
Our advanced edge computing technology won the best edge computing platform award at the recently held 2020 APAC content delivery conference. By utilizing our comprehensive network and scheduling management abilities, we offer customers efficient and reliable computing services, earning acclaim from both customers and the APAC City and industry alliance.
Nicole Shan, Investment Relations Manager
In relation to the financial services 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 for 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 assets 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 the major municipal government of Guangdong Province to kick off the construction of a cloud-based industrial internet platform. In May, the project for its ID resolution system launched successfully. The system focuses 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.
Yulin Wang, CEO
The project for our ID resolution system launched successfully in May. This system emphasizes file applications such as device management, intelligent applications, big data analysis, collaborative office, and robotics, aiding enterprises in their transition to intelligent manufacturing. Additionally, we secured two bids for central ministry projects in the realm of artificial intelligence, showcasing our technological and service capabilities.
Nicole Shan, Investment Relations Manager
To sufficiently meet the growing demand for cloud-based services, we continue to upgrade our infrastructure. In the second quarter, we received approval for the energy consumption data center from the government for our new data center. The new data center meets national E-level standards and has a capacity of up to 6,600 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.
Yulin Wang, CEO
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.
Nicole Shan, Investment Relations Manager
I will now pass the call to our CFO, Henry, to go over our financials for the quarter. Thank you.
Haijian He, CFO
Thank you, Yulin. Thank you, Nicole. Hello, everyone. I will now discuss our financial performance for the second quarter. Please be reminded all the numbers quoted here are in RMB. Please also refer to our earnings 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 was 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 year-over-year and 35.5 percent quarter-over-quarter. 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 points. Adjusted EBITDA margin has now steadily improved for eight consecutive quarters. Despite uncertainties in the macroeconomy, 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 our bottom line performance as we are achieving greater economies of scale. This demonstrates our ability to provide quality services to our customers even in very challenging market conditions. Now I will go through the details 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 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, it 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 purchases, outsourcing costs, channel costs associated with both public cloud and enterprise cloud, as well as other equipment costs related to enterprise services. Other costs were RMB244.9 million, and the staffing costs were RMB13.2 million. As we continue to improve the efficiency of IT resources, we expect IDC and D&A costs as a percentage of total revenue to gradually decline. Adjusted gross profit was RMB83.8 million compared with an 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 economies of scale and operating leverage, we are pleased to see that our profitability has improved. Total operating expenses increased to RMB511 million, up 80.4 percent from the same period in 2019. The increase was mainly due to one-time IPO-related share-based compensation expenses. Total share-based compensation in operating expenses was RMB172.1 million, representing a 289.7 percent increase year-over-year. Our share-based compensation helps us retain and attract talent. 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 in this quarter. Our operational efficiency continues to improve. Excluding share-based compensation, adjusted R&D expenses as a percentage of revenue declined from 13.5 percent last year in Q2 to 12.3 percent in 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 a 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 a 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 the second quarter this year from negative 12.6 percent 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 was 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 currently expect 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.
Nicole Shan, Investment Relations Manager
This concludes our prepared remarks. Thanks for your attention. We are now happy to take your questions. Operator, please go ahead.
Operator, Operator
The first question is from Alex Yao at JPMorgan. Please proceed.
Alex Yao, Analyst
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's development? And then lastly, when do you expect the commerciality of cloud gaming will hit the inflection point in China? Thank you.
Yulin Wang, CEO
What is the key driver leading to the acceleration in top-line growth? Regarding the development of cloud gaming in China, what is your perspective on its current stage? What steps have you taken to position yourself in the industry's growth? Lastly, when do you anticipate that cloud gaming will reach a significant commercial milestone in China? Thank you.
Nicole Shan, Investment Relations Manager
As Henry has said, we have read our outlook for the third quarter at RMB1.67 billion to RMB1.74 billion. Now we also see some seasonality in our revenue growth. For the quarter-on-quarter revenue increase, we have been very consistent over the past several quarters. We also see that last year was a little bit slow. So we grow from a 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 contributes to cloud market development and, thanks to our premium customer focus and selective industry focus, we believe we can deliver a higher revenue growth than other peers in this industry. And for your second question, we believe Kingsoft Cloud's cloud-based game solution is among the cloud-based technologies. 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 service providers are still in the testing phase, and now we have seen some small games transitioning to the cloud. We have already cooperated with many of the top game providers to advance into this industry. However, we think the commercialization of the cloud-based games still takes time. It generally takes six to 18 months to make a game available to the public. So for cloud-based games, we think it's still under research and will 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. We think the commercialization of cloud-based games will take a longer time.
Operator, Operator
Thank you. The next question is from the line of Fauston Wu of UBS. Please go ahead. Please ask your question.
Unidentified Analyst, Analyst
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?
Yulin Wang, CEO
Thank you. The next question is from Fauston Wu of UBS. Please go ahead and ask your question. My first question is how should we consider the effect of Microsoft and TikTok's situation in the U.S. on your business in China? Additionally, should we anticipate any impact from COVID on the guidance for the third quarter?
Nicole Shan, Investment Relations Manager
For the first question, we think that TikTok has no direct impact on our business as we haven't cooperated with TikTok in the American market. However, we'll keep an eye on the macroeconomic and geopolitical issues to see if there will be further impact on our potential or new opportunities. For the second question, we discussed the issue last quarter. We think the pandemic has had a positive trend for our online business as people spend more time at home. The video consumption and e-commerce consumption have increased, which is boosting public cloud service usage. However, for offline business, there is still some impact. The digitalization trend is strong, but we are experiencing secondary impacts as a result of the pandemic in Beijing, which has prevented us from delivering some of the projects offline. However, we haven't seen any meaningful impact on our work or business in this quarter but we will continue to monitor macroeconomic trends to see if there will be a direct impact from the pandemic.
Operator, Operator
Next question is from Kyna Wong of Credit Suisse. Please go ahead.
Kyna Wong, Analyst
I have 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 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 are from multi-cloud and are already using our cloud for new customer gains?
Haijian He, CFO
Thank you, Kyna, for the question. Happy to address that. Regarding the first question about the premium customer strategy, we are pleased to see that we continue to execute our premium customer strategy very robustly. Although we are not planning to disclose a number of premium customers on a quarterly basis, based on our internal management counts, we are happy to see that on a year-over-year basis as well as on a quarter-over-quarter basis, the number of premium customers from both public cloud and enterprise cloud has continued to improve. I would say, in terms of quality, the number of premium customers is increasing to a level greater than the number you just mentioned. Additionally, when we track our net dollar retention number as well as the attrition number, these are two important internal KPIs that measure how the premium customers perform on both a quarterly and year-on-year basis, which has also been robust and improving. Regarding the second question about the verticals, especially in the prepared remarks, we mentioned that in the public cloud market, we are seeing great potential in online education, remote work collaboration, and various e-commerce spaces. In these verticals, they are majorly attracting new premium customers as well.
Operator, Operator
Thank you. Next question is from the line of Libnin Yao of CICC. Please, your question.
Unidentified Analyst, Analyst
I have two questions here. My first question is about 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 gross profit margin level for our delivery business segment right now and our future strategy in this segment? My second question is regarding the CapEx plan for this year. Because we noticed the company had planned to build up their self-operated IDCs in the Tianjin District. And also due to U.S. and China tension, will the company change the server CapEx for this year and next year? Thank you.
Yulin Wang, CEO
I would like to know if the expansion of the cloud delivery service will impact our pricing and what the current gross profit margin is for our delivery business segment, as well as our future strategy in this area. Additionally, I have a question about the capital expenditure plan for this year. We noticed the company intends to build self-operated data centers in the Tianjin District. Given the tensions between the U.S. and China, will there be any changes to the server capital expenditure for this year and next year? Thank you.
Nicole Shan, Investment Relations Manager
We have noticed some small cloud storage providers launching their IPO programs. However, as we have solidified our position as a top cloud storage provider in terms of scale and premium customer relations, there is little impact from these small players in the market. We believe the price of our CDN business has remained stable in recent years. For top cloud service providers, they all consider their profitability in recent quarters and for ourselves, we have also delivered profitability improvements as we mentioned in the IPO. For the second quarter, our Tianjin data centers have been planned for a while, and the investment and capital expenditure have been included in our budget. Concerning the servers, we haven't seen any significant impact from geopolitical issues on the supply chain, but we will monitor the policies to see if there will be further impacts on our business. In this quarter, as public cloud service increased rapidly, we anticipate a meaningful impact on our financials. We have still delivered the results as scheduled. Thank you.
Operator, Operator
Thank you. Next question from the line of L.C. Chang of Goldman Sachs. Please ask your question.
Unidentified Analyst, Analyst
Thank you, management, for taking my question. Just to follow up in terms of the product categories, if we look into the recent products, can management share a little bit more color into the revenue mix change and outlook in this space? Thank you.
Yulin Wang, CEO
Thank you, management, for taking my question. Just to follow up regarding the product categories, could management provide more insight into the changes in the revenue mix and the outlook for this area? Thank you.
Nicole Shan, Investment Relations Manager
For the ISAN, there are different categories of features. For internet industries, as we mentioned, in the video sectors, we have launched our VR and 8K technologies. Also, our encoding technology is widely used by our customers. As we mentioned, our arch computing has been recognized by the APAC Edge alliance and our customers. For other product performances maintains at a normal level. The usage keeps increasing rapidly. For other sectors, the services are integrated into various enterprise technologies, especially in the financial services, internet sector, and healthcare sectors. We provide one-stop solutions to the customers based on their needs.
Unidentified Analyst, Analyst
Got it. Thank you very much.
Operator, Operator
Thank you. Next question is from the line of Dan Wong of Macquarie. Please go ahead.
Dan Wong, Analyst
Thank you, management, for taking my question. My first question is regarding ByteDance using GDS for their own data centers. Do you anticipate any negative impact from the movement of your largest clients? Additionally, could you share insights on which sub-sector is expected to bring in the majority of new key customers in the upcoming year? Thank you.
Yulin Wang, CEO
Thank you. Next question is from Dan Wong of Macquarie. Please go ahead. So, thanks, management for taking the question. Our first question is that we heard that ByteDance is actually using GDS for their own data centers. Do you expect any negative impact from the move of your largest clients? Additionally, can you share some details on which sub-sector is likely to provide the majority of the new key customers in the next year? Thanks.
Nicole Shan, Investment Relations Manager
Concerning ByteDance, it has always maintained its own IDC operations. They have rented some computing services from our data center, so there is no direct impact on their operations with us. ByteDance, as our largest customer, has maintained a stable relationship with us for a long time. Regarding the second question, we haven't discussed customer numbers in different sectors. However, overall, all sectors have delivered good performance. The number of customers has increased steadily. To sum up, there has been no significant change in the distribution of sectors. Thank you.
Operator, Operator
Thank you. There are no further questions at this time. I would now like to hand the conference back to the presenters. Please continue.
Nicole Shan, Investment Relations Manager
Thank you, everyone. This concludes our conference call. See you next time.
Operator, Operator
Thank you, ladies and gentlemen. This concludes today's conference call. Thank you for participating. You may now disconnect.