Earnings Call Transcript - KC Q1 2023

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to Kingsoft Cloud First Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there is going to be a question-and-answer session. I’d now like to hand the conference over to the IR Manager, Nicole Shan. Please go ahead, ma’am.

Nicole Shan, IR Manager

Thank you, operator. Hello, everyone, and thank you for joining us today. Kingsoft Cloud’s first quarter 2023 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 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 financials and the 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 demand 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. Thank you.

Tao Zou, CEO

Hello, everyone, and thank you for joining Kingsoft Cloud’s first quarter 2023 earnings call. We have maintained our commitment to high-quality and sustainable development, focusing on technology and innovation to build success, enhance our reputation throughout our business processes with a customer-centric approach, and improve our operations management. In this quarter, we saw an increase in profitability. Our revenue reached RMB1.86 billion, aligning with our expected guidance. The adjusted gross margin rose to 10.4%, a record high and an increase of 6.6 percentage points compared to the same period last year. This also marks our fourth consecutive quarter of sequential improvement in adjusted gross margin. The adjusted gross profit hit RMB194.4 million, a historic high, reflecting a 133% year-over-year increase. The normalized adjusted EBITDA margin was negative 5.9%, significantly improving by 4.2 percentage points from the last quarter. Now, I will share some updates on our progress in four key areas: public cloud, enterprise cloud, product and technology, and business updates. Starting with public cloud services, revenue was RMB1.15 billion, and the gross margin improved to 2.1%, up from a negative 3.4% in the same period of 2022. We have focused on three main goals in public cloud services: supporting the Xiaomi and Kingsoft ecosystems, optimizing our customer structure, and improving cost efficiency. We remain committed to supporting the Xiaomi and Kingsoft ecosystems with leading products and technologies to drive sustainable revenue and reputation. This quarter, revenues from these ecosystems increased year-over-year, representing a growing share of our total revenues and maintaining a healthy margin. We actively sought feedback from customers to enhance service experiences and adapt our offerings. Next, optimizing our customer structure is vital for establishing a differentiated approach and enhancing profitability. We are focusing on expanding our medium-sized business client base while strategically stepping back from less profitable projects involving larger customers. In this quarter, we secured contracts with several medium-sized clients, including those in the EV and V2X technology sectors, like Black Sesame. We also undertook several cost-reduction initiatives, improving efficiency through better supply chain management. This quarter, we raised our resource utilization rate by eliminating redundancies and minimizing bandwidth commitments, which allowed us to efficiently allocate resources based on customer demand while protecting profitability. Turning to enterprise cloud services, revenue was RMB710 million and the gross margin rose to 24%, a notable increase from 16% a year ago. We have continued enforcing strict project management standards focused on customer quality, business sustainability, and core capability reuse. Our public services cloud business grew, renewing our contract with Beijing Public Services for the ninth consecutive year and expanding into regions like Shandong and Shanghai. Over the years, we have developed a resilient public services cloud business model that supports healthy margins and prospects for value-added data projects. In digital health, we have been enhancing five key business models: regional healthcare cloud, medical image cloud, integrated healthcare organization, regional integration, and smart hospital models. These models help us capitalize on market opportunities and leverage our capabilities. This quarter, we made significant headway in our Data-as-a-Service portfolio, especially in the hospital market through our data management platform, contributing to major national R&D projects on biology and information integration. Looking ahead, we anticipate utilizing our technical and product strengths in the healthcare sector. In finance, we successfully delivered big data platforms for major institutions like Industrial Bank and CITIC, assisting clients in overcoming new challenges while focusing on areas where we have a competitive edge, such as big data. Our commitment to innovation remains steadfast as we continuously refine our products and enhance the customer experience. In cloud computing, our container instances now support the elastic scaling of container clusters for customers' data centers, allowing unified management of on- and off-cloud resources, which significantly reduces costs. Our cloud storage offerings are gaining traction, having risen to fourth place in the market according to the latest IDC report. We developed a new all-flash array object storage product that doubles performance, catering to demanding data applications while delivering high-cost efficiency. In enterprise cloud, we upgraded the Galaxy Stack to address management pain points for clients, resulting in a better experience in usability, safety, and intelligence. I’d like to address the recent developments in China’s AI landscape, which has intensified since the introduction of GPT 3.5. We are closely monitoring this field, strategically aligning with Xiaomi and Kingsoft companies to support key initiatives. We maintain a neutral stance within the large language model space, preserving trust with independent AI firms using our platform. Additionally, our blend of owned and leased assets allows us to offer sufficient GPU resources to our customers. In summary, our recent performance reflects the effectiveness of our strategy. As we face future opportunities and challenges, we will continue to adapt our approach to create value for customers, shareholders, employees, and society. Now, I will pass the call to our CFO, Henry, to review our financials for the first quarter of 2023. Thank you.

Henry He, CFO

Thank you, Tao Zou, and welcome, everyone, for joining the call. Now I will walk you through the financial results for the first quarter 2023. Guided by the high-quality and sustainable development strategy, we are pleased to see that our profitability further improved steadily in the first quarter. Our adjusted gross profit continued to grow for the fourth consecutive quarter and achieved a record high of RMB194.4 million, increased by 133% year-over-year, representing adjusted gross margin of 10.4%. Along with our strict expenses control, our normalized adjusted EBITDA margin improved from negative 6.6% in the same period last year and a negative 10.2% in the last quarter to negative 5.9% this quarter. Our total revenue were RMB1,864.4 million this quarter, which were in line with our previous outlook. Within that, revenue from public cloud services was RMB1,153.7 million compared with RMB1,380.8 million in the same period of last year. The decrease was mainly due to our proactive adjustments of the CDN business as well as impact from our clients structure adjustments. Revenue from enterprise cloud was RMB710 million compared with RMB792.5 million in the same period of last year. The decrease was mainly due to the January infection of COVID-19, seasonality impact and the product quality control. We continue to enhance our cost control measures. Total cost of revenue decreased by 20.2% year-over-year to RMB1,670.2 million. IDC costs decreased significantly by 21.4% year-over-year from RMB1,110.3 million to RMB872.4 million this quarter. Depreciation and amortization costs decreased by 8.7% from RMB246.1 million in the same period of last year to RMB224.6 million this quarter. Solution development and services costs decreased by 11% from RMB476 million to RMB423.6 million this quarter. Fulfillment costs and other costs were RMB122.7 million and RMB26.9 million this quarter. Adjusted gross profit of this quarter increased by 133% to RMB194.4 million, representing adjusted gross margin of 10.4% compared with 3.8% in the same period of last year. The significant margin improvement demonstrates the success of our strategic adjustment of our revenue mix, optimized enterprise cloud project selections and efficient cost control measures and reaffirms our strong commitment to improving our profitability and delivering high-quality and sustainable development. To help the market and investors better understand our business and our path to profitability, we separately disclosed the gross margin and gross profit for public cloud and enterprise cloud in order to better reflect our business nature. Within our business line, gross profit of public health services was RMB24.8 million, which was significantly improved from the gross loss of RMB47.2 million in the same period of last year. Gross margin of public cloud services was 2.1% compared with negative 3.4% in the same period of last year. The improvement was mainly due to the proactive scaling down of CDN services and adjustments of our client structure. Gross profit of enterprise cloud services was RMB169 million compared with RMB127.4 million in the same period of last year. Gross margin of enterprise cloud services was 23.8%, improved from 16.1% in the same period last year. The improvement was mainly due to our more stringent enterprise cloud product selection strategy. In terms of expenses, excluding share-based compensation and impairment of long-lived assets, our total adjusted operating expenses were RMB595.8 million, decreasing by 18.3% from RMB729.6 million last quarter. Within that, adjusted R&D expenses were RMB202.6 million, decreasing by 15.4% from last quarter. Adjusted selling and marketing expenses were RMB104.2 million compared with RMB118.4 million last quarter. Adjusted G&A expenses decreased largely by 22.3% from RMB371.9 million last quarter to RMB289.1 million. As of March 21, 2023, our cash and cash equivalents and short-term investments amounted to RMB4.5 billion, providing us a significant and sufficient liquidity for operations. The capital expenditure for this quarter was RMB44.6 million, which primarily consists of payments for service. We have been taking control of our procurement of traditional service such as the ones being used for CDS business. While for high-performance service, especially in the recent popular AIGC areas, we have been actively cooperating with our suppliers in various ways to access the resources needed, including but not limited to, capital expenditure model. We also in operational leasing, which will not be included in our CapEx, but amounted to be in OpEx model. Meanwhile, due to the payment schedule, certain cash payments for service purchases, including the service for the AIGC business, which we ordered earlier this year will be gradually reflecting sequentially in the following quarters. Lastly, we have recently released our ESG report for 2022, to present a very in-depth review of the company’s progress in the last year in ESG practice. We’ve also noticed that recognition from rating agencies and scoring of the company increased from certain well-known ESG agencies. We have taken great pride in advocating the highest ESG standards. We will continuously strengthen our ESG governance and engage with our partners to amplify our positive impact in the cloud industry and society thereby delivering long-term value for our shareholders. Looking ahead, we will continue to pursue our high-quality development strategies and unlock synergies within the Xiaomi and the Kingsoft Group’s ecosystems. While staying alert to capture new opportunities in the new era of AI technology advances, we expect our total revenue to be between RMB1.85 billion to RMB2.0 billion for the second quarter of 2023. While these forecasts and commitment comments above are based on our current and preliminary view on the market and operational conditions, which are subject to change, we firmly believe that given the time, the effect of our ongoing strategy initiatives and the new business opportunities, especially in the AIGC areas will continue to amplify and reflect our financial results in the mid to long-term. Thank you.

Nicole Shan, IR Manager

Thank you. This concludes our prepared remarks. Thanks for your attention, and 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

Ladies and gentlemen, we will now begin the question-and-answer session. We are now taking the first question. And the first question from Xiaodan Zhang from CICC. Please go ahead. Your line is open.

Xiaodan Zhang, Analyst

My first question is about our pricing strategies. We've noticed that several cloud service providers have recently announced price cuts on their products. Could you please share your thoughts on the price trend moving forward? Will we be making adjustments to our pricing strategies in response? My second question pertains to our gross profit margin. We've observed a significant sequential improvement in the gross profit margin for the first quarter. Is this improvement sustainable? What are our expectations for the segmental gross profit margins in the mid- to long-term? Thank you.

Tao Zou, CEO

We have observed that larger companies have implemented notable price reductions. After careful analysis, I can confirm that these changes have a limited impact on our current products and services, and there is no significant effect on our offerings. Regarding future pricing strategies, the price cuts from larger competitors are relatively restricted. A detailed examination of the specific products affected leads us to believe that there is currently no substantial impact on the industry. Therefore, we see these actions as primarily serving a public relations purpose. Thank you.

Henry He, CFO

Thank you, Xiaodan. Happy to take on the second question regarding the gross profit. As you mentioned, we are pleased to see that especially starting from the second half of last year, the company has adopted significant initiatives to expand our gross profits, which you can see have achieved positive results in recent achievements. However, I want to put the data into the context of the past six quarters. If you recall, the lowest point of our gross margin was in Q4 of 2021, when our gross margin was only about 1.2%. In the past six quarters, especially the second half of last year, we have sequentially increased the gross margin to about 10.2%, which is almost 7x to 8x higher than Q4 of 2021. This reflects a combination of several important reasons and drivers. First, it results from a better mix of the products, including our efforts to cut back on low profit margin products and also increase the diversification of our top clients and medium-sized clients, providing Kingsoft Cloud with better positioning in terms of pricing power and negotiation terms with our customers. Second, our efforts to cut back on certain resources from service, the bandwidth and the lower utilized cabinets contribute as well. All these efforts are cumulative to impacting our gross margin positively. Moreover, our internal strategy and management quality in terms of execution on our enterprise cloud projects are critical. This quarter, we are for the first time separating the gross margin of enterprise cloud and public cloud, demonstrating both business lines are making a positive gross margin, and we are optimistic about the trend moving forward. Regarding your second point, we believe the key trend is threefold. First, combined, we expect the gross margin of Kingsoft Cloud to improve on a quarter-over-quarter basis. We are confident in this trend moving forward, given the positive results we've already seen. Second, the potential for gross margin expansion in the public cloud will be more pronounced compared to the enterprise cloud. We are working to ensure that the potential for margin expansion in the public cloud plays a significant role in overall company results. We aim to keep the enterprise cloud's gross margin on a sustainable incremental growth path as well. Finally, we take a very careful view regarding growth versus profitability. Margin is not the sole focus; we must also balance growth opportunities, such as in the recent AI domain, and ensure we have ample resources to invest. Our CEO also mentioned that we will make rationale decisions and resist following irrational trends in pricing cuts that could risk our margins. Thank you.

Operator, Operator

Thank you for your question. We are now taking the next question. And the next question from Brian Gong from Citi. Please go ahead.

Brian Gong, Analyst

I will translate myself. Thanks, management, for taking my question. I would like to follow up on Henry’s point about Kingsoft Cloud balancing growth and profitability moving forward. When can we expect to see a resurgence in growth for public and enterprise cloud services? Additionally, Tao Zou mentioned the influence of AI on Kingsoft Cloud. Can management provide details on whether we have seen any large language models from third parties utilizing our cloud? Also, do we have sufficient resources to meet future demand? Thank you.

Tao Zou, CEO

Sure, I will answer your question for both public cloud and enterprise cloud. In the public cloud area, we mainly cater to internet customers. The current wave of AI-generated content presents a significant opportunity for us. We will continue to leverage our neutral position, enabling us to work with various independent AI developers. Our strategic collaboration with Kingsoft and the Xiaomi ecosystem is also advantageous for us. This highlights our public cloud opportunities. Now, regarding enterprise cloud, we focus on three main sectors: public services, digital health, and finance. First, for public services cloud, our strategy is to scale down and concentrate on core geographic areas. You might notice a reduction in projects, but we expect profitability to rise as we focus on key regions like Beijing and Hubei provinces. In the medium to long term, this will help us enhance our technology and services before expanding more sustainably. In the digital health sector, we are improving the five models of our digital health business. We anticipate growth not just in profitability but also in revenue scale. Concerning your question about how many large language model providers use our platform, I apologize for not being able to provide specific details due to confidentiality agreements. We currently have many companies in negotiation for potential transactions. Regarding your third question about our GPU chip reserve, we recognize that having more resources would be advantageous. There is considerable interest among customers to grow their AI-related business. Market restrictions have led to supply constraints, but we are employing flexible and combined channels to meet demand, including owning and leasing GPU chips and services. We are committed to fulfilling the needs of existing and potential customers in this area.

Henry He, CFO

Thank you, Tao Zou. And Brian, thank you for the question. I want to add two points. First, we are currently publishing our Q1 results. As you may recall, the AIGC topic began emerging in early April. Therefore, it is not reflected in Q1 results. We remain quite optimistic regarding growth prospects. In Q1, part of China was affected by COVID, and various bidding processes were delayed due to the two sessions back in March. As we promised one or two quarters earlier, we will now separately disclose our gross margin for public cloud and enterprise cloud. In the next few quarters, we also aim to disclose our backlog numbers and other metrics. This will provide a clearer view of growth potential, incorporating both AIGC opportunities and our strategy to balance growth and profitability. The second point is that you may have noticed that our CapEx number was a bit low in Q1. However, this does not reflect low growth spending, as we have not yet ordered the servers. The timing of those payments has not been recognized in our Q1 cash flow item, and many new opportunities arose in April and May, which we are currently pursuing. I hope these points are helpful to you in understanding our growth trajectory moving forward. Thank you.

Brian Gong, Analyst

Thank you. That’s very helpful.

Operator, Operator

Thank you for your question. There are no further questions. I will hand back the conference to Nicole Shan for closing remarks.

Nicole Shan, IR Manager

Thank you, operator. Thank you 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. Thank you. Have a nice day.

Operator, Operator

That concludes the conference for today. Thank you for participating. You may all disconnect.