Earnings Call Transcript - KC Q3 2024

Operator, Operator

Good day, and thank you for standing by. Welcome to the Kingsoft Cloud Third 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 is being recorded. I would now like to turn the conference over to your speaker today, Nicole Shan. Please go ahead. Thank you, Heidi. Hello, everyone and thank you for joining us today. Kingsoft Cloud's third quarter 2024 earnings release was distributed earlier today and is available on our IR website at ir.ksyun.com, as well as on our GlobalNewswire services. On the call today from Kingsoft Cloud, we have our Vice Chairman and CEO, Mr. Zou Tao and 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 conductive interpretation. Our interpretations are for your convenience and reference purpose only. In case of any discrepancies, management's statement in the original language will prevail. 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 expectations and current market and operating conditions and relate to events that involve known or unknown risks, uncertainties and other factors, 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 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.

Tao Zou, CEO

Hello, everyone. Thank you for joining Kingsoft Cloud's third quarter 2024 earnings call. I am Tao Zou, CEO of Kingsoft Cloud. This quarter, we have continued to achieve strong results due to our focus on high quality and sustainable development. Revenue is growing rapidly. After solid growth last quarter, our year-over-year growth rate has risen to 16%, surpassing the industry average. This success is a result of the strategic changes we made in 2022 to diversify our revenue and capitalize on our first mover advantage. Both our public cloud and enterprise cloud segments experienced double-digit year-over-year growth, thanks to our dual engine strategy that strengthens our foundation for ongoing development. Our profitability is also improving at a quick pace. Having achieved positive EBITDA for the first time in Q1 and a margin of 3.2% in Q2, this quarter, we have accelerated to a double-digit margin of 10%. Furthermore, our adjusted operating loss margin has narrowed significantly from 16.2% last year to 7% this quarter, reinforcing our commitment to high quality development. We are leading the transformation with AI as well, with AI revenue now contributing 31% of our public cloud business. Over the past five quarters, AI revenue has shown consistent triple-digit year-over-year growth, including a remarkable 6.9-fold increase this quarter compared to last year, exceeding industry growth rates. Our robust profit margins and diverse customer base reflect the sustainability of this growth. Additionally, we are exploring new AI business models in partnership with Shine Wing, a leading professional services firm in China, to create a one-stop platform for large model training, inference, application development, and long-term operations. We are taking full advantage of the unique opportunities within the Xiaomi and Kingsoft ecosystem. This quarter, our revenue from this ecosystem increased by 36% year-over-year, reflecting strong growth across all of Xiaomi's business lines, particularly in the automotive sector. As the primary cloud platform in this ecosystem, we are dedicated to supporting Xiaomi's autonomous driving and cloud service expansion. Despite declines in market share for other internet cloud providers, we have seen our own market share steadily rise. Now, let me highlight the key business results for the third quarter of 2024. Kingsoft Cloud has made significant strides in revenue growth, profitability, and operating cash flow. Our revenues reached RMB1.89 billion, rebounding to double-digit growth with a 16% year-over-year increase. The growth from our high-value products and services has countered challenges in our CDN business. Our adjusted gross profit rose to RMB308 million, representing a 56.7% year-over-year increase. The adjusted gross margin rose to 16.3%, reflecting a 4.2 percentage point increase year-over-year, despite a slight quarterly decrease primarily due to CDN profitability fluctuations. Adjusted EBITDA reached RMB185 million, with an adjusted EBITDA margin of 9.8%, showing significant improvement following our positive EBITDA turnaround in Q1 and a year-over-year increase of 13 percentage points. Our net operating cash inflow was RMB228 million, showcasing our strong operating cash generation capability. In the public cloud services segment, revenues reached RMB1.18 billion this quarter, marking a 16% year-on-year increase. Our cloud business opportunities within the Xiaomi and Kingsoft ecosystem are crucial to our growth, contributing to a 36% year-over-year revenue increase. As Xiaomi's AI empowers its ecosystem, the potential for cloud services driven by the AI era is unprecedented. We are actively pursuing opportunities in autonomous driving and AI within this ecosystem. Additionally, AI revenue surged to RMB362 million this quarter, growing 11% quarter-over-quarter and accounting for 31% of public cloud revenues, keeping us at the forefront of the industry. In our enterprise cloud services, revenues reached RMB710 million, a year-on-year increase of 16.7%. We are pursuing public services cloud and state-owned enterprise cloud opportunities, focusing on government and enterprise use cases to promote standardized operations. This quarter, we initiated a large language models project in the Zhuhai high-tech zone, training a model dedicated to government work, tailored for Zhuhai. Lastly, we are recognized as leaders in project quality and product capabilities in the state-owned enterprise markets. We have also secured a partnership with a well-known bank for real-time data services aimed at improving efficiency and quality in data management. Our Camelot business remains stable with significant progress in building Xiaomi's exclusive service center in Wuhan. In terms of product and technology, we prioritize building on technology and innovation to enhance customer experience. We launched a cloud-native platform for AIGC data cleaning, designed to be user-friendly and scalable. Our AI application platform aims to accelerate AI application development through low-code solutions. Kingsoft Cloud's model as a service has been recognized in the market leaders’ quadrant by a domestic authority. In summary, after two years of dedicated implementation of our high-quality and sustainable development strategy, Kingsoft Cloud is now experiencing healthy growth. Going forward, we will continue to improve profitability and cash generation, deepen our collaboration with the Xiaomi and Kingsoft ecosystem, strengthen our Wuhan Research Center, and explore new AI opportunities, creating ongoing value for our customers and stakeholders. I will now pass the call to our CFO, Haijian, to discuss our financials for the third quarter of 2024. Thank you.

Haijian He, CFO

Thank you, Mr. Zou, and thank you all for joining the call today. I will now walk you through our financial results for the third quarter of 2024. I would like to highlight the three areas of progress. Regarding the performance of this quarter, first of all, the company achieved a double-digit year-over-year growth in total revenue, reaching RMB1885.6 million, which is 2x the high single-digit average growth rate of the industry, restoring the high-speed growth of the revenue. There are three aspects we would like to highlight. First, thanks to the first mover advantage of our revenue structure adjustments starting from 2022, differentiated us from the situation of our competitors in the market. Both of our public cloud and industry cloud have already benefited from the development trend of the AI business, achieving double-digit year-over-year growth respectively. This has laid out a solid foundation for the balanced growth of the future business. Second, in this quarter, our AI gross billings reached RMB362 million, accounting for as high as 31% of the public cloud revenue. It has achieved triple-digit year-on-year growth for five consecutive quarters, far exceeding the industry average level. Third, we have repositioned the business strategy of the company. Regarding the strong performance of Xiaomi's new EV cars, as well as Kingsoft Games and WPS AI, the ecosystem business progress has exceeded market expectations. Thanks to the excessive demand of customers within the Xiaomi and Kingsoft ecosystem, the revenue growth of our ecosystem customers in a single quarter has exceeded 36% year-on-year, laying a good foundation for the growth of ecosystem customers in the future. The proportion of public cloud revenue contributed by the ecosystem client in this quarter has already reached 28%. Secondly, in terms of profit, the expansion of our gross profit and EBITDA profit far exceeds the industry average. Compared with adjusted gross profit margin of only 3.6% in the quarter before the company carried out business structure adjustments and AI transformation in Q2 of 2022, today, we have reached a 4.5x growth of the margin expansion to 16.3%. The adjusted EBITDA profit margin has been significantly improved from a loss of 8.6% in Q2 of 2022 to a profit of 9.8%, an increase of 18.4 percentage points. The company revenue structure adjustments and AI strategic transformation have achieved remarkable results. Thirdly, due to the effective progress of high-quality business and strong cash flow contribution brought about by the successful transformation of AI business in this quarter, we have achieved net inflow of operating cash flow reaching RMB228 million. In terms of the outlook, we have achieved a turning point for our successful AI strategy and the Xiaomi Kingsoft ecosystem strategy. Going forward, for the fourth quarter of 2024, we are happy to provide the following guidance for the performance of Q4. First of all, thanks to the concurrent drivers of both public cloud and enterprise cloud, we will continue to deliver healthy growth for Q4. We expect to achieve an accelerated growth rate for total revenues in Q4 2024, exceeding the average growth rate of the industry. Second, we expect our profitability will continue to improve. For the adjusted operating profit, we expect to deliver significant accelerated improvement in Q4. Third, for the AI business and the Xiaomi Kingsoft ecosystem strategy, we believe the revenue contribution will continue to grow. As a result, we will continue to take more market shares from competitors going forward. Meanwhile, given the promising growth of AI and the cloud demand from both Xiaomi and Kingsoft Group, for upcoming connected party transaction applications with our shareholders and the stock exchange in Hong Kong, we are applying for revenue to be generated from Xiaomi and Kingsoft Group for the next three years with a cap of RMB11.3 billion, 10 times over the historical revenue of RMB1.1 billion in the financial year of 2023, providing solid support for company revenue and profit growth. Now, let's dive into the details of our financial results. Total revenue of this quarter were RMB1885.6 million, reflecting a 16% year-over-year increase, of which revenues from public cloud services were RMB1175.5 million, up 15.6% from RMB1016.6 million in the same quarter last year. This growth was primarily driven by a significant increase in AI related revenues, which reached RMB362 million, partially offset by the scaling down of CDN services due to higher bandwidth costs and price adjustments with certain customers. Revenues from enterprise cloud reached RMB710 million, up from RMB608.5 million in the same quarter last year, primarily driven by increased demand in selected verticals and a growth in Camelot's IT solutions. We have continued to enhance our cost control by expanding our supply base and optimizing procurement costs, which has improved both service quality and pricing. Total cost of revenue was RMB1582.2 million, up 10.7% year-over-year, but remained stable quarter-over-quarter. IDC cost dropped significantly by 8.7% year-over-year from RMB737.7 million to RMB673.8 million this quarter, reflecting the strategic scaling down of our CDN services and the batch rep utilization. Depreciation and amortization costs increased from RMB200.4 million in the same period of last year to RMB297.5 million this quarter, mainly due to the depreciation of newly acquired GPU service. Solution development and service costs rose by 70.3% year-over-year from RMB425.3 million to RMB499 million, driven by expansion in Camelot personnel to support revenue growth. Fulfillment costs and other costs were RMB59.5 million and RMB52.3 million this quarter, respectively. Our adjusted gross profit for the quarter was RMB307.6 million, a 56.7% increase year-over-year, with an adjusted gross margin of 16.3%. On the expense side, excluding share-based compensation and impairment of long-lived assets, our total adjusted operating expenses were RMB491.2 million, a decrease of 2.6% year-over-year and 11.5% quarter-over-quarter, of which our adjusted R&D expenses were RMB232.3 million, up 16.1% from last quarter, due to higher personnel costs. Adjusted selling and marketing expenses were RMB110.6 million, down from RMB117.5 million last quarter, representing 5.9% of total revenues. Adjusted G&A expenses were RMB148.3 million, significantly lower than RMB237.7 million last quarter, reflecting strong cost control and a reduction in credit losses. As of September 30, 2024, our cash and cash equivalents totaled RMB1,617.9 million providing a strong liquidity position to support our operations and AI investments. Our capital expenditure and assets obtained through financial leasing reached RMB1.22 billion, the majority of which are used to invest in servers to support AI business. Looking ahead, we remain committed to the principle of high quality and sustainable development. We expect ongoing revenue growth, driven by deeper collaborations with Xiaomi and the Kingsoft ecosystems, further expansion of AI-related gross billings and a continued reduction of low margin CDN business. We also expect to achieve another milestone in adjusted operating profit in the near future. Thank you.

Operator, Operator

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

Xiaodan Zhang, Analyst

Thank you to management for addressing my questions. I have two inquiries. First, the revenue contribution from Xiaomi and Kingsoft Group has significantly increased in recent quarters. Could you elaborate on the growth potential of these strategic customers and your service strategy? Second, can you provide your outlook on adjusted EBITDA margin and operating margin, considering depreciation and amortization expenses, as well as the increasing AI-related capital expenditures?

Tao Zou, CEO

Yes, the business opportunities arising from the Xiaomi and Kingsoft ecosystem have been growing rapidly and consistently. This growth is largely driven by the unprecedented AI opportunities that began last year. The AI-related business prospects with Xiaomi and Kingsoft Corporation have been expanding quickly. As mentioned in the Xiaomi results released yesterday, they have achieved historically strong results, including robust EV deliveries. Consequently, the use of cloud services and applications related to Xiaomi’s growth provides a solid foundation for further expansion. Additionally, on the WPS office side, their focus on AI capabilities to introduce new functions, along with a significant increase in paid customers for AI features, has contributed to the growth in our cloud revenue. In conclusion, the strong growth of the Xiaomi and Kingsoft ecosystem has established a firm foundation for revenue growth and business opportunities for Kingsoft Cloud. We believe we are still experiencing positive business momentum for further growth.

Haijian He, CFO

Thank you, Xiaodan. I probably will comment on the second question regarding the margin expansion. So as I mentioned in my prepared remarks, I think the sequencing we are seeing is our continued expansion from the gross margin to the EBITDA margin and then drop to the operating profit. So back in 2022, our gross margin was as little as only around 3%. And this quarter, we are reaching a certain level. We think it's getting even closer to the top tier players in the market in terms of the gross margin in the near term. And for the EBITDA margin, you can also notice that the EBITDA margin has converted from a loss of 8.6% in Q2 2022 to a positive around 10% this quarter. And I think the speed of expansion of EBITDA margin will be faster than the gross margin expansion. In addition, I think our EBITDA margin given the AI has already contributed around one-third of the total public revenue, which is also higher than the major peers on the street. And I think given that reason, our EBITDA margin will continue to deliver a much higher expansion speed compared with the peers of the industry as well. So in addition, as you speak about the operating margin, as you noticed, our expense control and cost cutting in terms of operations as well as improving efficiency in operations all contributed to the operating line as well. So I think we're hoping for the near term, we can deliver a positive surprise to the shareholders. You may see accelerated and a significant improvement of the operating profit in the very near term. And hopefully, we can keep that track after we made a breakeven in the near term. But at this moment, we're not providing formal guidance for the timing, but hopefully, we can keep the speed and expansion from the gross margin to EBITDA and then to the operating profit as a trend you may observe.

Timothy Zhao, Analyst

Thank you, management, for addressing my questions. I have two inquiries. First, I would like to know about the margin profile of your AI business as well as the revenue from Xiaomi and Kingsoft Group. How does the margin of these compare to the overall margin profile of public cloud? Secondly, I am interested in your outlook for capital expenditures this year and next year, and how you plan to use resources on the balance sheet or off-balance sheet to meet the funding demands for growing your business, especially in the AI sector?

Haijian He, CFO

Happy to take on those two questions. The first question, as you all know, we are not disclosing the separate line of gross margin for each of the product line given, as you know, sometimes each customer, they may use multiple different business segments. It's a bit difficult to separate that. But happy to provide some high-level guidance on that. Overall, the AI-related computing products are delivering much higher gross margin compared with the traditional public cloud services, including the traditional storage and networking. And our entire public cloud gross margin is higher than enterprise cloud in most cases. However, as Mr. Tao Zou also mentioned in his prepared remarks, the reason why this quarter we're delivering much stronger and robust top-line growth as well as margin expansion is our both public cloud and enterprise cloud have achieved double-digits year-on-year growth, which is unlike other peers on the market because we actually did our business strategy adjustment much earlier back in two years ago. So we do see both parallel growth drivers have been very solid for this quarter. Coming back to your margin question, I think if we want to take in order the different product lines, I think the current revenue contribution for the incremental revenue, especially the AI has delivered double-digits gross margin and a double-digits EBITDA margin. The traditional public cloud also delivered a decent gross margin as well. But, when you look at the EBITDA margin, I think AI is doing a very good margin as well. Our traditional non-public cloud services, especially for the CDN as you know, we have already planned out the scaling down as planned, which we actually execute very effectively. The margin contribution from CDN has been very effective and well on our budget. So, these are the first question I probably want to mention. The second part is given the CapEx, I think the one part I want to mention is we actually have already secured many of the additional CapEx resources, including the banks, financial leasing companies as well as the state-owned enterprises, which actually can cooperate with us to invest together into the GPU and AI investments. But more importantly, as I mentioned also in my prepared remarks, for the next three years, we are currently applying for the cap of the related party transaction from both Xiaomi and Kingsoft around RMB11.3 billion for next three years, which is about 10 times over this year's number. So from that budget, we are going to look into more closer financial support from shareholders and we are confident we will not dilute the public shareholders in terms of the additional share issuance or potential transactions that maybe dilutive to the public shareholders, we will keep that in mind. And the strong support from both business and CapEx from the major shareholders will be very important for our company growth as well as the margin expansion and the robust financial position for the next few years. And we have our internal discussion for the annual budget meeting as well. I think we will talk about that in the later quarter and you may find that we'll maintain a very robust way to managing both leverage as well as the investment speed in relation to AI investment.

Operator, Operator

This concludes today's question-and-answer session. I will now hand back to Nicole Shan for closing remarks. Thank you, operator. Thank you once again for joining us today. If you have any further questions, please feel free to contact the IR team. Look forward to speaking with you again next quarter. Have a nice day. Thank you. Bye.

Operator, Operator

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