Earnings Call Transcript - KC Q1 2022

Operator, Operator

Good day and thank you for standing by. Welcome to Kingsoft Cloud's First Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. And now, I would like to turn the conference over to Ms. Nicole Shan, IR Manager of Kingsoft Cloud. Thank you. Please go ahead.

Nicole Shan, IR Manager

Thank you, operator. Hello, everyone, and thank you for joining us today. Kingsoft Cloud's first quarter 2022 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 CEO, Mr. Yulin Wang; and the CFO, Mr. Haijian He. Mr. Wang will review our business 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 interpretations. Our interpretations are for your convenience and reference purposes only. In case of any discrepancy, management's statement in the original language will prevail. Before we begin, I would like to remind you that this conference call contains forward-looking statements within the meaning of Section 21-E of the Securities Exchange Act of 1934 as mandated 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 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 CEO, Mr. Yulin Wang. Please go ahead.

Yulin Wang, CEO

Thank you, Nicole, and thank you all for joining our 2022 first quarter earnings call. In the first quarter, we generated RMB2.17 billion in total revenues, which was an increase of 20% year-over-year and above the high-end of our revenue guidance range. Our public cloud services revenues reached RMB1.38 billion, remaining stable year-over-year, and our enterprise cloud services revenues reached RMB792.5 million, up 89% year-over-year. As previously communicated, starting from the second half of 2021, the Internet sector faced pressures from market headwinds, new regulations and the epidemic. For public cloud services, traffic-driven demand continued to grow, but at a pace slower than before as Internet companies focus more on high-quality development. In response to the market change, we initiated our strategic adjustments in the fourth quarter of last year. We have proactively downsized our CDN services and allocated more resources to core cloud services, including computing, storage and enterprise cloud, facilitating their fast growth. We are pleased to say that we completed the strategic adjustments planned for this quarter, which started to bear fruit. Gross billings from core cloud services increased 61.2% year-over-year and exceeded our guidance. The proactive downsizing adjustments of the CDN services are progressing in an orderly manner. In Q1, the gross billings for CDN services decreased 20.2% year-over-year. In terms of profitability, our initiatives to cut costs and improve efficiency have delivered substantial results with our adjusted gross margin improving to 3.8% from 1.2% in the fourth quarter of 2021. In future quarters, we expect to continuously evaluate and dynamically optimize resources allocation, enhancing business agility and promoting gradual improvements of profitability. Since the beginning of March, the COVID resurgence across China and the corresponding prevention measures adopted significantly slowed down market demand and severely interrupted offline business operations. For us, in response to the continued slowdown of traffic-driven demand in the Internet sector, we proactively scaled down CDN services, while the growth of computing services among public cloud services remained strong as gross billings of computing achieved 45% year-over-year growth. As a result, our public cloud services remain stable as a whole. In terms of our enterprise cloud services, the market demand potential remains enormous. However, the epidemic did cause delays in bidding, delivery and acceptance checks of cloud projects. On customer fronts, benefiting from our premium customer strategy and the robust business operations such customers enjoy, we are able to maintain stable relationships with our existing premium customers, while strengthening our efforts to expand our customer base with industry vertical leaders. For example, in the first quarter, we teamed up with Camelot to sign our first partnership agreement with Genki Forest, a fast-growing beverage brand in China. Overall, in the short-term, we still face challenges from the macro environment. For this year, we plan to focus on quality growth, margin improvements, and core industry verticals. In the long run, we believe that the ongoing trends for digital transformation where enterprises increase cloud adoption to drive efficiency and save costs remains intact and will keep driving massive demand for our business. Now on to our public cloud services. Internet companies have been transferring more non-traffic driven business operations from their internal on-premise environment onto cloud services. Therefore, computing services growth remains strong. We'd also like to mention that on the gaming front, with the recent release of several gaming licenses, we are actively engaging with our gaming customers on their incremental cloud service needs and are making progress in our cooperation with leading gaming companies to support the launch of their new games. Moving to enterprise cloud services, enterprises and institutions across the board have been increasingly turning to cloud as the natural choice of digital transformation. However, the epidemic has disrupted the pace of such demand, causing delays to project timelines and increases in delivery costs. To mitigate the impact, we are implementing higher project quality standards and margin thresholds. In the public services sector, we won the bid to build a one-stop rental housing e-platform for Industrial Development Holdings Park. The platform allows users of various roles to operate, manage, and supervise the affordable rental housing services for the city. As a leading cloud company with core technology capabilities, we continue to take part in the national project transporting data from eastern regions to western regions for storage and calculation. We expect to seize more opportunities in big data and computing projects. In the financial services sector, we continued to dive deeper into top customers' needs for cloud services in multiple scenarios, deliver industry lighthouse projects, and keep perfecting our solutions offering. With Camelot joining us, we further expanded our coverage of top financial services customers. We now serve 90% of China's top 20 banks and have been continuously adding cooperation dimensions. Take some of our key account projects, for example. During this quarter, in the banking space, we won a bid to provide data management and cloud infrastructure products to ICBC Technology to jointly build a unified financial service and management platform. In the insurance space, we will provide public cloud services to China Life Insurance, a leading insurance company in China. This represents an important landmark project as it pioneers insurance companies transitioning from on-premise deployment to hybrid cloud environments by improving their recognition of public cloud. In the healthcare sector, digitalization upgrades have become a key topic for medical institutions, regional healthcare networks, and smart health cities since COVID started. Healthcare Cloud Solutions need to address several challenges, including the magnitude of data size, complicated structure, high storage requirements for image data, and varying digitalization levels among regions. Our robust and stable digital cloud infrastructure provides the foundation for the value maximization of data assets. And cloud service companies like us have proved to be an essential component of the digital upgrade for the healthcare industry. As the epidemic resurged in Shanghai and Jiangsu province since March, we took quick action and urgently deployed our teams together with cloud infrastructure resources to support local containment efforts. We set up a cloud infrastructure dedicated to Kunshan of Suzhou City for academic containment. The infrastructure enables data collection, aggregation, governance, analysis, integration, and sharing, providing high-quality and stable data support. In Hubei Province, following our success with the healthcare project in Hubei Province and Wuhan City, we won another project to build an information system for special disease prevention and control, where we will be building a middle platform. In conclusion, the complex economic environment and epidemic resurgence this year have put pressure on short-term growth, but thanks to the strategic adjustment since Q4 last year, we have laid a solid foundation for mid-to-long-term revenue expansion and margin improvement. Cloud computing carries long-term potential. Looking ahead, we will adhere to our strategic direction and pursue steady and high-quality development while improving our business stability and profitability. We will fully leverage our technological strength to provide stable and efficient cloud services to our premium customer base. I will now pass the call over to our CFO, Haijian, to go over our financials for the first quarter. Thank you.

Haijian He, CFO

Thank you, Yulin, and welcome everyone for joining the call. Before turning to the financial detail, I would like to walk you through the following highlights for the past quarter. First of all, our total revenue reached RMB2.17 billion in Q1, above the high-end of our guidance, which ranged from RMB2.05 billion to RMB2.15 billion, representing a growth of 20% year-over-year. Within that, our core cloud services, including computing, storage, and enterprise cloud services increased by 61.2% year-over-year this quarter. Second, we are pleased to see that we have been making significant progress in our cost control strategy execution. The adjusted gross profit for this quarter increased by 152% quarter-over-quarter to RMB83.6 million. Adjusted gross margin increased largely from 1.2% in the previous quarter to 3.8% this quarter. Adjusted EBITDA margin narrowed from negative 10.5% in the previous quarter to negative 7.1% this quarter. As we introduced in the last quarter, the new technology budgets from Internet sector clients in general have been increasing at a slower pace than expected. Starting from the second half of last year, the demand for us has softened, affecting our resource efficiency connected to the bottom line. In response to the market change, since Q4 last year, we proactively downsized our CDN services and allocated more resources to our core cloud services. We have taken active cost control measures and improved overall operational efficiency. Even though we are still facing the challenging macroeconomic environment, we believe we are on track to achieve quarterly adjusted EBITDA margin breakeven in Q4 2022. Third, as of March 31, 2022, we had cash and cash equivalents and short-term investments amounting to RMB5.6 billion, providing us sufficient liquidity for operations. The CapEx for this quarter was RMB622.4 million. The increase was primarily due to the procurement of high-performing services, which align with our increasing demand from our core computing services, as well as the cash payment for the services we ordered last quarter. For the full-year 2022, we expect to keep our total capital expenditure plan in the range of RMB1 billion to RMB1.5 billion. We've firmly executed our high-quality development targets and allocated online server resources prudently to our core cloud service growth. Lastly, our Board of Directors has recently authorized the company to repurchase up to US$100 million of our ordinary shares in the form of American depository shares during a 12-month period. Today, we are pleased to announce that we have entered into a share repurchase program, which demonstrates our strong confidence in the company's growth and a commitment to generating long-term value for our shareholders. I will now go through our financials in detail. Revenues from public cloud remained stable year-over-year at RMB1.38 billion this quarter. It was primarily due to the 45.1% year-over-year growth of our computing services, offset by a 20.2% year-over-year decrease of our CDN business, which was proactively narrowed down. In terms of enterprise cloud services, even though the COVID-19 pandemic has disrupted the delivery of certain offline products, market demand from traditional enterprises and organizations remains strong. Our enterprise cloud services achieved a solid increase of 89% year-over-year to RMB792.5 million. In terms of cost control and optimization, we have achieved effectiveness this quarter. Total cost of revenues decreased by 20% quarter-over-quarter to RMB2.09 billion. The IDC cost decreased by RMB221.6 million from last quarter to RMB1.11 billion this quarter. It remained consistent in terms of bandwidth and cabinet costs, and the decreasing trend was in line with our adjustment of the CDN business. Solution development and services costs decreased by 8% quarter-over-quarter to RMB476.0 million, which consists of payments to our solution design, development, and services personnel. Depreciation and amortization costs increased by 10% quarter-over-quarter to RMB246.1 million. Fulfillment costs were RMB184.5 million this quarter, representing the cost of purchasing technologies, products, and services from third parties to fulfill the demands of our solutions. Other costs were RMB76.9 million this quarter. In terms of expenses, we have completed the preliminary organizational optimization and efficiency improvement, resulting in decreased personnel expenses compared with Q4 last year. Excluding share-based compensation and D&A, total adjusted operating expenses were RMB532.2 million, increasing sequentially by 9.6% from RMB578.7 million in Q4 last year. Within that, adjusted R&D expenses were RMB221.7 million, compared with RMB246.2 million last quarter. Adjusted selling and marketing expenses were RMB127.6 million, compared with RMB161.2 million last quarter. Adjusted G&A expenses remained stable at RMB174.0 million. As of March 31, 2022, we had sufficient cash and cash equivalents and short-term deposits of RMB5.6 billion. During this quarter, capital expenditures were RMB622.4 million. The increase was mainly due to the increasing purchase of high-end performance services to meet the incremental demand from strategic core services of computing and storage. We expect our full-year CapEx will range from RMB1 billion to RMB1.5 billion, which will be prudently allocated to meet the demand from our core cloud services. Meanwhile, we have released our ESG, Environmental, Social and Governance Report for 2021 along with our Annual Report in early May. I would highlight that nominating the corporate governance committee of the Board was primarily responsible for overseeing ESG initiatives, and the company has appointed its first independent female Board of Director, enhancing gender diversity and workplace inclusivity. Looking ahead, we keep focusing on a balance between revenue expansion and margin improvement. We expect our total revenue to be between RMB2.0 billion and RMB2.2 billion for the second quarter of 2022, representing a year-over-year increase of about negative 8% to positive 1.2%. It is mainly due to the offline fulfillment delay of enterprise cloud business in the middle of the short-term COVID-19 resurgence. We will continue to embrace opportunities post-pandemic. We also view that our profitability will maintain an upward trend. The adjusted gross margin will continue to be higher in the second quarter, compared with Q1. Under the stable market condition assumptions, we believe we are on track to achieve quarterly adjusted EBITDA margin breakeven by Q4 2022. All of these forecasts and comments above are based on our current and preliminary views of the market and operational conditions, which are subject to change. In addition, based on the capital market condition, we have already commenced a share repurchase program, which was authorized by the Board in March to purchase up to US$100 million of shares during the 12-month period. We have been closely hearing from feedback from shareholders and delivering significant value to all shareholders. Finally, we are moving forward with our Hong Kong Stock Exchange listing plan and we are on track with this progress. We seek to maintain independent listing status in both Hong Kong and the U.S. to maximize protection for our shareholders. Given the recent positive progress in the negotiations, combined with fluctuations in the global capital markets, we will carefully monitor and proactively adjust our execution timeline to safeguard the interest of our existing shareholders. We will closely monitor the market and the regulatory dynamics and proceed prudently at the right time. The final listing decision and timeline are subject to both regulatory approvals and market conditions. Thank you.

Nicole Shan, IR Manager

Thank you. This concludes our prepared remarks. 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 the line of Thomas Chong from Jefferies. Please ask your question.

Thomas Chong, Analyst

Thanks, management, for taking my questions. My question is about the Q2 revenue guidance. Can management comment on the monthly trend we are seeing in April, May, and June, respectively? Given right now, we have already passed the first week of June, I want to get a sense of our confidence level in terms of the guidance. Under what scenario would we be hitting the low end and the high end? Because I think the low end we are talking about negative growth. So, I just want to get some color about our thoughts at this point. Thank you.

Yulin Wang, CEO

Thank you very much for your question. Essentially, the second quarter is mainly impacted by the COVID situation. As I explained, in terms of public cloud services, we think the impact is limited. There is some small impact for the increased amount in our data centers in Eastern China and Northern China for their increasing business operations, but it's not any material impact. The impact on the other hand on the enterprise cloud side is relatively large, especially in Q2 because basically the control measures in terms of the scope and the timing of expense have exceeded our expectations, impacting the bidding, implementation, deployments, and delivery of our enterprise cloud projects. However, since the end of last week, some of the projects that are ongoing have already started to resume. We are trying to catch up with the timeline to meet our progress targets as much as possible. So, that leads us to the guidance that Haijian has provided towards the end of the prepared remarks. Thank you.

Operator, Operator

Thank you. Our next question comes from the line of Sophie Chang from CICC. Please go ahead.

Sophie Chang, Analyst

This is Sophie from CICC, and thanks management for taking my questions. We have heard about the news of headcount cuts across many top-tier Internet companies, many of which are our key customers. Do we expect any change in their demand? How will the dollar value of those core customers change? And shall we expect any headcount adjustments within Kingsoft Cloud?

Yulin Wang, CEO

Thank you very much for your question. In terms of public cloud, we know that the market is predominantly focusing on the Internet conglomerate, which some of them are our customers. For the changes and adjustments that you mentioned, we had already expected that. What we see happening this quarter is unfolding according to what we had anticipated. As we anticipated these changes, we proactively downsized our CDN business due to the increased volatility in the CDN market. By adjusting downward the CDN supply, we're able to command a more profitable business, which is consistent with our expectations. Additionally, for those customers who are focusing on cost reduction, it is also an incentive for them to increase cloud adoption, which is beneficial for their cost savings. We are observing increased amounts for non-CDN business cloud usage. In the enterprise cloud area, while you did not specifically ask, it is mostly impacted by the COVID situation. Regarding headcount adjustments at Kingsoft Cloud, since the integration of Camelot last year, we expect our combined headcount of about 10,000 people to remain relatively stable or see a small decline throughout this year.

Operator, Operator

Thank you. Our next question comes from Kyna Wong from Credit Suisse. Please ask your question.

Kyna Wong, Analyst

My first question is a follow-up on the enterprise cloud impact, as I anticipate some projects may not be completed by the end of this year due to the pandemic impact in the first and second quarters, or some that are impacted by adjusted budgets from the government, can you provide more detail? Additionally, I'd like to understand the public cloud industry trend due to the changes occurring here. Thank you.

Yulin Wang, CEO

Thank you very much for your question. Regarding the COVID impact, it is primarily concentrated on the enterprise cloud side. On the public cloud side, the effect is limited, and we actually see a potential short-term uplift for public cloud usage due to the COVID factor. For the enterprise cloud side, the impact is more severe in the second quarter due to COVID control measures affecting the bidding and execution processes. For ongoing projects, we believe there is still time to catch up within the year. As for new projects, we have not experienced any significant changes in customer interest, especially among public service customers and healthcare institutions, so we feel confident about our full-year guidance remaining intact. Regarding public cloud demand, our customers have expressed a smooth communication channel despite changes and challenges.

Haijian He, CFO

Kyna, if I may, I would like to offer a few more data points to help clarify. Our dollar retention rate for public cloud clients from last year was around 114%. So, even with the expected decreases in CDN revenue, that number remains above 100%. This provides a strong foundation for our revenue opportunities. Our computing business delivered solid growth of around 40% on a year-over-year basis, which is above the industry average, particularly in challenging market conditions. In Q1, we spent about RMB600 million on servers and high-end infrastructures, generating immediate revenue, illustrating the stability of demand from our client base. Thank you.

Kyna Wong, Analyst

Thank you. That's very helpful.

Operator, Operator

Thank you. Our next question comes from Joel Ying from Nomura. Please go ahead.

Joel Ying, Analyst

I have two questions. The first question is about the CDN business. Can we release the CDN business as a percentage of total public cloud revenue for Q1 2022? The second question is regarding the enterprise and cloud adoption strategy in the long-term; we are focusing on both public and enterprise cloud and partner R&D in both sectors. Am I understanding that correctly?

Haijian He, CFO

Yes, sure. Joel, regarding your first question, there are a few important considerations for planning and budgeting. We aim to balance not only the CDN revenue contribution but also the overall top line concentration risk. For 2022, no single client is assumed to contribute more than 20% of total revenue, and we expect around 25% of the CDN business as a total revenue for Kingsoft Cloud for the financial year. In Q1, the CDN revenue contribution to total revenue has decreased from historically around 50% to below 30%. The trend is clear, and while we anticipate stable absolute dollar values from the CDN revenue, its percentage of total revenue will continue to decline over the coming quarters. Thank you.

Operator, Operator

Thank you. Our next question comes from Alex Yao from JP Morgan. Please ask your question.

Alex Yao, Analyst

My question is to follow up on the enterprise cloud demand this year. Based on your observations, is the budget allocation for adopting enterprise cloud strong with or without the impact of COVID or economic slowdown? Will corporations be committed to cloud adoption, or do they have more flexibility in their cloud strategy? How does immediate efficiency improvement from cloud adoption play into their decisions?

Yulin Wang, CEO

To address your prior question about whether we continue with the dual-driven business model moving forward—absolutely. On the public cloud side, demand remains strong, driven by customers' incentives for cost reduction and increasing cloud adoption. In financial services, for instance, our coverage of virtually all top 20 banks confirms that demand is still elastic and not necessarily tied to budgeting. This demonstrates the demand is tech-driven rather than budget-constrained. The healthcare sector also increased demand because of COVID, as institutions must adapt to ongoing health challenges. In public services, discussions with potential customers indicate no signs of cancellations or budget reductions. Therefore, the enterprise cloud aspect is still on track for successful development.

Operator, Operator

Thank you. Our next question comes from Thompson Wu from UBS. Please ask your question.

Thompson Wu, Analyst

My first question pertains to the relationship between China's macro situation and its impact on enterprise cloud adoption over the long term. What verticals, specifically, could be affected? Additionally, on behalf of an investor on the call, could you share the full-year guidance beyond reaching an adjusted EBITDA breakeven point in the fourth quarter? Has the company given full-year 2022 guidance?

Yulin Wang, CEO

We understand the market's concern about the macroeconomic situation in China. From our experience in the public cloud services sector, we do not expect any material impact. As the Internet sector remains stable, we see robust business and strong growth potential. Regarding enterprise cloud, we haven't seen significant cancellations or budget alterations among our key clients. Additionally, we anticipate the government will introduce macroeconomic policies that could create opportunities for us in the second half of the year. Though COVID control measures in Q2 have had short-term impacts, the overall outlook remains promising, particularly for enterprise cloud.

Haijian He, CFO

Regarding the second question on profitability expectations, we project to hit quarterly breakeven for non-GAAP EBITDA by Q4 2022. As we approach June, our gross margin in Q2 is expected to exceed that of Q1 2022, along with a general upward trend. Although we have yet to provide formal guidance for total full-year revenue, we are executing our internal budget and have not made any changes. We expect to maintain our overall targets as planned.

Operator, Operator

Great. Thank you for all your questions. I will now turn the call back to Nicole for closing remarks.

Nicole Shan, IR Manager

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

Operator, Operator

Thank you. This does conclude our conference for today. Thank you for participating. You may all disconnect.