Kingsoft Cloud Holdings Limited (NASDAQ:KC) Q2 2024 Earnings Conference Call August 20, 2024 8:15 AM ET

Company Participants

Nicole Shan - IR Manager
Tao Zou - Vice Chairman & CEO
Haijian He - CFO

Conference Call Participants

Xiaodan Zhang - CICC
Timothy Zhao - Goldman Sachs

Operator

Good day, and thank you for standing by. Welcome to the Kingsoft Cloud's Second 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. [Operator Instructions] Please be advised today's conference is being recorded.

I would now like to hand the conference over to your first speaker today, Nicole Shan, IR Director of Kingsoft Cloud. Please go ahead.

Nicole Shan

Thank you, operator. Hello, everyone, and thank you for joining us today. Kingsoft Cloud's second quarter 2024 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 CFO, Mr. Haijian He. Mr. Zou will review our business strategies, operations and company highlights, followed by Mr. He who will discuss the financials and the guidance. They will be available to answer your questions during the Q&A session that follows. There will be consecutive interpretations. 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 21E of the Securities Exchange Act of 1934 as amended and as defined in the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements are based upon management's current expectations and current market and operating conditions and relate to events that involve known or unknown risks, uncertainties, and other factors, all of which are difficult to predict and many of which are beyond the company's control, which may cause the company's actual results, performance, or achievements to differ materially from those in the forward-looking statements.

Further information regarding this and other risks, uncertainties or factors are included in the company's filings with the U.S. SEC. The company does not undertake any obligation to update any forward-looking statements as a result of new information, future events or otherwise, except as required under applicable law. Finally, please note that unless otherwise stated, all financial figures mentioned during this conference call are denominated in RMB.

It's now my pleasure to introduce our Vice Chairman and CEO, Mr. Zou. Please go ahead. Thank you.

Tao Zou

[Foreign Language]

[Interpreted] Hello, everyone. Thank you and welcome all for joining Kingsoft Cloud's second quarter 2024 earnings call. I am Zou Tao, CEO of Kingsoft Cloud.

Looking back on the two years since August 2022, our entire Kingsoft Cloud team has firmly executed the high quality and sustainable development strategy and the company has undergone a complete transformation. First of all, profitability fundamentally improved as gross margin steadily increased from low-single digit to 17%. Adjusted EBITDA margin increased to 3% after turning positive in Q1 and we are well on track to turn operating and net profit positive.

Second, swiftly embracing AIGC opportunities as this new round of AI services revenue contribution to public cloud increased from 0% to 26%, a leading figure in the industry. Third, firmly phasing out low-margin businesses, as CDN services revenue contribution decreased from approximately 40% to 20% and along with it, a single large customer concentration risk fundamentally resolved. Fourth, implementing refined management in aspects of procurement, assets, and operations as quarterly costs and expenses decreased by approximately RMB300 million, representing 15% of quarterly revenues.

Fifth, taking long-term perspectives as Wuhan R&D center quickly scaled up to hosting approximately 30% of the entire workforce, including Camelot, laying a solid foundation for sustained technological leadership as well as completing dual primary listing on the Hong Kong Stock Exchange, followed by inclusion into the Hang Seng Composite Index and Hong Kong Stock Connect, solidifying our capital markets infrastructure. All of these have laid a solid foundation to the high quality and sustainable development in the future. I would like to express our sincere gratitude to all our customers, shareholders and employees who have consistently supported and cared for us over the long term.

Now, I will walk you through the business highlights of the second quarter of 2024. This quarter, Kingsoft Cloud has achieved new break-throughs in terms of revenue scale, profitability, and operating cash flow. In particular, our revenues reached RMB1.89 billion, not only a sequential growth of 6.5% but also a year-over-year expansion of 3.1%. Revenue from high value-added products and services has grown, offsetting pressure brought about by our proactive adjustment of the CDN services.

Adjusted gross profit reached RMB323 million, increased by 56.4% year-over-year. Adjusted gross margin increased to 17.1%, marking the eighth quarter of consecutive improvement. Adjusted EBITDA reached RMB60.59 million and adjusted EBITDA margin reached 3.2%, a sequential improvement after the milestone of turning positive in Q1 and a significant increase of 6.5 percentage points year-over-year. Net operating cash inflow amounted to RMB150 million, once again demonstrating our cash-generating ability from operating activities.

The improvement of various financial performance indicators signifies that Kingsoft Cloud's high-quality and sustainable development strategy has been effective, marking a new phase in our development and laying a solid foundation for long-term healthy growth in 2024 and beyond.

In terms of public cloud services, revenues reached RMB1.23 billion this quarter, representing a year-over-year increase of 6.5% and a quarter-over-quarter increase of 4%. We have seen positive outcomes across our three priorities for public cloud services, namely, the Xiaomi and Kingsoft ecosystem, AI businesses and supply chain.

First of all, serving as the sole strategic cloud platform within the Xiaomi and Kingsoft ecosystem, we firmly grasp the cloud business opportunities within the ecosystem. This quarter, revenue contribution from Xiaomi and Kingsoft have reached 20%, amounting to RMB370 million, and witnessed a year-over-year increase of 36.9%.

Secondly, AI businesses continue to bear fruit. This quarter, AI revenue surged to RMB326 million, doubling the amount in the first quarter and accounting for 26.3% of public cloud revenues, an industry-leading position. Our AI customer base also further diversified, including large language model companies, self-driving, Internet applications and others. We have established a substantial computing resource pool, leading the industry in large-scale network capabilities, capable of supporting the networking topology of supercomputing clusters at a 10,000 chips level.

Thirdly, we built a comprehensive supply chain system, securing the scale of a stable, intelligent computing resource pool and managing procurement costs. By fully utilizing data centers' resources in central and western regions of China. Costs have significantly reduced compared to the data centers in the core cities in the east. Meanwhile, we strictly control internal procurement costs, expand coverage of suppliers, and seek the best combination of price and quality.

Moving on to enterprise cloud services, where revenues amounted to RMB657 million. In public services space, we have actively pursued opportunities within public service cloud and state-owned enterprise cloud, implementing standardized operation and maintenance. We have leveraged our core components such as models, big data, and workspace collaboration, targeting use cases in the public service and enterprise domains.

In the China e-government cloud market research report released in June 2024 by CCID, a leading consulting company in China, we are ranked in the leaders quadrant. In the China e-government cloud operations service market report by IDC, we ranked as the top six companies in the industry. Such ranks reflect recognition from the industry market for our product capabilities and market share.

This quarter, we have promoted the benchmark project of implementing large language models in public services sector, which will assist the Beijing Municipal Commission of Housing and Urban-Rural Development, in building the 12345 hotline, intelligent decision-making and smart query and data projects, enhancing the accuracy and efficiency of the commission in summarizing statistics and categorizing the 12345 hotline data and improving the service quality and response speed.

In the healthcare space, Changzhou (ph) Health Cloud has launched its phase five expansion. It will meet its requirements of new business scenarios and the needs of extended archive of healthcare images, fully validating the potential to establish long-term cooperation for the construction and operation of industry cloud customers and projects.

In AI industry applications, Kingsoft AI, a subsidiary invested and established by us, has gradually started to promote its business, focusing on seizing business opportunities in enterprise AI software applications and delivery deployments. In terms of industry models, we officially launched strategic cooperation with Dentons law firm, a leading law firm in China, and established the joint laboratory of Legal Artificial Intelligence, taking a leap forward in the digital transformation of law industry.

In terms of product and technology, we uphold the principles of building success based on technology and innovation, focusing on delivering best-in-class customer experience across our core product offerings. In AI space, in response to surging data cleansing demand from AI clients, we have integrated products like Bare Metal and object storage to create a holistic solution for data cleansing, accommodating text, images and videos. This multi-modal solution is tailored to meet the data cleansing requirements for the creation of both pre-training and fine-tuning datasets.

In enterprise cloud space, the Galaxy Stack platform released a proprietary cloud platform with low cost and high density compared to original standard configuration. The high-density version has achieved a maximum reduction of 64% in cost per instance and an increase of up to 300% in instance density.

In summary, after two years of steadfast (ph) implementation of the high-quality and sustainable development strategy, Kingsoft Cloud fundamentals have undergone a complete transformation. Looking forward, we will continue to enhance our profitability and cash-generating capabilities, deepen cooperation with Xiaomi and Kingsoft ecosystem, strengthen Wuhan Research Center and develop comprehensive understanding of new AI and explore such opportunities. Thereby continuously creating value for our customers, shareholders, employees, and other stakeholders.

I will now pass the call over to our CFO, Haijian, to go over our financials for the second quarter 2024. Thank you.

Haijian He

[Foreign Language]

[Interpreted] Thank you, Mr. Zou, and welcome everyone for joining the call. Now I will walk you through our financial results for the second quarter of 2024. We would like to highlight three key areas of progress. First, we are very pleased with the ongoing improvements in our financial matrix. By applying the first principle thinking, we are committed to a profit-focused approach that has led to consecutive increases in our gross profit, gross margin, EBITDA profit, and EBITDA margin over the past several quarters.

This quarter, our adjusted gross margin reached 17.1%, marking eight consecutive quarters of steady growth, while adjusted gross profit hit RMB333.4 million. After turning a profit in adjusted EBITDA margin last quarter, we continued with this positive trend with RMB60.6 million in EBITDA and 3.2% in EBITDA margin, demonstrating our successful execution of a high-quality sustainable development strategy.

Second, this quarter our revenue reached RMB1,891.8 million reverting to a positive increasing trend with a 3.1% increase -- year-over-year increase and a 6.5% rise quarter-over-quarter. By strategically adjusting our revenue mix in line with our high-quality and sustainable development strategy, we have allocated more resources to develop high-value services.

This quarter, our AI revenues grew to RMB326 million, making up 26% of our total public cloud services revenue, doubled the amount from last quarter. We have established a resilient supply chain, scalable computing power and a long-term partnership with customers to support our growing AI revenues. In response to cost pressure and the low margin, we have strategically reduced the proportion of our CDN services to 19% of total revenue, down from 23% last quarter.

Third, we have recorded a net inflow of operating cash flow amounting to RMB151.2 million. We also reduced -- we also secured various financial channels to support our AI business, including but not limited to our loan facilities from Kingsoft Corporation, financial leasing and other bank loans.

Here are the details of our financial results. Total revenues for this quarter were RMB1,891.8 million, a 3.1% increase year-over-year, of which revenues from public cloud services were RMB1,234.5 million, up 4% from RMB1,187.4 million last quarter, primarily driven by the growth in AI-related revenues to RMB326 million. Revenues from enterprise cloud services reached and RMB657.2 million, up from 550 -- RMB588.2 million last quarter, due to accelerated project deliveries this quarter.

We have continued to enhance our cost control, expanding our supply base to improve service quality and procurement prices. Total cost of revenue decreased by 30.4% year-over-year and remained stable quarter-over-quarter at RMB1,573.4 million. IDC costs dropped significantly by 14.4% year-over-year from RMB860.7 million to RMB728.2 million this quarter, reflecting the strategic scaling down of our CDN services and optimize utility of the rack usage.

Depreciation and amortization costs increased from RMB202.1 million in the same period of last year to RMB265.9 million this quarter, mainly due to the depreciation of new servers acquired. Solution development and services costs increased by 8.4% year-over-year from RMB452.9 million to RMB491.1 million due to the solution personnel expansion of Camelot, which was in line with the revenue growth. Fulfillment costs and other costs were RMB37.6 million and RMB50.6 million this quarter, respectively.

Our adjusted gross profit for the quarter were RMB323.4 million, a 56.4% increase year-over-year with an adjusted gross margin of 17.1%. This marks a new record and the eighth consecutive quarters of steady margin improvement, up from 11.3% last year and 16.8% last quarter.

In terms of expenses, excluding share-based compensation and impairments of long-lived assets, our total adjusted operating expenses were RMB555.3 million, slightly increased by 3.2% year-over-year and 18.3% quarter-over-quarter, of which, our adjusted R&D expenses were RMB200.1 million, a 3.7% increase from last quarter due to the personnel cost increase.

Adjusted selling and marketing expenses were RMB117.5 million, up from RMB97.9 million last quarter, representing 6.2% of total revenues. Adjusted G&A expenses were RMB237.7 million compared to RMB178.7 million last quarter.

As of June 30, 2024, our cash and cash equivalents totaled RMB1,837.8 million, providing strong liquidity for operations and AI investments. Capital expenditures for this quarter was RMB654.8 million, reflecting our investment in infrastructure to support our sustainable AI business.

Looking ahead, we remain committed to the principle of high quality and sustainable development. We will continue to enhance revenue quality, reduce costs and expenses, and improve profitability. Thank you.

Nicole Shan

This concludes our prepared remarks. Thanks for your attention. 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.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] We will now take our first question. This is from the line of Xiaodan Zhang from CICC. Please go ahead. Your line is open.

Xiaodan Zhang

[Foreign Language]

[Interpreted] So thanks, management, for taking my questions. And I got two questions here. First of all, could you please update us on your CapEx guidance for the next two quarters? And secondly, could you give us some color on the ROI of your AI investment and how is your expectation for the AI revenue contribution for the full year? Thank you.

Haijian He

[Foreign Language]

[Interpreted] Regarding the CapEx. So I think -- first of all, I think you pointed out correctly, this year, we're actually accelerating our investment in, we think, a very good area of financial business growth opportunities. Most of the CapEx, I think probably over 95% or even higher, are relating directly to the AI investment, which we think is a very good positive opportunity for us.

So, at this moment, while we cannot give a full guidance for the full-year CapEx investment, but I think we can probably look into two different areas. First of all is, for this quarter, you may also notice that we recorded a net cash inflow from the operations side, which is around about RMB151 million. And I think you can already see that the CapEx investment into the good area of business already converted into a positive inflow from operation cash flow. So this is actually the first point.

So the second point is, we also expanded our financing channels. For example, you also notice, last year, we secured financing support from Kingsoft Group as well as the leasing potential opportunities from Xiaomi Group as well. But this year, especially in the last two quarters, we also got great support from, for example, the national policy banks, the state-owned financial institutions, including both banks and also the leasing companies.

So, in that way, we actually do not limit ourselves with a certain cap of the CapEx investments just to looking the only amount of our cash balance today. So, my point is, giving those additional opportunities and financing channels, we actually can reopen and have a very high ceiling of the financial capability we can get to support an AI investment.

The third point is, given the investment is a long term, we also measure very carefully regarding the profitability and the sustainability of those investments. And at this moment, we are happy to share, most of our AI client are the well-known names you probably also notice on the market. And the second, we do also have a very long-term contract from sales side which can secure the incoming cash flow as well as the client opportunities with a potential upside to secure more business from the same client as a recurring basis.

So I remember, first few quarters ago we talked about recurring as most important driver for our profitability. I think right now, given the AI, we do see that recurring revenue percentages are much higher if you compare with the old so-called the only IaaS services in the old model we did before.

So, I think that the three areas I just mentioned can come to a conclusion that we do not limit ourselves with the cash we already have today, we can have more cumulative increased investments with the capacity. Number two, every dollar we invest today, the ROE and also the recurring cash flow to serve those liability and increase in the revenue will be very long-term and very secure. And the third is we also use our capacity to secure a good universe of the client, especially the AI company in the market in China today. I think we are leading on the front with the revenues, with the financing sources we have and we can matching those two sides for the long term going forward.

But last note, I think, Xiaodan, you probably want to have a kind of ballpark number, which I can mention that, the total CapEx for this year will be always probably a few times if you look at it from a ballpark number compared with last year, and that will actually have a very good possibility to convert to accelerated revenue growth on the top line in the coming quarters. Thank you.

Tao Zou

[Foreign Language]

[Interpreted] Okay. Let me just translate -- simply translate what Mr. Zou said. So, in terms of AI, I really want to take this opportunity to elaborate a little bit about my overall thoughts. So, in my mind, it's really about three dimensions. One is the supply of computing power. The second is the inference, which is the application of the artificial intelligence. And the third is the training, which -- from the current financials that you are able to see, obviously, which is a tremendous growth.

For example, it's 10 times year-over-year growth and two times the AI revenue growth versus the first quarter. But all these numbers that you're currently seeing are mostly coming from the area of the supply of computing power. However, I do think that in the future, the potential room for revenue and for business in terms of training and in terms of for the application of the models have far more potential.

Now, circling back to your question about the ROI, I have to say that the GP margin for the AI business is far higher than that of the other parts of the business, which is also a major contributing factor for the improvement of the company's overall GP margin.

Now, looking ahead, I would also like to talk about it from two different dimensions. One is the supply of computing power, and the second is the inference and the application of AI capabilities. Now, in the first dimension, two areas poses a lot of opportunities. One is electric vehicles, and in particular, the autonomous driving demand for the EV space, which since the launch of Tesla's FSD, we have been engaging with a lot of EV firms, and all of them have significant and real kind of tangible intention to do this and to implement and to train their own autonomic driving models. So, this is a lot of space for our business opportunity.

Now, the second one is robotics, which essentially empowers robots with artificial intelligence. So we do think we will be having a lot of opportunities in this area as well. Noticeably, there's one certain company, which I'm not going to mention its name, has secured RMB3 billion financing recently. So the confidence is very high in this space.

Now, the second dimension about the inference or the use cases for the model capability, as we have talked about in prepared remarks, some of the projects that we have collaborated with some of our partners are being implemented as we deepen such collaboration and the progress and the progress and achievements elaborated in these areas. We do think that this is actually going to be laying a solid foundation for the one-stop mass model as a service -- services that we aim to provide in this space.

So, in summary, we do think that our overall strategy of owning AI since June last year has been very fruitful and we look forward to continue our pace in its investment and development. Thank you.

Nicole Shan

[Foreign Language]

[Interpreted] Thank you.

Operator

Thank you. We'll now take our next question. This is from Timothy Zhao from Goldman Sachs. Please go ahead.

Timothy Zhao

[Foreign Language]

[Interpreted] Thank you, management, for taking my question. I have two questions here. And the first question is regarding the revenue contribution from Xiaomi and the Kingsoft Group. As I noticed that there was a very strong revenue growth in the past quarter and the total revenue contribution already achieved 20% of the total revenue.

So, may I ask what is the driver behind that and what is the AI-related revenue contribution from Xiaomi and Kingsoft Group to their revenue to Kingsoft Cloud? And into the second half of this year and into the longer term, given we have more cars from Xiaomi on the street as well as the WPS monetization from Kingsoft Group, how do you think about the revenue outlook from here?

And second question is regarding the CDN revenue. As we see a continued proactive downscaling of the CDN revenue, could you maybe share any thoughts on the outlook for this business line going forward? Thank you.

Haijian He

Hey. Thank you, Tim.

[Foreign Language]

[Interpreted] The first question regarding the related parties' revenue contribution, I think, Tim, you're right. I think we do see a few very important leading positive signals regarding the revenue potential growth in the future. I think the first of all is really, as we mentioned, giving a stronger business connection, especially with Xiaomi and the Kingsoft Group. We allocated more resources and we prioritized the revenue and client demand from our internal client. As we mentioned a few months ago, I think this is actually a very good opportunity for Kingsoft Cloud.

So for this quarter, the revenue from Xiaomi and Kingsoft Group increased around 36.9% year-over-year, and are contributing to about RMB370 million for this quarter alone. I think it is a very positive signal given it is a proven of our capability to serve very important internal clients, including Xiaomi and Kingsoft, including WPS as well.

So, I think the scenario and applications from auto driving from the AI-related SaaS services are very important driver for this opportunity. And we also have to see given this trend going forward, maybe it is possible by end of this year as we are turning to a new financial year, we may asking the shareholders to give us an increasing cap of the related party revenue approval.

So I just want to also share this good news with you that maybe for the next two or three quarters in the shareholder meetings, we are going to -- happy to propose a higher ceiling of the revenue cap to prove that we do have a great visibility of the internal revenue from related parties.

The second part is relating the AI revenue contribution. I would say that the incremental revenue from our internal parties are primarily due to the AI-related revenues. So, that's the first point. The second point is, around half of the AI total revenue, as you'll notice that, it's actually approximately one-quarter of the revenue of public cloud for this quarter.

Let's say, half are coming from related parties, but also they added more than half from external clients. I think that strikes a good balance regarding, we prove our capability to serve internal clients, but also have equal capability to have those services and products for outside clients. As you may notice that, our outside clients are also most of them are the tier-one AI model companies in the China tech space today. I think that actually strikes to balances from internal and outside, but also to see potential increase, especially the visibility of the potential upside of the revenue growth going forward.

And the last note on the first question, I would mention that given you can find that you can observe our gross margin has improving steadily, the incremental dollar of the gross profit are also primarily due to the contribution from our AI-related business. And, given we are carefully select the AI clients today and we think those revenue can be sustainable, secured and visible going forward. And we're going to also learn from past experience that we will control, for example, the business contracts and the business model and also notice the potential risks in working on those revenues. And, we can also strike a return and risk profile for the profits and contracts we're working on in the AI space. I think that's all for the first part of the question.

Tao Zou

[Foreign Language]

[Interpreted] So, I think the right way to understand -- to think about this question is that we have to make a distinction between two types of CDN business. One is the standard CDN business which is typically marked by a lower profit margin and this other kind of CDN business which represents usually higher margins, for example, like the live broadcasting acceleration, the dynamic acceleration, et cetera. And this usually has higher margin because they have -- there are higher value added.

So, my quick answer is that in -- for the first type of standard CDN business, the minimum amount that we aim to maintain on a quarterly basis is RMB300 million and I do not expect it to be lower than that as service as a base for our business -- overall business and that will continue to invest and to expand the higher margin part of the CDN business. Yeah, that concludes my answer.

Nicole Shan

Thank you, operator. This concludes our…

Timothy Zhao

Thank you.

Nicole Shan

Yeah. Thank you, Tim Zhao. And this concludes our Q&A. [Technical Difficulty]

Operator

Thank you. There are no further questions at this time. So I will now hand back to Nicole Shan for any closing remarks.

Nicole Shan

Thank you, and thank you all 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 all. Bye.

Operator

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