Kingsoft Cloud Holdings Limited (NASDAQ:KC) Q2 2022 Earnings Conference Call September 6, 2022 8:00 AM ET

Company Participants

Nicole Shan - Investor Relations Manager
Tao Zou - Vice Chairman and CEO
Haijian He - Chief Financial Officer

Conference Call Participants

Brian Gong - Citi
Thomas Chong - Jefferies

Operator

Good day and thank you for standing by. Welcome to Kingsoft Cloud's Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] Please be advised that today’s conference is being recorded.

And now, I'd like to hand the conference over to Ms. Nicole Shan, IR Manager of Kingsoft Cloud. Thank you. Please go ahead.

Nicole Shan

Thank you, operator. Hello, everyone, and thank you for joining us today. Kingsoft Cloud's second 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 Vice Chairman and the CEO, Mr. Tao Zou; and the CFO, Mr. Haijian He. Mr. Zou will review our business strategy 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 purpose 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 the Section 21-E 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 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

Hello everyone. Thank you all for joining Kingsoft Cloud second quarter earnings call. And it is my great pleasure to be with you today. For long time, I’ve been involved in the overall management of the company as Vice Chairman, and that experience has given me in-depth understanding of the company's strategy, business and team.

Since taking over as CEO in August, I’ve been in close communication with the Board of Directors, the management and the core team to discuss our development strategy and conduct a strategic evaluation of our business under the current new circumstances.

At the same time, I’ve also performed a deep dive into our front line business operations and made visits to our customers and partners. I’m delighted to report that the senior management team remain stable and committed. And our day-to-day business operates as usual.

Now I would like to share some thoughts on our business before briefly taking you through our performance for the second quarter. Since Kingsoft Cloud's incorporation, we have established several core strategies as our business developed. The first one is to focus on and explore core industry verticals, with great potential, including the internet, finance, health care and public services sectors, and develop landmark projects and industry specific solutions.

The second one is to further advance our products and technologies, enhance long-term relationships with customers through superior services, and help our customers grow. Third, we firmly adhere to our neutral position to provide customers with long-term trusted cloud services amid multi-cloud landscape.

Fourth, we seek to enhance our professional solution and project deployment capabilities, including integrating with the resources from Camelot and the wider ecosystem to provide customers with one stop digital transformation services. Through the implementation of these strategies, we have been able to achieve rapid growth, generate annual revenues close to RMB10 billion and thrive to become a first year cloud service provider.

despite the challenging external operating environment since the second half of 2021, we have also seen clear medium to long-term opportunities brought about by digital transformation across industries. According to a recent McKinsey Report, China has the second largest cloud computing market in the world behind only the United States. And China's public cloud market is expected to grow to USD90 billion in 2025, from USD32 billion in 2021.

The 40th 5-year plan has also made a clear call to build digital economy advantages and holistically strengthen the research and development of cloud computing systems in core software technology, particularly in smart health care and public services. In addition, there has been a growing demand for the end-to-end cloud solutions and services from enterprise cloud customers. All these serve as powerful drivers for the long-term development of the cloud service market.

At this stage, we're facing the challenges head on. As we do so, we will keep our original aspiration of building business led by technology firmly in mind. Technology strength leads to product strengths, which will in turn drive our sales capabilities and establish overall competitiveness.

As long as we excel at our core technologies and products, we will be able to hold our ground amid the highly dynamic environment, thereby achieving the long-term sustainable development of the company and creating greater value for our customers, shareholders and employees. Going forward, we will focus more on core technology areas including computing, storage, networks and big data, enhance our product strength and focus more on scalable and replicable products that deliver the ultimate customer experience.

In terms of business development, we will continue to focus on penetrating selected industry verticals, while cautiously exploring new areas. On one hand, the internet finance, health care and public service sectors are the pillars of our business where we have accumulated in depth expertise and experience. We will continue to focus on these industries, refine our replicable products and services and managing the balance between scale and profit.

On the other hand, we won't give up exploring new areas. We will capitalize on the advantages of the Xiaomi and Kingsoft ecosystems, as well as our replicable technologies and products to steadily open up new space for growth after prudent strategic analysis of potential new vertical prospect for cloud computing.

In terms of sales, we are committed to engaging with customers through a model driven by integrated solutions. Unlike in mature markets, such as the United States, many of the traditional industries in China have complex business scenarios and are late starters in digitalization.

The cloud computing ecosystem still has a long way to develop. As a result, customers cannot satisfy their business needs by simply purchasing and combining cloud products. To address this common paying point, we adapt to the Chinese customers point of view.

In other words, instead of being product driven, we adopt a turnkey solution driven approach by integrating our own proprietary products and technologies, our partners products and technologies as well as Camelot deployment capability delivering one stop solution with readily accessible and tangible value to our customers.

Lastly, and very importantly, we will ramp up collaboration with our strategic shareholders as we all embrace the digitalization trend. As an important Xiaomi and Kingsoft Group portfolio company, we have always offered quality cloud services to and in turn received a strong support from these two strategic shareholders.

Going forward, we will explore collaboration opportunities across various dimensions, including digitalization, research and development and sales to promote thriving Kingsoft and Xiaomi ecosystems in a win-win manner.

These are our thoughts on strategy. We will continue to make improvements and maintain active communication with all stakeholders as we implement our business strategy. On behalf of the company, I would like to thank all our customers, shareholders, employees and ecosystem partners for their steadfast support at every stage of our journey. We will remain focused on development and committed to delivering long-term value to our stakeholders

Now, let me walk you through our performance in the second quarter. Our total revenues were RMB1.9 billion in the second quarter. Revenues from public cloud was RMB1.3 billion, primarily due to the company's proactively scaling down of CDN services. Excluding CDN services, computing and storage services increased by 5.3% year-over-year.

Revenues from enterprise cloud amounted to RMB620 million in Q2, largely stable from the same period last year, lower than our expectation. This was primarily due to the resurgence of COVID between April and June, which slowed down project deployment process.

Our adjusted gross profit this quarter was RMB68.4 million, representing an adjusted gross margin of 3.6%. Adjusted EBITDA margin was negative 7.7% this quarter. The decrease in margin was mainly due to the impact on revenue from COVID resurgence, among other factors, which were more material than our previous estimates.

Although our cost saving measures yielded remarkable results, our profit margin decreased due to the lower-than-expected revenues. Despite the significant short-term results pressures, our Board and management team are committed to long-term development, actively managing our operations to face current challenges.

On business front, in the internet sector, we provided exclusive and a full spectrum of cloud services for JX3 origin season games blockbuster MMO RPG [ph], including computing power, database and delivery, enabling a smooth gaming experience for players.

We also deployed multi active architecture for WPF at our proprietary data center in Tianjin, ensuring business continuity with highly available and highly reliable cloud services. In addition, in this quarter, we entered into an agreement with [indiscernible], a Chinese e-grocery platform to provide a full suite of cloud migration services. We also signed into a partnership with [indiscernible], a Chinese smart mobility company providing reliable cloud computing services and jointly developing a one stop solution integrating IF, TAF and SaaS layers for the mobile industry.

Moving to the enterprise cloud business. As part of the dong shu xi suan project, which entails transporting data from different parts of China to the western regions for storage, and computation. We took the lead in constructing an underlying data platform for the Guangdong, Hong Kong, Macau Greater Bay Area, which is one of the eight national computing power hubs.

The platform will serve as the underlying infrastructure for broad entities data processing and analytics needs in the area. The platform is equipped with a number of functions, empowering data cleaning, comprehensive data governance, data quality assessment, free processing and compliant and secure data sharing.

At another national hub in Gansu Province, we developed the integrated computing power scattering platform and the Tianjin computing resource scheduling center. The project will coordinate computing power between the East and the West regions to enterprises outside of Gansu Province, while providing computing power for local businesses within the province.

In public services space, we deployed high performance servers, cloud hosts, server cabinets, and storage resources for the [indiscernible] education cloud ensuring uninterrupted learning during COVID-related school suspension. In the financial services sector, we continued to deepen cooperation with top banks by offering additional products such as DylaxiCloud [ph], big data and storage.

Taking the data lake project of a leading commercial bank as an example, the data lake helps our customer carry out historical data storage and integrated computing, and supports high concurrency large scale, upload and download of unstructured files. In the meantime, we built an intelligence system to provide all the bank's data analysts with self service data analytics and data mining services, significantly improving data response efficiency

In the health care sector, we continued to promote five models through our successful Lighthouse projects, namely the province level health care cloud model demonstrated in the Hubei Healthcare Cloud. The province level medical image cloud model demonstrated in the Jiangsu Image Cloud. The municipality level regional integrated model demonstrated in the city in Changsu. The City County integrated health care organization model demonstrated in should be and the hospital level model in Grade A tertiary hospitals in Wuhan and Changsu.

Overall, the complex external environment has put our short-term performance under pressure. Despite the headwinds, we firmly believe that cloud computing is the foundation that drive digital transformation. We will remain committed to our all-in cloud strategy and stay positive about our leading position in the cloud service industry.

Nicole Shan

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

Haijian He

Thank you, everyone, and welcome, everyone, for joining the call today. Now I will walk you through the financial results for the past quarter. Our total revenue was RMB1.91 billion in Q2. Within that, revenues from public cloud were RMB1.29 billion. The changes were primarily due to the company's proactive scaling down of our CDN business, with its gross billing decreasing by 30% on a Y-o-Y basis, while the gross billing from computing and storage increased by 5% year-over-year.

Revenues from enterprise cloud was RMB616.6 million. We managed to deliver stable revenues from enterprise cloud year-over-year as we navigated through a difficult operating environment of COVID-19 resurgence across the country, with slowdown of the bidding and project deployment process.

The COVID-19 impact on our business between April and June was more serious than our previous estimates. As new biddings and the deployment process for enterprise cloud projects both slowed, meanwhile, some of the Internet customers paused their spending and the dialogue with the new customers' leads were also affected this quarter temporarily impacting our revenue growth.

Nonetheless, our cost saving measures yielded expected results, leading to a quarter-over-quarter decrease of RMB252.6 million in total cost savings and RMB8.7 million in non-GAAP R&D and sales and marketing expenses. Our profit margin decreased slightly sequentially due to the slower-than-expected revenues, and we expect such impact to be largely reflected in Q2 and Q3 this year. With the overall market environment returning to normal, we believe that our business will gradually begin to stabilize in Q4 and onwards.

In terms of cost, total cost of revenue decreased by 12.1% quarter-over-quarter to RMB1.84 billion. The IDC cost decreased by RMB81.3 million from last quarter to RMB1.03 billion this quarter. It mainly consists of bandwidth and cabinet cost and a decreased trend was in line with our adjusted of CDN services.

Solution developments and service costs increased slightly quarter-over-quarter to RMB489.8 million. It consists of payments to our solution design, development and services personnel.

Depreciation and amortization costs remained stable at RMB249.1 million. Fulfillment costs were RMB24.7 million this quarter, which was in line with the trend of enterprise cloud services revenue. Due to the impact from COVID lockdown, offline deployment has been [indiscernible]. Fulfillment cost presents the cost of purchasing technologies, products and services from third party to fulfill the demand of our solutions. Other costs were RMB48.6 million this quarter.

The adjusted gross profit of this quarter was RMB68.4 million, representing adjusted gross margin of 3.6% this quarter. Adjusted EBITDA margin was negative 7.7% this quarter. The decrease of margin was mainly due to the impact of revenue from COVID resurgence among other factors than our previous estimates.

In terms of expenses, excluding share-based compensation, total adjusted operating expenses were RMB507.0 million, decreasing by 3.1% from RMB523.2 million. Within that, adjusted R&D expenses was RMB190.8 million compared with RMB221.7 million last quarter.

Adjusted selling and marketing expenses were RMB120.1 million compared with RMB127.6 million last quarter. Adjusted G&A expenses increased slightly from RMB174.0 million last quarter to RMB196.1 million, which was primarily due to the one-time of compensation expenses for personnel adjustments.

As of June 30, 2022, we had cash and cash equivalents and short-term investments amounting to RMB5.4 billion, providing us sufficient liquidity for operations. The capital expenditure for this quarter was RMB450.9 million, which primarily consists of cash payments for the service we ordered previously.

For the full year of 2022, we expect to keep our total CapEx plan in the range within RMB1.5 billion. In terms of the share repurchase program, we are pleased to announce that we intend to adopt a share repurchase agreement with potential size no more than US$30 million during a 90-day window, subject to agreements to be finalized with the repurchase agent. This action is persuaded to and a part of the US$100 million repurchase program authorized by the Board and announced earlier in March 2022.

As usual, the timing, structure and the dollar amount of repurchase program will be subject to, among others, the market conditions, terms to be agreed with relevant repurchase agent, the trading prices of ADS and the relevant securities rules and regulations. We believe this demonstrates our continued and unwavering efforts to align share price with long-term value of the business.

Finally, we are on track with our Hong Kong Stock Exchange listing plan and submitted the prospectus and A1 filing on July 27. Despite recent positive progress in the negotiations on the Sino-U.S. auditing cooperation, we continue to seek new primary listing status in both Hong Kong and the U.S. to proactively manage potential risks. We will closely monitor the market dynamics and proceed prudently at the right time. The final listing decision and time lines are subject to both regulatory approvals and market conditions.

Looking ahead, we expect our total revenue to be between RMB1.95 billion and RMB2.15 billion for the third quarter of 2022, representing a quarter-over-quarter increase of 2.3% to positive 12.8%. All these forecasts and comments above are based on our current and preliminary views of the market and operational conditions, which are subject to change. Thank you.

Nicole Shan

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Brian Gong from Citi. Please ask your questions.

Brian Gong

I will translate myself. Thanks management for taking my questions. I have two questions. First is regarding our third quarter revenue guidance. Can management give the assumption of the revenue scale of public cloud and also the enterprise cloud? And secondly, management has just mentioned that you see the slower bidding process of enterprise cloud projects. How is latest trend in recent months? And how do you expect the tendering pace in the rest of the year? And how would that impact your revenue ahead. Thank you.

Haijian He

Thank you, Brian. I'm happy to take on the first question. So to start with, as we explained, I think the Q2, especially the COVID impact in the city of Beijing, affected quite a lot of the business deployment process. So looking to 3Q, I think there are something unchanged. There are something that we executed, on track, and there are something still with some uncertainties.

I have to kind of elaborate one by one. First of all, I think our plan to keep a relatively scaling down size of the CDN, this plan is no change, which we communicated earlier this year. So if you look at the dollar value and the total size of the business, I think, in Q3, our CDN business will keep a relatively stable, but on a Y-o-Y basis, will be still around about 30% or about 25% to 30% Y-o-Y decline for the CDN business.

And for the core part of the public cloud, which actually we are providing services on storage and computing to the key Internet clients as well as some diversified non-Internet clients who are using our product cloud, which also we are seeing that as a very positive sign, I think, for that part, we are going to see a sequential increase of the public cloud usage on cloud computing and storage in Q3. I think that we will see some trends actually picking up.

On the enterprise, we keep relatively prudent and cautious in Q3 as you probably understand. The public cloud -- or the enterprise cloud will need to have some phases to be deployed and finally executed. So when we look at our backlog, still very strong and robust. And the core part of the backlog for this year, given the timing and the pacing, I think the majority of that important projects will be completed in Q4 for this year.

But even with that, I think, in Q3, our enterprise cloud will have gradually a sequential increase compared with Q2 for the enterprise cloud. So that's actually formed the basis of a sequential increase of the total revenue compared with Q2. The mix of the revenue will keep relatively stable. The CDN will be relatively lower. The Enterprise Cloud, robust on the backlog, and most of them will be delivered in Q4. So I think the execution is still on track and the revenue conversion will be taking some time for this year. Thank you, Brian.

Tao Zou

So just to briefly translate for Mr. Zou. So as you rightly pointed out, and as we reported in the prepared remarks, the COVID impact during -- between April and June, especially the lockdown in core and hub cities in Beijing and Shanghai, has inevitably created delay of our enterprise cloud bidding and deployment activities in the process. Currently, we can see for sure that commercial and business activities has improved. This is something that we can see. So I would say that for the third quarter and the fourth quarter, with the absence of other major top cities lockdown measures, we would say that recovery speed is something that we can be expected. However, it is still rather difficult to have a comprehensive estimate about the ongoing and lasting impact of COVID situation, especially under the backdrop that the global macro economy continue to be very weak and remain uncertain.

As the nature of our business, it's a 2B business, if our customers' performance are under challenges under the overall macroeconomic conditions, it is hard for us to deliver a much better result. And therefore, I would say that, at least from what we can see from business activities in July and August, the pressure, to be quite honestly, we expect that pressure will be continuing for a period of time, stretching into the future. Thank you.

Operator

Thank you. Our next question comes from the line of Thomas Chong from Jefferies. Thomas, please ask your questions.

Thomas Chong

Thanks management for taking my questions. My first question is about the competitive landscape in the public and the enterprise cloud side. Do we see any changes in terms of the competitive landscape? For example, like we are seeing more new entrants? And my second question is about the pandemic outbreak and the global headwinds that we are facing. We have just talked about that the macro situation globally is still very challenging. So I just want to get some thoughts from management, qualitatively speaking, when should we expect business back to the pre-COVID level and back to normal situations? Any color would be great. And is that really impacting the ARPU or the number of customers? And my final question is about the timing that we should expect adjusted EBITDA to reach breakeven? Thank you.

Tao Zou

So let me briefly translate for Mr. Zou. So in terms of competitive landscape, my brief answer is that, from my perspective, during the past 10 years since our inception, we believe, fundamentally, there's no material change in terms of competition because as we started out, we were competing with Ali Baba and Tencent Cloud business. And more recently, there's the players joining in the game, including giants like Huawei, but ultimately, all of them are giant companies, whereby, in any short period of time, it is not likely that our scale can actually match with theirs.

However, the fact that we have developed and grown rapidly in the past 10 years, has shown that we have considerable comparable advantages even in this market in playing with the giants. The one key reason is that the nature of the 2B service industry because the nature of this industry is that the selling single product does not really deliver value to the enterprise customers, but the company has to jointly develop solutions together with the customer to really develop and deliver value to that customers. And therefore, it is never a winner takes it all market for the 2B service companies.

So a metaphor would be a horse race whereby our competitor might have 20 to 30 horses, where we focus deeply on the 3 to 5 horses, which can race really well. I think in the past, especially 5 years, the growth of our businesses, in particular in financial services and in health care has been demonstrating this point. In particular, in the health care space, we believe our solutions and products are actually leading the game. So I think, in the future, we will continue to focus on a limited number of verticals and to deliver our value to the customers.

And to answer your second question, it's actually very difficult for me to answer when or if we are ever going to be able to revert to our status before the pandemic. It is quite apparent that the COVID has changed a lot of things, prevailing from our daily life to larger geopolitical struggles. However, if you only refer to the revenue and financial aspect of it, I would say that the largest impact of the COVID situation to the cloud service industry in China is that the players in the market are shifting swiftly from the rather aggressive pursuit of top line growth to pursuit of more balanced growth and profitability.

We have observed our competitors, for example, Ali Cloud [ph] and Tencent Cloud to adopt such adjustments. And we have also reported in the prepared remarks that we are also adjusting to a more balanced growth rather than emphasizing on revenue only. We believe that this also gives more comfort to investors and other stakeholders as we are, by doing so, switching to a more sustainable development model. Thank you.

Haijian He

I'll take on third question regarding the profitability path. So we understand earlier this year, when we think about this year's total budget and the pacing of improving profit margin before the April and May of the COVID impact, our initial intention has two things. First of all, we want to actually improving the efficiency and cutting loss on certain nodes and regions, especially from the CDN business. Those are two major drivers that we were set earlier to seeing improving sequential improvement of both gross margin and EBITDA margin. And we budgeted for by Q4 on a single quarter basis, hopefully, our non-GAAP EBITDA margin will turn profit.

However, the COVID happening this quarter obviously affected the pacing of implementing certain measures and also the market environment also reduced certain demand for certain high-quality products demand from certain customers. So I think, at this moment, we are seeing flat, especially on the gross margin side for this quarter. Hopefully, I think we are seeing improving gross margin, hopefully, for the next two quarters. And we understand that actually very important for ourselves, but also for the shareholders and the market to see our results quarter-over-quarter to improving gross margin. That reflects the quality of the products and the value of our technology.

However, also on the product aside, that given our strategy today, as we discussed earlier by Mr. Zou that we will continue and especially more focused on the investment into the R&D and R&D personnel. So I think we will make some adjustments in terms of our internal budgets on some high-quality product investments and the people investment in the next two quarters that may affect certain R&D expenses and related expenses in those two items on a marginal basis. So I think the expenses, the budgets always follow the strategy and the business demand and the vision.

And I think we explained earlier in the remarks today, we have laid out that clearly regarding the priorities we want to pursue in the next two quarters. So as a result, I think I will have two attentions as a summary. First of all, we will try our best to improve the gross margin on a quarter-over-quarter basis. This is no change. And point #2, we will make necessary investment into the R&D for the next two quarters and especially for high-quality products. So if that will have some impact, I think the timing of the EBITDA margin may be delay, or earlier or later. But again, I think it's only about the timing. And I think if we make the right investment on the products and the customers, our EBITDA margin will turn breakeven sooner or later. Thank you.

Operator

We thank you very much for all your questions. We have now reached the end of the question-and-answer session. I'll now turn the conference back to Ms. Nicole Shan for closing remarks.

Nicole Shan

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 later.

Haijian He

Necessary investment into the R&D.

Operator

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