Kingsoft Cloud Holdings Limited (NASDAQ:KC) Q1 2024 Earnings Conference Call May 22, 2024 8:15 AM ET

Company Participants

Nicole Shan - IR Manager
Tao Zou - Vice Chairman and 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 Kingsoft Cloud's First 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 that today's conference call is being recorded.

I would like now to turn the conference over to 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 first quarter 2024 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 CEO, Mr. Zou Tao; and our CFO, Mr. Henry 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. All interpretations are for your convenience and reference purposes only. In case of any discrepancy, the 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, and thank you all for joining Kingsoft Cloud's first quarter 2024 earnings call.

This quarter, Kingsoft Cloud's high-quality and sustainable development strategy has achieved fruitful results. After more than a year of unwavering optimization and adjustments, and alongside our continuous and steady increase in gross profit margin, we have achieved a milestone of turning adjusted EBITDA positive for the first time since the establishment of Kingsoft Cloud. This milestone demonstrates Kingsoft Cloud's profitability and growth sustaining ability, marking the commencement of a new stage of development. It establishes a robust foundation for our long-term sustainable and healthy progression into 2024 and beyond.

Now I will walk through the business highlights of the first quarter of 2024. This quarter, we continued to achieve dual improvements in both our revenues and profitability. In particular, our total revenues reached RMB1.78 billion, increasing 3.1% quarter-over-quarter.

Adjusted gross profit for the quarter reached around RMB300 million, increasing 54% year-over-year. Adjusted gross margin saw a significant boost rising by 1.6 percentage points quarter-over-quarter to reach 16.8%, marking the seventh quarter of consecutive improvement. Adjusted EBITDA reached RMB33.19 million with an adjusted EBITDA margin of 1.9%, representing a significant improvement of 8.9 percentage points year-over-year.

In terms of public cloud services, revenues reached RMB1.19 billion this quarter, representing an increase of 12.9% quarter-over-quarter. Excluding the CDN business, public cloud revenues saw a 9% quarter-over-quarter increase. We have seen positive outcomes across our three priorities for public cloud services, namely the Xiaomi and Kingsoft ecosystem, AI business and CDN strategic adjustments.

First of all, serving as the sole strategic cloud platform within the Xiaomi and Kingsoft ecosystem, we firmly grasped the cloud business opportunities within the ecosystem, especially after the launch of Xiaomi SU7 and the commercialization of WPS AI, which led to strong demand for computing power in autonomous driving and AI office use cases. This quarter, revenues contributed by Xiaomi and Kingsoft ecosystem reached 19%, representing an increase of 4 percentage points year-over-year.

Secondly, we have been proactive in seizing the strategic opportunities brought about by this round of AIGC and have made significant strides in our AI business. This quarter, AI revenue surged to RMB160 million, an increase of 93% quarter-over-quarter, accounting for 13.5% of public cloud revenues. This expansion further diversified our customer industry distribution.

On one hand, we continued to invest in infrastructure with capital expenditure exceeding RMB1.2 billion this quarter, establishing a high computing cloud resource pool with substantial scale. On the other hand, recognizing the historic opportunity of AI empowering various industries, we have established Kingsoft AI as a wholly-owned subsidiary, seizing the opportunities in intelligent digital transformation of enterprises and professional services.

Thirdly, we continued to push forward our strategic adjustments of CDN business. This quarter, CDN revenue remained stable compared to the last quarter, accounting for 23% of total revenues. We remain committed to enhancing profitability of CDN by promoting high value-added product sales externally, rigorously controlling procurement costs internally, expanding supplier coverage, and optimizing market price and service offerings.

Moving on to enterprise cloud services. Revenues amounted to RMB590 million. In public service space, we have actively pursued opportunities within public service cloud and state-owned assets cloud. Implementing standardized operation and maintenance, we have leveraged our core components such as model capabilities, big data and workspace collaboration, targeting applications in the public service and enterprise domain.

During this quarter, we initiated a trial operation for the Wuhan Optics Valley cloud that we constructed, providing an independent and controllable centralized computing and storage platform for entire Wuhan East Lake High-tech Development Zone. This platform has assisted in collecting data, exploring data sharing and providing convenient public cloud infrastructure services for science and technology innovation enterprises in the high-tech zone.

In addition, we have remained attentive to the trend of data asset inclusion on balance sheet. Recently, we convened a seminar on data assets and data elements, engaging experts and scholars from various institutions such as data exchanges, accounting firms, big data centers and data research institutes to discuss topics such as policy interpretation, data assetization and state-owned enterprises, cloud services as well as data asset inclusion practices, closely following the business opportunities of data assetization.

In health care space, our DaaS platform, medical imaging cloud platform and integrated electronic medical record platform have all passed evaluations and being selected as one of the first batch of high-quality development panorama of digital medical products and services by China Academy of Information and Communications Technology. This showcases our achievements in product innovation and service capabilities in medical artificial intelligence industry.

In financial services space, we provide object to storage expansion services for a leading joint stock bank, with comprehensive storage capabilities such as object storage, file storage and big data gateways while making full use of existing clusters.

Turning to Camelot. This quarter witnessed stable and healthy revenue and profitability. We have signed up four new well-known customers while maintaining robust relationships with existing major customers. From the perspective of overall ecosystem business developments, Camelot has launched a dedicated cooperation service plan with Xiaomi and Kingsoft ecosystem customers, exploring new models of talent and business operations.

In terms of product and technology, we uphold our principle of building success based on technology and innovation, focusing on delivering best-in-class customer experience across our core product offerings. In the AI space, we have accumulated technology and extensive service experience in deploying 256 and 512 node cluster, achieving automation in large-scale cluster deployment, acceptance and operation and maintenance management.

In enterprise cloud space, the Galaxy Stack platform released an updated version of its operations and maintenance platform, adding 84 new hardware and performance monitoring capabilities to assist customers in refined statistical management. At the same time, new version of the operation platform calculates the usage of cloud resources, such as cloud hosts and networks for all talents from a business standpoint, enabling efficient and refined operation. This enhances our intelligence and precision in cloud migration, cloud management and cloud usage for our customers.

In summary, our high-quality and sustainable development strategy has been steadily implemented, achieving the milestone of turning EBITDA positive for the first time. Additionally, revenues have also achieved continuous growth in the past two quarters, and our gross profit margin has improved for seven consecutive quarters.

Looking forward, we will remain committed to our long-term strategy, focusing on high value-added products and services, embracing AI opportunities, promoting technological advancements and continuing to enhance profitability. By increasing management efficiency, maintaining a strict cost and expense control, enhancing talent training and expanding our Wuhan R&D center, we are confident that we will continue to create value for our customers, shareholders, employees and other stakeholders.

I will now pass the call over to our CFO, Henry, to go over our financials for the first quarter of 2024. Thank you.

Haijian He

[Foreign Language] Thank you, Mr. Zou, and welcome, everyone, for joining the call. Now I will walk you through the financial results for the first quarter 2024.

We are very pleased to see our adjusted EBITDA margin turn profit for the first time with our adjusted gross margin has been consecutively improving for seven quarters, verifying the well-executed of our strategy of high-quality and sustainable development. Having successfully achieved profitable EBITDA margin, we would like to highlight the following three key efforts we have made to yield the results.

First of all, we strategically adjusted our revenue mix under the guidance of high-quality and sustainable development strategy. During the past year, we scaled down proactively our CDN services with low margin profile. This quarter, CDN services contributed around 23% of our total revenue compared with over 50% in the peak time, looking back into 2020. Meanwhile, we expand our revenue from high-margin AI business achieving RMB160 million this quarter, contributing around 13% of our public cloud revenues.

Second, both of our public cloud and enterprise cloud services improved their margins in 2023 and the quarters beyond compared with 2022. Since last year, we focused on high-margin products and services, and we select carefully about our clients, which yield better margin profiles.

Third, we have been taking strict measures and a supply chain strategy to cut down our costs and expenses. We have streamlined our procurement process and enlarged our supply force to achieve higher cost effectiveness. We also closely monitor the daily operation expenses. These key initiatives bear fruit in this quarter by recording EBITDA profit, and we believe these are still potentials in the future, and we will keep our commitment into improving our profitability.

Our adjusted gross profit continued to grow to RMB299.1 million, increased by 53.8% year-over-year, representing adjusted gross margin of 16.8%, which is a record high for the company, and improved 1.6 percentage points compared with last quarter.

Our adjusted EBITDA narrowed from negative RMB130.5 million in the same period of last year and a negative RMB27.7 million in the last quarter to positive RMB33.2 million this quarter. Adjusted EBITDA margin further narrowed from negative 7% in the same period of last year and a negative 1.6% in the last quarter to positive 1.9% this quarter.

Our total revenues were RMB1,775.7 million this quarter, increased by 3.1% sequentially, of which revenues from public cloud services were RMB1,187.4 million, representing an increase of 12.9% compared with RMB1,052 million in the same quarter -- in the last quarter. The increase was primarily due to the expansion from AI-related revenues and a relatively stable scale of our CDN business.

Revenues from enterprise cloud services were RMB588.2 million, representing an increase from RMB670.3 million in the last quarter as fewer projects are scheduled for delivery during the Chinese New Year holiday period.

We continue to enhance our cost control measures, expanding our coverage of suppliers to search for better service quality and procurement prices. Total cost of revenue decreased by 11.2% year-over-year and a relatively stable quarter-over-quarter to RMB1,482.4 million. IDC costs decreased significantly by 11.9% year-over-year from RMB872.4 million to RMB768.5 million this quarter. The decrease was in line with the scaling down of our CDN services.

Depreciation and amortization costs decreased by 18.3% from RMB224.6 million in the same quarter last year to RMB183.5 million this quarter. The decrease was mainly due to the previous impairment of our long-lived assets and partially offset by the depreciation of new services -- new service we acquired.

Solution development and services costs increased by 5.3% year-over-year from RMB423.6 million to RMB446.0 million this quarter. The increase was mainly due to the solution personnel expansion of Camelot. Fulfillment costs and other costs were RMB36.1 million and RMB48.3 million this quarter, respectively.

Adjusted gross profit for this quarter increased by 53.8% year-over-year to RMB299.1 million, representing adjusted gross margin of 16.8% this quarter compared with 10.4% in the same period of last year and 15.2% last quarter, making another record high as well as the third consecutive quarter of steady margin improvement.

In terms of expenses, excluding share-based compensation and impairment of our long-lived assets, our total adjusted operating expenses were RMB469.6 million, decreased by 21.2% year-over-year and 5.1% from last quarter, of which our adjusted R&D expenses were RMB193.0 million, increased by 18.8% from last quarter. The increase was mainly due to our continuous investment into technology.

Adjusted selling and marketing expenses were RMB97.9 million, representing a decrease of 8.3% from RMB106.7 million last quarter. Adjusted G&A expenses were decreased by 20.8% from RMB225.6 million last quarter to RMB178.7 million. The decrease was mainly due to the strict control over daily operational expenses and a decrease of bad debt provisions.

As of March 31, 2024, our cash and cash equivalents amounted to RMB1.8 billion, providing us liquidity for operations and investments into AI. The capital expenditures for this quarter were RMB1,212.2 million, as we invested in our infrastructure to build a sustainable AI business.

In April, we released our ESG report for 2023, providing an in depth review of the company's progress in the last year in its ESG practices, including business ethics, responsible operation, talent development, green development, sustainable supply chain and corporate responsibility.

In 2023, we were awarded as a member out of a total of TOP 88 companies in the first edition of S&P Global's Sustainable Yearbook China Edition. We are also rated as a single A rating in MSCI ESG rating, leading in the whole ADR stock of China. We will fulfill our social responsibility and create value to our customers, employees, shareholders, suppliers and whole society.

Looking ahead, our core principle of high-quality and sustainable development, we keep taking initiatives to improve our revenue quality, cutting down costs and expenses, and improve our profitability. The breakeven of EBITDA is a well beginning for us, and we expect the more balanced and healthy business performance and the financial results are coming in the future. Thank you.

Nicole Shan

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

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from Xiaodan Zhang with CICC. Your line is now open.

Xiaodan Zhang

[Foreign Language] I got two questions here. First of all, what is your expectations for the adjusted EBITDA margin improvement pace for the subsequent quarters? And secondly, how are you going to cope with the increasingly aggressive pricing strategies of IC and large language model vendors? Thank you.

Haijian He

[Foreign Language]. So I probably will take on the first question. So as we mentioned in the prepared remarks, we're actually happy to see during the 12 years of history of Kingsoft Cloud is actually the first quarter we hit the EBITDA margin breakeven. And the underlying drivers, as we mentioned, are very clear.

And we believe that those drivers will be continue to unleash the value and profits in the following quarters, namely, the better mix of the revenue from different BUs, high-margin contribution from AI business, the revamping of the supply chain tactics which are actively changing many of the suppliers to remain competitive in the cost side. And also, we improved the internal operational efficiency by streamlining certain internal operation initiatives and process. So these are the things. Obviously, other companies do the same, but I think we do in a better committed way, and we will carry for a long way.

And also for -- if we're looking forward, we believe partial of the benefits on the profit from the initiatives we already took will continue to have the results in the coming year quarters. And in addition, as you can see that, we also have the better trends to go with the higher growth on the top line. So I think that will also give a good kick into the bottom line of the profitability as well.

So in short, I think we are not going to say it's going to be onetime profitability on the EBITDA line. It will be consistent and it will be probably carried along in the following quarters. And we also see the improving better gross margin will also kick down to the EBITDA margin line as well. So I think sequentially, we'll see a better gross margin carry forward and also will be a narrowed spread between the gross margin and EBITDA margin. So we'll see probably a more accelerated trend of the EBITDA margin improvement as well.

I think there's other two things we can share. Obviously, we're not going to give kind of a numeric guidance on the EBITDA margin going forward. But I think we're going to achieve kind of industry top level of the tier players in a very similar ballpark number of the gross margin and EBITDA margin line. And what I can kind of commit is the EBITDA margin breakeven for this quarter is not going to be a onetime off event. So we are pretty confident both gross margin and EBITDA margin will continue to improve in several quarters down the road as well. Thank you.

Tao Zou

[Foreign Language] [interpreted] Okay. So I'll just very quickly summarize and translate. So to be quite honest, it is something that we had expected already. As I mentioned, people have noted the price cut of large language model offered by ByteDance, Alibaba and Baidu, and I've also commented on this, which is a sign that the large language model development in China has entered a stage of relatively mature, which I would call, the round of competition, which eliminates some of the players.

However, I think it's important to mention one point that what we at Kingsoft Cloud do is different from what this large language model players do because we actually provide services and computing power to the large language model players. But we don't do like large language model ourselves. And therefore, the importance for us is that what we are closely looking at is whether these customers of us, namely the independent large language model players in the market, are going to be able to survive this competition and remain a player in the market.

From the current situation, we have seen that many of them have secured a very large amount of financing in recent past. And therefore, overall, we evaluate the situation for these customers to be relatively robust, at least in the next one or two years, which is well within our contract period.

From the long-term standpoint, we do think that this is a stage of development of large language model in China that is going to come, which is not going to be that sustainable for all kinds of players to remain on the table. However, we do think that vertical application models -- there's a -- for vertical application models, there's a good chance that many of them will be able to have their own niche and unique markets in the market competition.

Nicole Shan

Operator, could you please. Thank you.

Operator

Please stand by for the next question. The next question comes from Timothy Zhao with Goldman Sachs. Your line is now open.

Timothy Zhao

[Foreign Language] Thank you management for takin my question. My question is regarding AI and the relevant investments. I do notice that the AI revenue actually showed strong Q-on-Q growth either from an absolute number perspective or as a percentage of revenue. Just wondering if management can share any color on what is driving that very significant AI revenue growth.

And secondly, on CapEx, as you mentioned, you already spent around RMB1.2 billion CapEx. I was just wondering if management has any guidance into the total CapEx for this year. Thank you.

Haijian He

Thank you, Tim. Probably I'll take on part of the question and our SVP also will probably give more color on the business side as well. So regarding the investments, so I think we are probably in the -- still in the early age and there's still a lot of opportunities. We want to invest into the right clients. As we mentioned, we want to carefully select the clients. But after we committed to the client as we are getting to know client better, we will continue to make more investments.

So the RMB1.2 billion for this quarter, I think it's only part of the demand we received from the clients, and we'll continue to invest more in the following quarters, which we think will result in a higher revenue in the following quarters. But on the other hand, given the AI business itself is carry a better margin and the supply/demand trend in the market is more balanced. So we are actually changing the way we use our money as you probably realize that not only we're using our equity capital, but also we leverage different sources, including the financial leasing, including some operational leasing, including the bank borrowing and other partnerships with -- for example, with the suppliers that will provide certain credits to us as well.

So I think we are going to explore as many channels as possible to extend the capital we have. So the thing I want to mention, we don't want to set a cap about how much we want to invest into AI just because the cash we have on the balance sheet, right? So I think you can model for different level of the ceilings on the cash number we have today.

So I think that's -- on your second question. So if you put a total number on the 2024, I think the total investment, including the CapEx, including the investments in the R&D expenses we put on AI team, including different ways -- we have flexible ways to work with suppliers, I think the total investment into AI for this year is going to be a few more times multiplied by this quarter's number. I think that's probably the ballpark number I can give. And that will yield, again, a better and a much higher AI revenue in the following quarters.

And for the opportunity of the AI business, one thing I just want to start and Liu Tao can add on the following points. So the demand from client actually carry a more diversified way. So not only one vertical from, for example, a big model company, but also, as you can see, as AI business getting to the year two, right, last year from year zero, then into the year two, more clients and different type of clients will use the AI computing power not only for the computing itself, but also will carry with applications, data scenarios from all different verticals, including Internet, including probably the financial services, the legal and auditing and other, for example, public sector clients will all probably use that.

And actually, those revenue will gradually come in and book into different -- the products we have today. So I think probably that's the better mix and diversified revenue streams we're happy to see in the following quarter as well.

Tao Liu

Yes. We just mentioned that we have many incomes from different type of companies. For example, the AI companies, they are now building the base cluster on our cloud. So as we mentioned on the report, we have built about 256 or even 512 clusters. So this all -- these kind of companies will expand their new clusters on the cloud, so we were expecting in the new quarter, we will have better revenues.

And also, you can see that all cloud companies, we have the requirement not only on the hard drive technologies, but also on the language models technologies. And also we have some customers from the Internet companies. They are creating their own language models. And now we are not only can provide cluster services for them, but also we can help them to train their own models and even dealing with their new data. So -- and also, we can see some GC companies, which is something like picture and videos. They are also having the increasing requirement. So this requirement while -- we were expecting increase on that. Thank you.

Nicole Shan

Thank you, operator.

Operator

Yes. I show no further questions at this time. I would now like to turn the call back over to 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 next quarter. Have a nice day. Thank you.

Operator

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