Kingsoft Cloud Holdings Ltd

NASDAQ:KC

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Good day and Thank you for standing by. Welcome to the Kingsoft Cloud's Second Quarter 2024 Earnings Conference Call. [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, executive]

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 GlobeNewswire services.

On the call today, from Kingsoft Cloud, we have our Vice Chairman and the CEO, Mr. Zou Tao; 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 interpretation. All interpretations are for your convenience and reference purpose only. In case of any discrepancy, management's statement in our original language will prevail.

Before we begin, I'd like to remind you that this conference call contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 as amended and as defined in the U.S. Private Securities Litigation Reform Act of 1995.

These forward-looking statements are based upon management's current expectations and current market and operating conditions and relate to event 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.

[Tao Zou, executive]

[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 2 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 margins 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, single large customer concentration risk fundamentally resolved.

Fourth, implementing refined management in aspects of procurement, assets and operation, as quarterly costs and expenses decreased by approximately RMB 300 million, representing 15% of quarterly revenues.

Fifth, taking long-term perspective 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 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 this have laid 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 breakthroughs in terms of revenue scale, profitability and operating cash flow. In particular, our revenues reached RMB 1.89 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 RMB 323 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 RMB 60.59 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 RMB 150 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 RMB 1.23 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 3 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 grasped the cloud business opportunities within the ecosystem. This quarter, revenue contribution from Xiaomi and Kingsoft reached 20% amounting to RMB 370 million and witnessed a year-over-year increase of 36.9%.

Secondly, AI businesses continue to bear fruit. This quarter, AI revenue surged to RMB 326 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 [ highlights ] of 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 center resources in Central and Western regions of China, costs are 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 RMB 657 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 model, 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 operation service market report by IDC, we ranked as the top 6 companies in the industry. Such ranks reflect recognition from the industry markets for our product capability 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 health care space, Changzhou Health Cloud has launched its [ space cloud ] expansion. It will meet the requirements of new business scenarios and the needs of extended archive of health care images, fully validating the potential to establish long-term cooperation for 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 a 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 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 cleaning, accommodating text, images and videos. This multimodal solution is tailored to meet the data cleansing requirements for the creation of both pre-training and fine-tuning data sets.

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 the cost per incident and an increase of up to 300% in instant density.

In summary, after 2 years of dotnet implementation of the high-quality and sustainable development strategy, Kingsoft Cloud's fundamentals have undergone a complete transformation.

Looking forward, we will continue to enhance our profitability and cash generating capabilities, deepen co-operations 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.

[Haijian He, executive]

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 3 key areas of progress. First, we are very pleased with ongoing improvements in our financial metrics. By applying the first principal 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 8 consecutive quarters of steady growth, while adjusted gross profit hit RMB 333.4 million. After turning a profit in adjusted EBITDA margin last quarter, we continued with this positive trend with RMB 60.6 million in EBITDA and a 3.2% in EBITDA margin, demonstrating our successful execution of a high-quality sustainable development strategy.

Second, this quarter, our revenue reached RMB 1,891.8 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 RMB 326 million, making up 26% of our total public cloud services revenue, double 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 a 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 RMB 151.2 million. 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 RMB 1,891.8 million, a 3.1% increase year-over-year, of which revenues from public cloud services were RMB 1,234.5 million, up 4% from RMB 1,187.4 million last quarter, primarily driven by the growth in AI-related revenues to RMB 326 million. Revenues from enterprise cloud services reached RMB 657.2 million, up from RMB 588.2 million last quarter due to accelerated project deliveries this quarter.

We have continued to enhance our cost control, expanding our supply base to improve services quality and procurement prices. Total cost of revenue decreased by 3.4% year-over-year and remained stable quarter-over-quarter at RMB 1,573.4 million.

IDC costs dropped significantly by 14.4% year-over-year from RMB 860.7 million to RMB 728.2 million this quarter, reflecting the strategic scaling down of our CDN services and optimize utility of our REC usage.

Depreciation amortization costs increased from RMB 202.1 million in the same period of last year to RMB 265.9 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 RMB 452.9 million to RMB 491.1 million, due to the solution personnel expansion of Camelot, which was in line with the revenue growth.

Fulfillment costs and other costs were RMB 37.6 million and RMB 50.6 million this quarter, respectively. Our adjusted gross profit for the quarter were RMB 323.4 million, a 56.4% increase year-over-year, with an adjusted gross margin of 17.1%. This marks a new record and the 8 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 impairment of long-lived assets, our total adjusted operating expenses were RMB 555.3 million, slightly increased by 3.2% year-over-year, and 18.3% quarter-over-quarter, of which our adjusted R&D expenses were RMB 200.1 million a 3.7% increase from last quarter due to the personnel cost increase.

Adjusted selling and marketing expenses were RMB 117.5 million, up from RMB 97.9 million last quarter, representing 6.2% of total revenues. Adjusted G&A expenses were RMB 237.7 million compared to RMB 178.7 million last quarter.

As of June 30, 2024, our cash and cash equivalents totaled RMB 1,837.8 million, providing strong liquidity for operations and AI investments. Capital expenditures for this quarter was RMB 654.8 million, reflecting our investments in infrastructure to support a 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, executive]

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.

[Operator]

[Operator Instructions] We will now take our first question. This is from the line of Xiaodan Zhang from CICC.

[Xiaodan Zhang, analyst]

I've got 2 questions here. First of all, could you please update us on your CapEx guidance for the next 2 quarters? And secondly, could you give us some color on the ROI of your AI investments? And how is your expectation for the AI revenue contribution for the full year?

[Haijian He, executive]

Regarding the CapEx. So I think -- first of all, I think you pointed out correctly. This year, we're actually accelerating our investments in, we think, a very good area of potential 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 opportunities 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 2 different areas. First of all is, for this quarter you may also notice that we recorded a net cash inflow from operations side, which is around about RMB 151 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 operational cash flow. So that is actually the first point.

So the second point is, we also expanded our financing channels. For example, you'll also notice, last year we secured the financing support from Kingsoft Group, as well as the leasing potential opportunities from Xiaomi group as well. But this year, especially in the last 2 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, given those additional opportunity in financing channels, we actually can reopen and have a very high ceiling of the financial capability we can get to support AI investment.

The third point is, given the investment is long term, we also measure very carefully regarding the profitability and the sustainability of those investments. And at this moment, we've been happy to share most of our AI clients are 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 the most important driver for our profitability.

I think right now, given the AI, we do see that recurring revenue percentage are much higher if you compare with the old so-called only ICE services in the old model we did before.

So I think that 3 areas I just mentioned, we can come to a conclusion that we do not limit ourselves with the cash we already have today. we can have more cumulative increased investment with the capacity.

Number 2, every dollar we invest today, the ROE and also the recurring cash flow to serve those liability and increasing 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 that front with the revenues, with the financing sources we have, and we've been matching those 2 sites for the long term going forward.

But last note, I think, Xiaodan, you probably want to have a 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 an accelerated revenue growth on the top line in the coming quarters.

[Tao Zou, executive]

[Interpreted] So in terms of AI, I really want to take this opportunity to elaborate a little bit about my overall thought. So in my mind, it's really about 3 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 10x year-over-year growth and 2x 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 2 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, 2 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 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, have secured RMB 3 billion financing recently. So the confidence is very high in the space.

Now the second dimension about the inference or the use cases for the model capability, as we have talked about in prepared remark, 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 MaaS, Model as a 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.

[Operator]

We'll now take our next question. This is from Timothy Zhao from Goldman Sachs.

[Timothy Zhao, analyst]

I have 2 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 to 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 the Kingsoft Group to your revenue to Kingsoft Cloud?

And into the second half of this year and into the longer term, given we had 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 on the CDN revenue as we see a continued proactive downscaling of the CDN revenue. Can management share any thoughts on the outlook for this business line going forward?

[Haijian He, executive]

Thank you, Tim. The first question regarding the related parties' revenue contribution. I think Tim, you are right. I think we do see a few very important leading positive signals regarding the revenue potential growth in the future. I think first of all, it's really, as we mentioned, given a stronger business connections. Especially with the Xiaomi and Kingsoft Group, we allocated more resources and we prioritized the revenue and client demand from our internal clients.

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 contributing to about RMB 370 million for this quarter alone. I think it is a very positive signal given it is a proven of our capability to serve a very important internal plan, 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 these opportunities.

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 increase in cap of the related party revenue approval. So I just want to also share this good news with you that, maybe, for the next 2 or 3 quarters in our shareholder meeting, we are going to be happy to propose a higher ceiling of the revenue cap to prove that we do have a great visibility of the internal revenue from a related parties.

The second part is relating to 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 notice that, it's actually approximately 1/4 of the revenue of public cloud for this quarter. Let's say half are coming from related parties, but also the other more than half up from the 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 the outside clients. As you may notice that our outside clients are also, most of them, are the Tier 1 AI model companies in the China tech space today. I think that actually strikes to balance 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 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 revenues can be sustainable, secured and visible going forward.

And we are going to also learn from our 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 are working on in the AI space. I think that's all for the first part of the question.

[Tao Zou, executive]

[Interpreted] So I think the right way to understand -- to think about this question is that we have to make a distinction between 2 types of CDN business. One is the standard CND business, which is typically marked by 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 are higher value added.

So my quick answer is that for the first time, our standard CDN business, the minimum amount that we aim to maintain on a quarterly basis is RMB 300 million, and I do not expect it to be lower than that. That serves as a base for our business -- overall business and that we'll continue to invest and to expand the higher-margin part of the CDN business. Yes, that concludes my answer.

[Nicole Shan, executive]

Thank you. And this concludes our Q&A.

[Operator]

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

[Nicole Shan, executive]

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.

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]