Kingsoft Cloud - Q3 2023

Transcript

Operator (participant)

Welcome to the Kingsoft Cloud third quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this session, you will need to press star one and one on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star one and one again. Please be advised that today's conference is being recorded. I would now like to turn the conference over to your speaker today, Wayne Wang, Investor Relations Manager of Kingsoft Cloud. Please go ahead.

Wayne Wang (IR Manager)

Thank you, operator. Hello, everyone, and thank you for joining us today. Kingsoft Cloud third quarter 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. Tao Zou, and 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 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 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 achievement 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 statement 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 factors mentioned during this conference call are denominated in RMB. It is now my pleasure to introduce our Vice Chairman and CEO, Mr. Zou. Please go ahead.

Tao Zou (Vice Chairman, Executive Director, and Acting CEO)

[Foreign language]大家好，欢迎参加金山云2023年第三季度业绩电话会。公司继续秉持高质量可持续发展原则，坚持技术立业，以客户为中心，打造全过程口碑，强化经营管理，积极拥抱新AI时代。本季度，金山云实现了盈利能力的进一步提升，收入达人民币16.3亿元，调整后毛利率达12.1%，实现了连续5个季度持续稳步提升，再创历史新高。调整后毛利额达人民币1.96亿元，较去年同期增长57.5%。常态化调整后的EBITDA率为-2.7%，较去年同期大幅收窄7.6个百分点，较上季度收窄0.6个百分点。

Speaker 9

Hello, everyone, and thank you all for joining Kingsoft Cloud's third quarter 2023 earnings call. During the quarter, we continued to uphold the principle of high quality and sustainable development, build success based on technology and innovation, and forge our reputation throughout the entire business process with customer centricity. We have enhanced our operations management and proactively embrace the new AI era. This quarter, our profitability further improved. Total revenues reached CNY 1.63 billion. Adjusted gross margin increased steadily for the fifth consecutive quarter to 12.1%. Adjusted gross profit reached CNY 196 million, increasing by 57.5% compared with the same quarter last year.

Normalized adjusted EBITDA margin was negative 2.7%, which represents a significant improvement of 7.6 percentage points from the same quarter last year, and 0.6 percentage points from the previous quarter.

Tao Zou (Vice Chairman, Executive Director, and Acting CEO)

[Foreign language]公有云方面，本季度实现收入10.2亿元人民币，毛利率4.7%，较去年同期的负1.6%显著提升。我们继续着力围绕三方面下工夫，即小米金山生态、AI业务、CDN战略调整。首先，我们继续服务好小米金山生态RMB ，系统性梳理，对接生态内企业的云需求规划。本季度，小米及金山收入贡献达17%，环比提升2.2个百分点，同比提升3.6个百分点。...

其中在小米业务驱动下，对所使用的专区集群大幅扩容，成为我们最大的客户。而金山办公在其AI业务驱动下，九月收入环比增长近50%。其次，我们大力发展AI业务。当前AI业务需求旺盛，已签约及洽谈商机的客户达数十家。本季度AI相关资本开支超过CNY 400 million，超过前三个季度的总和，并且已经连续两个季度上升。在我们的坚定投入和高效执行下，我们的AI业务收入环比二季度猛增超过70%，毛利率健康。第三，我们继续推进CDN业务的战略调整。本季度CDN收入环比下降近20%，占总收入比例降至约30%，而最大的CDN客户占比由上季度的16.2%显著降至本季度的12%。

Speaker 9

In terms of public cloud services, revenues were RMB 1.02 billion, with a gross margin of 4.7%, significantly higher than the -1.6% compared with the same quarter last year.

We continued to focus on three priorities for public cloud services, namely the Xiaomi and Kingsoft ecosystem, AI business, and CDN strategic adjustments. First of all, we continued to serve Xiaomi and Kingsoft ecosystem well, and coordinate enterprises within the ecosystem to systematically sort out their cloud planning and fulfill their cloud demand. This quarter, Xiaomi and Kingsoft contributed 17% to our revenue, an increase of 2.2 percentage points quarter-on-quarter and 3.6 percentage points year-on-year. Among them, driven by Xiaomi business, the capacity of its dedicated cluster has expanded significantly and Xiaomi has become our largest customer. Kingsoft Office's revenue in September increased by nearly 60% compared to January, driven by its AI business. Secondly, we proactively developed our AI business. Currently, there is a strong demand for AI business, with tens of customers who have signed contracts with us or in the process of business discussions. AI related capital expenditures in this quarter exceeded CNY 400 million, exceeding the total of the previous three quarters, and have increased for two consecutive quarters. With our continued investment and efficient execution, our AI business revenue surged by over 70% compared to last quarter, with a healthy gross profit margin. Thirdly, we continued to push forward our strategic adjustments in CDN business. This quarter, CDN revenue decreased by nearly 20% compared to last quarter, and CDN revenue as a percent proportion of total revenue has decreased to about 30%. The revenue share of our largest CDN customer has significantly decreased from 16.2% in the previous quarter to 12% in this quarter.

Tao Zou (Vice Chairman, Executive Director, and Acting CEO)

[Foreign language]运营方面，本季度实现收入CNY 6.1亿元，毛利率保持24%以上的健康水平。公共服务领域，我们选择聚焦政务云、国资云、教育云等核心领域，进一步完善了从上云、用云到管云的全链路管理模式，形成以大数据、大模型和今天协作为核心的产品矩阵。例如，我们已经连续9年服务北京政务云，安全、可靠、易用性获得高度认可，本季度续签合同24个，形成良性循环。数字健康领域，我们继续推进5大模式，取得新的突破。本季度，我们作为唯一一家云厂商参与修订国家级健康标准，标志着区域健康云为代表的模式、方法、技术能力和实现成果形成明确先发优势。我们联合金山办公，承接了国家卫健委电子病历编辑器的项目，圆满完成任务。我们 在持续交付瑞金医院项目的同时，还成功签约珠海高新区人民医院信息化建设项目，在院端取得新的进展。金融领域，我们继续深化以大型国有银行的业务合作，准期完成老项目验收以及新项目中标。我们还积极参与国有大型银行AI大模型的选型阶段工作。此外，开拓经营稳健，在维持已有大客户合作稳定的基础上，本季度新签约5家知名客户，利润率水平稳定回升。

Speaker 9

Moving on to enterprise cloud services. Total revenues were RMB 609 million, while gross margin has maintained at a healthy level of more than 24%. In public services space, we opted to focus on core areas such as public services, cloud, state-owned assets cloud, and education cloud, further improving the end-to-end model from cloud migration, cloud use to cloud management, forming a product matrix centered on big data, large models as well as WPS collaboration. For example, we have been the partner for the Beijing Public Services Cloud for nine consecutive years, winning a strong reputation to deliver secure, reliable, and easy-to-use systems and services, resulting in 24 contract renewals this quarter and forming a virtuous cycle. In digital health space, we continued to promote the five business models and make new breakthroughs.

This quarter, as the only cloud service provider, we participated in the revision of a national-level healthcare standard-setting project, gaining a first-mover advantage as demonstrated by our business model, technical capabilities, and our concrete achievements in the regional health cloud space. We have collaborated with Kingsoft Office to develop an electronic medical record editor for the National Health Commission and successfully completed the task. While continuously delivering the Ruijin Hospital project, we have also successfully signed a contract for the information construction project of the Zhuhai High-Tech Zone People's Hospital, making new progress in the hospital space. In the financial services space, we continued to deepen our business cooperation with large state-owned banks and complete the delivery of the existing projects as scheduled, while winning new projects. We also actively participated in the selection stage of AI models for large state-owned banks.

Turning to Camelot, during the quarter, Camelot business is stable, signing up five new customers while maintaining robust relationships with existing major clients. Its profitability has been rising again steadily.

Tao Zou (Vice Chairman, Executive Director, and Acting CEO)

[Foreign language]产品技术方面，我们继续秉持技术立业，聚焦于打造核心产品的一流客户体验。计算领域，我们持续升级核心产品，着力提升稳定性和国产环境兼容性。我们还以重点领军客户，确定八大项目 ...

啊，八大产品技术共建项目，与客户需求规划精准匹配，深入协同发展。存储领域，我们发布了对象存储新版本，大幅优化小IO场景下的读取性能，整体性能提升幅度超过50%，逼近理论极限。大数据领域，我们的云原生大数据平台对Hadoop的兼容性大幅提升，有效实现Hadoop作业平滑迁移。行业云领域，我们围绕上云、用云、管云的全链路定位，在易用性、开放性、效率层面持续优化用户体验，构建领导驾驶舱，统一呈现数...

运营数据，并再次升级一云多芯适配能力，提供更丰富的国产环境支持能力。我们的银河云平台在国家权威级的云基准评测中获得最高等级引领级认证，标志着金山云的专属云服务和保障能力达到中国顶尖水平。

Speaker 9

In terms of product and technology, we uphold our principle of building success based on technology and innovation by delivering best-in-class customer experience across our core product offerings. In computing space, we continue to upgrade our core products, focusing on improving stability and domestic environment compatibility. We have also identified eight major product and technology co-construction projects with key leading customers, so as to accurately match customer demands, planning, and deepen collaborative development. In storage space, we have released a new version of object storage, significantly optimizing read performance under small IO scenarios, with an overall performance improvement of over 50%, approaching the theoretical limit. In big data space, our cloud-native big data platform has significantly improved its compatibility with Hadoop, effectively achieving smooth migration of Hadoop tasks.

In enterprise cloud space, we focus on the end-to-end positioning of cloud migration, cloud use, and cloud management, continuously optimizing the user experience in terms of ease of use, openness, and efficiency, building a unified presentation of operational data in the management cockpit, and once again, upgrading the OneCloud multi-CPU compatibility to provide more domestic environment support capabilities. Our Galaxy Stack platform has obtained leadership grade designation, the highest level of certification in the national authoritative cloud benchmark evaluation, testifying that our dedicated cloud service capabilities are top-notch in China.

Tao Zou (Vice Chairman, Executive Director, and Acting CEO)

迎接新AI时代，我们从各个维度全面拥抱AI。客户方面，我们全面对接小米，金山办公用云规划，同时发挥中立性优势，积极满足一大批独立AI公司的训练推理需求。业务模式方面，在通用型AI算力服务起飞的同时，前瞻性布局专业的垂类全栈数字化转型服务，做精选垂直行业的AI赋能专家。产研方面，在人才、产品和解决方案三个方向发力，建立AI研发中心，从应用算法平台三大能力板块支撑AI研发。同时面向AIGC，升级核心存储、数据库、网络等产品，完善MaaS模型解决方案。供应链方面，面向国际市场的不确定性，积极开拓国内供应链渠道。

Speaker 9

We embrace the new AI era in a comprehensive approach. In terms of customers, we aim to fully align with AI cloud planning from Xiaomi and Kingsoft ecosystem... In the meantime, leveraging our neutral position to proactively meet the model training and inference demand from a large number of independent AI companies. In terms of business model, while the general AI computing service business is taking off, we preemptively explore one-stop AI cloud transformation services, aiming to become the AI enabler in select verticals. In terms of R&D, we make efforts in three directions: talent, products, and solutions. Establishing our AI R&D center to support the research from three major capability areas, including application, algorithm, and platform. We also upgraded our core storage, database, network, and other products with AIGC-facing features, and continued to perfect our MaaS mutual trust designated zone solution.

In terms of supply chain, facing the uncertainty of the international market, we actively explore domestic supply chain alternative channels. Moving on to talent strategy. Firstly, it's about building our Beijing, Wuhan dual R&D center. In less than a year since its founding last October, through voluntary relocation of key R&D staff from Beijing and Wuhan local recruitment, our Wuhan team has quickly grown to over 500 people, accounting for approximately 50% of our total R&D personnel. Secondly, we are promoting the implementation of the high potential talent program, which aims to identify and nurture the future backbone of our company. Thirdly, despite the uncertainties in macroeconomy, we continued to increase campus recruitment efforts to forge a talent base as foundation for the company's long-term development.

In summary, the continuous and steady improvement in our profitability over the past consecutive quarters has strengthened our belief in the strategies and the directions we have chosen. With both opportunities and challenges ahead of us, we will continue to uphold the strategy of high quality and sustainable development, leverage on technology, reputation, and operational management to drive progress, maintain our risk awareness, optimize business structure, embrace AI opportunities, and continue to improve profitability, thereby creating value for our customers, shareholders, employees, and the society. I will now pass the call over to our CFO, Henry, to go over our financials for the third quarter of 2023. Thank you.

Henry He (Board Member and CFO)

Thank you, Mr. Zou, and welcome everyone for joining the call. Now, I will walk you through the financial results for the third quarter of 2023. Under the strategy of high quality and sustainable development, we are pleased to deliver another quarter of steady profitability improvement. Our adjusted gross profits continued to grow for the fifth consecutive quarter and achieved R&D 196.3 million, increased by 57.5% year over year, representing adjusted gross margin of 12.1%, which is a record high for the company. Our normalized adjusted EBITDA narrowed from R&D -202.0 million in the same period of last year, and R&D -59.9 million in the last quarter, to R&D -44.1 million this quarter.

As a result, normalized adjusted EBITDA margin further narrowed from -10.3% in the same period last year, and -3.3% in the last quarter, to -2.7% this quarter, making another solid step towards EBITDA breakeven. Our total revenue were R&D 1,625.2 million this quarter, of which revenue from public cloud services wereR&D1,016.6 million, representing a decrease of 9.5% compared with R&D 1,113.0 million in the last quarter. This is primarily due to the strategic scaling down of our CDM business by approximately 20% quarter-over-quarter, and are partially offset by non-CDM public cloud services.

Revenues from enterprise cloud services were CNY 608.5 million, representing a slight decrease of 2.2% from CNY 622.0 million in the same period of last year.... as we continued to be stringent on our project selection. We continue to enhance our cost control measures. Total cost of revenue decreased by 22.6% year-over-year to CNY 1,429.0 million. IDC costs decreased significantly by 13.6% year-over-year from CNY 1,078.3 million to CNY 737.7 million this quarter. Depreciation and amortization costs decreased by 21% from CNY 253.7 million in the same period of last year to CNY 200.4 million.

Solution development and services cost decreased by 4% year-over-year from CNY 443.1 million to CNY 425.3 million this quarter. Fulfillment costs and other costs were CNY 25.7 million and CNY 39.9 million this quarter, respectively. Adjusted gross profit of this quarter increased by 57.5% to CNY 196.3 million, representing adjusted gross margin of 12.1% this quarter, compared with 6.3% in the same period of last year, making another record high as well as a fifth consecutive quarter of steady margin improvement. Each of our business line achieved margin improvement on a year-over-year basis.

Gross profit of public cloud services were CNY 48.1 million, which was significantly improved from the gross loss of CNY 22.1 million in the same period of last year. Gross margin of the public cloud services were 4.7%, compared with -1.3%-1.6% in the same period of last year. The improvement was mainly due to our success in AI business, proactive scaling down of the CDM services, and adjustments of our client structure. Gross profit of enterprise cloud services were CNY 147.3 million, compared with CNY 143.8 million in the same period of last year.

Gross margin of enterprise cloud services was 24.2%, representing a slight increase from already healthy margin level of 23.1% in the same period of last year, as we continue to carry out stringent project selection. In terms of expenses, excluding share-based compensation and impairment of long-lived assets, our total adjusted operating expenses were CNY 504.5 million, decreased by 6.2% from CNY 538.1 million last quarter, of which our adjusted R&D expenses were CNY 187.2 million, increased by 2.7% from last quarter, as we continue to focus on technology prowess and welcome new graduates campus recruiting employees.

Adjusted selling and marketing expenses were CNY 114.1 million, representing a decrease of 11% from CNY 128.3 million last quarter. Adjusted G&A expenses also decreased by 10.7% from CNY 227.5 million last quarter to CNY 203.1 million. As of June 30, 2023, our cash and cash equivalents and short-term investments amounted to CNY 2.6 billion, providing us sufficient liquidity for operations. The capital expenditures for this quarter was 415.3 million RMB, as we invested in our infrastructure to build a sustainable AI business. Our operating cash flow once again recorded a net inflow, recording CNY 20.4 million. It resulted from our margin improvements, as well as our enhanced internal cash management.

Looking ahead, we will continue to pursue our high-quality and sustainable development strategy and unlock synergies within the Xiaomi and the Kingsoft Group ecosystems, while staying agile to capture new opportunities in the new era of AI. Thank you.

Wayne Wang (IR Manager)

This concludes our prepared remarks. Thank you for your attention. We're now happy to take your questions. Please ask your questions in both Mandarin and English, if possible. Operator, please go ahead.

Operator (participant)

Thank you. As a reminder, to ask a question, you will need to press star one and one on your telephone and wait for your name to be announced. To withdraw your question, please press star one and one again. We will take our first question. Your first question comes from the line of Xiaodan Zhang from CICC. Please go ahead. Your line is open.

Xiaodan Zhang (Equity Research Analyst)

Hey, Zhang, good afternoon. Thank you for taking my question.

Speaker 9

So my first question is regarding our AI strategy. So Kingsoft Cloud has become the first choice for some of the industry-leading independent large language model providers when they select AI vendors.

So what is the growth trajectory for these type of clients in the recent quarters, and how will the recent supply constraints impact our AI strategy? And secondly, could management share your most recent guidance on the timing of adjusted EBITDA margin breakeven? Thank you.

Tao Liu (SVP)

[Foreign language]好，第一个问题呢，那个先由刘涛这个回答一下，然后我，我来做一个补充。啊，第二个问题由Harry来回答，好吧，那刘涛。

好，我先说一下，就是我们目前签署的这些，这个头部的AI玩家呢，就是中国除了BBAT以外的所有的大型玩家，这些玩家的资金实力和他们的融资规模，我想在资本市场大家也可以看得到。那么这些玩家跟我们签的这个，用量需求实际上都是非常大规模的，啊。就是，起步原则上应该是128到256节点的第一期，然后呢未来会扩容到512节点以上。啊，然后他们因为训练的最终目标是在大模型方面去跟海外的这个OpenAI相关的去对标，所以呢，模型规模都是千亿以上，那么对应的需要的训练资源的量级也是这种512节点以上。好，我就说这么多。

好，剩下的就是说这个受这种外部环境的不确定影响啊，对我们这个业务，业务可能会产生哪些，实质性的影响，以及我们怎么应对啊。确实啊，大家也都看到了，这个十月份以来啊，这个美国对于这个芯片的禁令呢，是，应该来说，对整个，中国的整个的这个AI行业的发展都有比较大的影响，对我们也不例外啊。但是庆幸的是呢，说实话，就是从年初我们就对整个的这个，这个AI，AI的这种，这种限制的有，一定的预判性吧。所以呢，我们认为，这个，这个，这个，这一波禁令这个发布以来，其实这个，这个由于我们之前的一些储备吧，我，我们目前来看呢，就是有一定的影响，但是呢，短期之内这个影响我们还是认为相对可控。但是从中长期看，这还得看进一步这个，这个未来，这个，围绕这个高端芯片的这个，这个限制，这个，这个，这个持续性如何啊。但从长期来看呢，这个，这个影响会，会更，更深远一点。所以呢，我在上个Q呢也回答过这个问题啊，就是我们也考虑，充分考虑了这一点，所以呢，我们也在积极地寻找这个，国产替代的这，这条路径。而且呢，经过一个Q的努力吧，我们认为在这条路上呢，我们也取得一些实质性的进展。所以呢，综合来看呢，我觉得短的这个在，在，在未来这个一，一，一两个Q之内，其实对金山云本身的影影响呢，我反倒认为还可控。对，接下来从长远看，其实，就就要看这个国产替代这条路，这个，这个，这，这条路是能走通的，其实是要看它本身的，产能，和性能，这俩块来做一个综合评估。但是从长远看呢，我们认为还是蛮有信心的，尤其是中国今年，总体来讲呢，在一些芯片领域取得的一些进展。对，所以呢，就是说，我，我在刚才电话会议也谈到啊，机遇和挑战并存。对，一方面呢，这个市场供，这个需求极其旺盛，我们凭借着我们这种中立人的地位呢，获取了大量的客户。另外一方面，确实这个阶段性的也，也会受这个供货的影响。但是呢，我们之前前瞻性的一些决策吧，使得我们在目前这个，这个市场环境下反而有一定的局部优势，好不好？

Speaker 9

So the first part of the answer was provided by Mr. Liu Tao. So to answer your question, the customers that we have signed and are engaging in business with are the leading players in the AI market, apart from BBAT, and they have relatively strong capital strength and business scale. Roughly, their starting point of the business cooperation usually starts from 128-256 server units, and likely to expand to 512 server units, group of servers. And because their final goal is to move to the large language models, and their parameters usually amounting to hundreds of billions, so the required resources of computing power are also at the level that is above 512 server units and above. So for the uncertainties that you asked about the external environment, people have seen as well as you have noticed as well, that since October, the export control from the United States has created quite an impact to the industry, including that industry in China, and we are no exception. However, fortunately, we have actually foresaw this coming and have made some preemptive actions. So due to our preemptive planning, we have actually got only limited impact from that export control. However, how do we see this from the medium to long term? I think it depends on a couple of factors, including the performance of made-in-China's GPUs, as well as the production capacity.

So I think all in all, in the short term, in the future, for example, in one or two quarters, the impact to Kingsoft Cloud should be limited. I think it's relatively under control. In the longer term, we're also actually relatively confident, because we have seen some of the positive progress the Chinese chip industry has made during the past year. So as I mentioned in the prepared remarks, we are seeing both opportunities and challenges ahead in the future. Because we have obtained a larger number of independent AI customers, we are relatively comfortable with the potential impact.

Henry He (Board Member and CFO)

Okay. Thank you. I will take on the second question. So there are actually the two different drivers. First of all, as some of you may remember, we actually hit quite dramatically back then, in back of, late part of 2021, right? Given, the slowdown of the internet, consumer business, as well as the certain impact on the enterprise cloud sector, in the later part of 2021. So at that time, our gross margin was only 1.2%. As you all noticed that today, that increased from 1.2%-2% on the gross margin side. So that actually is the fundamental, results of our collective efforts around improving the efficiency of the resources we have, improving the client selections and the client quality.

So all putting that aside, that give us about 10 times up of the gross margin percentage. So I think, on top of that, as you probably also noticed, that the spread between the gross margin and the EBITDA margin, I think, the largest spread, probably about last year, were around about 19%-20%. But this quarter, as you may see, the spread has been also narrowed from about 20%-14%, which means, on expenses control side, we also reduced significantly in terms of how we spend on research, how we spend on the travels, how we spend on the, the general management purposes. So putting everything together, the two fundamental driver from the business, as well as how we improve the operational efficiency, has given us leading to today's improvements on the EBITDA margin improvement.

For the true question, I think given all the initiatives and the strategy we already put into place, those impact and the results will gradually be released quarter by quarter. It's not going to be a one-time off thing for this quarter. It's going to be carried out for the next few quarters steadily. In our attention, we are hoping to improve both gross margin, as well as narrowing the spread between the gross margin and EBITDA margin in next few quarters, while, as you may understand, the management team will not be given a guidance for the formal EBITDA margin breakeven at this moment. As you can see, the trend has been steady for the past four quarters, and we hopefully can keep the trajectory and the pacing of improving the margin.

Hopefully, we can report a breakeven, not only on the EBITDA margin, but also on other items, in the near future as well. So, so just give us a bit of time, and then we can, we can probably deliver those results, to expectation. Thank you.

Operator (participant)

Thank you. We will take our next question. Your next question comes from the line of Timothy Zhao from Goldman Sachs. Please go ahead. Your line is open.

Timothy Zhao (Equity Research Analyst)

Thank you, management, for taking my question. I have two questions, both regarding the public health sector. First one is regarding the AI business. Could management share more color on the AI business in terms of its revenue contribution, as well as the profitability level in either gross profit margin or EBITDA margin? And as you mentioned in the third quarter, you spent around CNY 1 billion CapEx in the AI business. Just wondering if management has any guidance into your CapEx into fourth quarter and next year in including the AI business? And second question is regarding the CDN business, as we understand that there's a the overall competitive environment in China, in the cloud segment is quite dynamic.

Just wondering, for the CDN, are we going to see more adjustments in the next few quarters? And after adjustment, what is management view on the midterm normalized gross profit margin level of the public cloud business? Thank you.

Henry He (Board Member and CFO)

Thank you, Tim. It's Henry here. I'll probably take on the first question, and then I'll translate myself briefly, and so they can comment as well. So regarding the AI business contribution, the first point is on the CapEx. So last quarter we spent, in my script, I mentioned is about CNY 415 million, so 400 level, on the third quarter. But go back to your first point regarding the contribution and the revenue margin. A few things to share. First of all, you know, as you know, following very fundamental and the basic economic principle, right? It's really driven by two things. One is the supply-demand balance, and the second is about the technology we offer and the products we offer, right?

So, as we all know, that today really is about the buyers, it's a seller's market, right? So if you do have a very robust infrastructure and resources, and it can provide a very robust service and product to the clients, clients definitely willing to pay. And for the client, it's also giving them a cutting-edge advantage when they try to compete and training their model to a certain level, they can compete in a world-class stage. So that actually convert to a very good logic for us to have a better margin compared with other kind of resources-driven IaaS services historically. So we also observe the second phenomenon is the client also willing to pay for value-added part of the services, not only by charging them on a fundamental resource usage basis.

So by giving them the best practice and giving them a value-added service and products, we can share certain value with the client, and that can embed it into part of the pricing we give to the client. So those are the two fundamental reasons that we believe the higher margin from AI business will carry out for the future as well. That's the second point. And the third point is really about contribution, right? So the reason we didn't give a percentage for this quarter is, you know, every day count for this quarter. So given we have a strong client demands, and given we're also providing enough sufficient resources for our clients, and each quarter, we do see a very good growth trajectory at this moment.

But when you look at, because the third quarter means from 1st of July until the 30th of September, and right now we're already end of November. So today's situation is very different with the 1st of July. And we do believe, if we look at the tail impact of the third quarter, the growth trajectory and the incremental revenue, even on a weekly basis, is a very significant contribution to Tencent Cloud total revenue. But if you combine as a total quarter for the third quarter alone, I think this number will be, you know, really, misleading to a certain way that definitely does not account for the full credit of the AI business for us. So that's my second point. And third point, regarding the CapEx direction and the guidance.

So, as we probably talked last quarter as well, we do believe this part of the CapEx is a very good growth driver for us. So the more we spend, the more incremental revenue will come, for sure, and the more and the better growth margin will come to follow as well. So even you'll see, we spent about CNY 400 million this quarter for CapEx. We're seeing the trend for next quarter, and maybe the early part of next year, this number will continue to increase. And mathematically, you will have a direct linkage for those spending convert to a new revenue for next year. I think you can do the math, by the way, I'm not going to give you the answer, but you can see that trend is very visible as well.

So I think these are the three parts. I just want to give you color. Given the importance of this question, I'll translate myself as well.

...

Tao Zou (Vice Chairman, Executive Director, and Acting CEO)

[Foreing language]然后第三呢，是你讲到就是这个季度AI的收入贡献。因为刚才我其实提过，今天是12月，11月21号，那我们第三季度是从7月1号到9月30，其实11月21的时间跟7月1日的时间是天差地别的，已经发生了重大外部环境的变化。所以我刚才提到，其实我们这个季度其实披露一个占比，反而不一定能说明我们现在这块业务做得非常好的一个趋势。所以我们现在是用天在计量，就是每周每天我们这个进展和贡献的比例都 在有一些明显的增加。但是如果仅看第三季度，就是从7月1号到9月30号，跟今天的我们的需求情况已经完全不一样了。所以我们相信在第四季度大家能够看到一些更好的一个趋势，所以我们内部是按周和天来衡量刚才你讲的三个问题。我就大概翻译一下中文的情况，也听一下，看看周总。

第二个问题我先说一下啊，等下那个还有包括老炮可以补充。就关于CDN的调整啊，就是，实际上我们内部基本上按照现在的计划来看呢，定的一个时间，时间点是明年的630，对吧？就总体来讲呢，就是，从今年的831开始，制定了一个总体的调整计划。从结果来看呢，就是我们今年还会根据市场的这个情况还会做一定的调整。我们单独披露了CDN收入嘛，是吧？对，其实，我们从现在应该每个季度还有5亿左右嘛。对，我们还会调整到大概是这个3-4亿的这样一个区间。对，就。反正总体来讲呢，就是到明年630呢，我就认为基本上达到一个我们认为比较稳定的一个阶段，好不好？这是一个调整阶段。然后问到刚才长期看公有云的毛利，毛利率的问题啊，我觉得把它——其实刚才应该分两块吧，一个是CDN这块，CDN这块呢，本身我们从明年全年的这个调整计划来看呢，也是争取，从明年Q3开始，Q4到逐渐逐渐的从这个毛利水平，甚至净利水平能够达到去年的这个Q4的那么一个状态。然后这个泛互这边呢，也包括刚才谈的这个AI这个部分，从目前我们这个预测来看啊，这个还是在稳步提升的。当然这里头有一个非常不确定的因素啊，就刚才谈到AI，其实就是还是说这个GPU这个供应，这个还是这个受很大影响。说实话，就是这几个季度我们都在，包括上个季度开始我们都在谈嘛，其实这是供求，需求很大，供给，我们现在最大的矛盾，有些矛盾还是在供应上，就如果供应能够这个跟这个需求匹配的话，其实这个整个的这个公有云的毛利水平的提升会更显著和更快，好不好？所以呢，这个，但是就是就算受这个的影响吧，我们目前，预测看到的总体的来讲也是稳步向好的，好不好？这是第二个问题。

Speaker 9

Okay, so let me quickly translate. So in relation to your second question about the CDN strategic adjustment, we have actually started the adjustment in October 31st this year, and we have an internal deadline of June 30th, 2024. As I can see this, we are continuing to do some adjustment according to the market conditions. Currently, we get in the CDN revenue on a quarterly basis around CNY 500 million, and it might continue to scale down to somewhere between CNY 300 million-CNY 400 million per quarter, and thereby reaching a relatively stable status, till after June 30th later next year. And in relation to your question about the profit margins for the public cloud services business, it's of two components.

One is CDN and one is the so-called PAN Internet sector. For the CDN sector, as mentioned, up to the third quarter next year, we expect the strategic adjustments to have completed, and by then we would hope the margin of this business line to revert to the relatively healthy level that was as of the fourth quarter of 2022. Now, for the PAN Internet space, we are still seeing the margin, including both the GP margin and as well as the operating profit margin, steadily and gradually improving. As mentioned, one of the uncertainties is the GPU supply, and obviously in the AI space, the demand significantly outpaces the supply. And if that supply chain issue can be resolved completely, obviously the improvement of our business as well as margin in the AI and thereby the PAN Internet space will be much faster. But even with that uncertainty, we are already seeing relatively good progress in terms of margin improvement and business scale expansion.

Thank you。

Timothy Zhao (Equity Research Analyst)

Thank you, that's very helpful.

Operator (participant)

Thank you. We will take our final question. Please stand by. Your final question comes from the line of Katrina Chu from Citi. Please go ahead, your line is open.

Katrina Chu (Equity Research Analyst)

Good evening. Thanks management for taking my question. This is Katrina Chu asking on behalf of Brian Wong from Citi. Can management share with us the overall revenue outlook in 2024, and whether we can expect positive revenue growth next year? Thank you.

Henry He (Board Member and CFO)

Yeah, Catherine. Thank you, Katrina. So, you know, after our relisting in Hong Kong, we actually didn't publish our kind of management guidance, but happy to share some color as well as we moving towards the year end of 2023. First of all, as you know, even today, right now, we have about 25%, 20-25% by different quarter, the revenue is coming from the CDN business, our CEO just mentioned as well. So we're kind of in the phase of, you know, some adjustment from climate, from the products we offer and as well as we control the cost, we procure the bandwidth as well.

But if you look at that business, the first priority is we try to change the mix and the structure of the client and products, right? So we try to remain relatively stable, but we just the combination of the clients and the products within the business. So that's actually what we're trying to do next, towards three quarters, right? So that's kind of first factor you probably can consider. But we're not gonna see the dramatic changes or swings from that business, but change the better structure of that. So that's first part. The second part is, as I mentioned, the new money and the capital expenditure we're spending to the AI, right?

The infrastructure we build for clients and the MaaS, we call it Model as a Service, the solutions and the services we deliver to clients, as well as the value-add part of the projects we do for the clients. So those are actually combined, will be one of the, probably the one, priority for next year to grow the revenue. And if you do a quick math, I put this way, as every, you know, $3 or $2 we spend this year, you're gonna see probably $1 or relatively around that $1 of the incremental revenue you're gonna see for the next year. So there's a kind of mathematical connection, given the CapEx converts to products, and products converts to the incremental revenue. So that's the second part.

So you can do a bit of kind of analysis on that. The third part is really about our very stable enterprise business. As you can see that, our sub Camelot is delivering relatively stable revenue. Then for next year, I think given the macro environment has been kind of improving, so you are gonna also to see that revenue contribution from Camelot is going to be a relatively growth as well. Our healthcare, public sectors and financial services, enterprise cloud will also see certain growth, given we already have some flagship products in place for this year, and we can replicate that from city A to city B, from client A to client B going forward for next year.

So we're hoping we can remain around 30% in terms of the GP contribution on the project level, but we replicate that to more projects for next year. So if you combine those three things, stable CDN, but better mix, the spending on CapEx convert to incremental AI revenue for the public cloud, YOY growth for Camelot, as well as the stable revenue and profits, but a growing revenue for enterprise cloud, for financial services, so on and so forth. Putting together, you know, we are, we are kind of confident to see without any kind of big changes on the big environment, our top line revenue for next year, you may see, kind of back to the YOY growth and the QOQ growth as well.

Tim mentioned in the previous question as well, we're hoping to getting to a certain point that not only the EBITDA will be breakeven next, you know, next near future, but also we're going to see the OP side is going to put in our back pocket to have an intention to bring a better profitability for the shareholders as well. But the last point I want to mention is, we also will keep a very close eye on the competitive landscape. Means our peers and the competitors. We're trying to do a better quality of the work compared with other peers, but also we're happy to see we may, in the next quarter or two, we've been catching up on the growth margin side, in the next few quarters.

But also in the while, while on the growth side, we can maybe catching on even better than the competitors as well, because we did a few things, since last year, when CEO Zou has come to the office and, we actually have a few things in place. And those efforts are, I think, 2 or 3 quarters earlier than the major competitors. You will probably see the recovery we are doing probably sooner than others as well. Thank you.

Katrina Chu (Equity Research Analyst)

Thank you. That's very helpful.

Operator (participant)

Thank you. I would now like to turn the conference back for closing remarks.

Wayne Wong (Investor Relations Manager)

Thank you, operator. Thank you once again for joining us today. If you have any further questions, please feel free to contact us. Looking forward to speaking with you again next quarter. Have a nice day.