Kingsoft Cloud - Q3 2024

Transcript

Operator (participant)

Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Nicole Shan. Please go ahead.

Nicole Shan (Head of Investor Relations)

Thank you, Heidi. Hello, everyone, and thank you for joining us today. Kingsoft Cloud's third quarter 2024 earnings release was distributed earlier today and is available on our IR website at ir.ksyun.com, as well as our global newswire services. On the call today from Kingsoft Cloud, we have our Vice Chairman and CEO, Mr. Zou Tao, 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 the guidance. They will be available to answer your questions during the Q&A session that follows. There will be simultaneous interpretation. Our interpretations are for your convenience and reference purposes only. In case of any discrepancies, management statements in the 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 events that involve known or unknown risks, uncertainties, and other factors, some of which are difficult to predict, and many of which are beyond the company's control, which may cause the company's actual results, performance, or achievements to differ materially from those in the forward-looking statements. Further information regarding these and other risks, uncertainties, or factors is 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 figures mentioned during this conference call are denominated in RMB. It's now my pleasure to introduce our Vice Chairman and the CEO, Mr. Zou. Please go ahead. Thank you.

Tao Zou (Vice Chairman and CEO)

[Foreign language]

Hello everyone, thank you and welcome all for joining Kingsoft Cloud's third quarter 2024 earnings call. I am Zou Tao, CEO of Kingsoft Cloud. This quarter, we continue to see strong results from our unwavering commitment to the high-quality and sustainable development strategy. First of all, revenue is on an accelerated growth trajectory. Following solid year-over-year and month-over-month growth in Q2, we have seen our year-over-year growth rate rise to 16% this quarter, outpacing the industry average. This momentum stems from the strategic adjustments we made in 2022 to diversify our revenue structure, leveraging our first-mover advantage. Both our public cloud and enterprise cloud businesses achieved double-digit year-over-year growth, driven by a dual-engine strategy, resulting in a stronger foundation for continued development. Second, our profitability is improving at an even faster pace.

After turning EBITDA positive for the first time in Q1 and reaching a margin of 3.2% in Q2, this quarter, it has accelerated to a double-digit margin of 10%. Meanwhile, our adjusted operating loss margin has significantly narrowed from 16.2% in the same quarter last year to 7% this quarter, further solidifying our path towards high-quality development. Third, we continue to lead the transformation with AI. The proportion of AI revenue as a percentage of our public cloud business has continued to grow to 31% this quarter. Over the past five consecutive quarters, AI revenue has consistently shown triple-digit year-over-year growth, and this quarter, we saw a remarkable 6.9-fold increase compared to last year, outpacing the industry's growth. Our strong profit margins and customer distribution demonstrate the sustainability of this growth.

Meanwhile, we are also exploring new AI business models, having entered into a deep collaboration with ShineWing, China's leading comprehensive professional services firm. Together, leveraging our full-stack AI expertise, we're building a one-stop platform that integrates large model training, inference, application development, and long-term operational capabilities. Fourth, we are fully capitalizing on the unique historical opportunity within the Xiaomi and Kingsoft ecosystem. From EV, AIoT, gaming, large language models, to WPS AI, this quarter, our revenues from the ecosystem have increased by 36% year-over-year. We have witnessed fast growth across all of Xiaomi's business lines, among which, notably, its automotive business has garnered strong market recognition. As the sole strategic cloud platform within the Xiaomi and Kingsoft ecosystem, we're fully committed to supporting Xiaomi's autonomous driving, on-device, and cloud-based models, among other areas, to meet their expanding cloud service needs.

Thanks to our industry-leading and rapid growth of AI revenue and the practical AI use cases within the Xiaomi and Kingsoft ecosystem, we're able to seize the opportunities arising from the market structural changes. Amid a decline in market share for other internet cloud service providers, our market share has steadily increased.

million。[Foreign language]，EBITDA[Foreign language]9.8%。[Foreign language]EBITDA[Foreign language]13[Foreign language] CNY 230 million [Foreign language]

Now, let me walk you through the key business highlights for the third quarter 2024. This quarter, Kingsoft Cloud has made solid progress in revenue scale, profitability, and operating cash flow. Our revenues reached RMB 1.89 billion, marking a return to double-digit growth with a 16% year-over-year increase. The growth in revenue from our high-value-added products and services offers to offset the pressure from the proactive adjustments in our CDN business. Adjusted gross profit amounted to RMB 308 million, up 56.7% year-over-year. Adjusted gross margin increased to 16.3%, representing a year-over-year increase of 4.2 percentage points. Despite the slight quarter-over-quarter decrease, primarily driven by fluctuations in CDN business profitability. Adjusted EBITDA reached RMB 185 million, with an adjusted EBITDA margin of 9.8%, continuing to improve quickly following the positive turnaround in EBITDA in Q1, and showing a significant year-over-year increase of 13 percentage points.

Net operating cash inflow amounted to CNY 228 million, once again demonstrating our strong cash-generating ability from operating activities.

[Foreign language]

In terms of public cloud services, revenues reached CNY 1.18 billion this quarter, representing a year-on-year increase of 16%. As the sole strategic cloud platform within the Xiaomi and Kingsoft ecosystem, the cloud business opportunities within this ecosystem are fundamental to our growth. This quarter, total revenue contribution from Xiaomi and Kingsoft grew by 36% year-over-year. As Xiaomi's AI fully empowers its entire ecosystem, covering human, car, and home, coupled with the advancement of WPS AI, the growth potential of cloud service business driven by the AI era is unprecedented. We are actively capitalizing on the fast-growing opportunities in autonomous driving and AI within the ecosystem. Besides, our AI business continues to gain momentum. This quarter, AI revenue surged to CNY 362 million, increased by 11% quarter-over-quarter, and accounting for 31% of public cloud revenues, positioning us as an industry leader.

We have built a substantial computing power resource pool, leading the industry in large-scale supercomputing network capabilities, capable of supporting the networking topology of supercomputing clusters at the scale of 10,000 nodes. This computing resource pool enables us to simultaneously deliver the integration and commissioning of supercomputing clusters while offering the full range of public cloud products.

[Foreign language]

Moving on to enterprise cloud services, revenues amounted to RMB 710 million, representing a year-on-year increase of 16.7%. In public services space, we have actively pursued opportunities within public services cloud and state-owned enterprise cloud, focusing on two key use cases, namely government and enterprises. We are promoting standardized operations, leveraging a foundation built on large model capabilities, big data, and collaborative office tools. This quarter, we started large language models projects in Zhuhai High-Tech Zone, jointly training a large model dedicated to government office work in collaboration with our customer and Kingsoft Office tailored for Zhuhai. We also supported the Shenzhen National High-Tech Industrial Innovation Center in completing the construction of the Great Bay Area Data Elementization Platform, facilitating trustworthy data circulation.

According to the 2024 China Central and State-owned Enterprise Market Research Report released by a domestic authoritative institution, we have been recognized in the Leaders' Quadrant with our project quality and product capabilities on par with those of domestic leading peers. In financial services space, we reached an agreement with a well-known joint stock bank for real-time data service projects. This initiative will assist the bank in constructing a real-time publication and subscription model, optimizing real-time data collection and management, as well as creating a low-code development platform for real-time data to improve development efficiency and quality. We also established a real-time data application center to achieve rapid configuration and management of business applications. Besides, Camelot's business remains stable, with significant strides made in the construction of Xiaomi's exclusive service center in Wuhan, which has now exceeded 500 staff members.

[Foreign language]

In terms of product and technology, we uphold the principle of building success based on technology and innovation, focusing on delivering best-in-class customer experience across our core product offerings. In AI space, we launched a cloud-native fully managed platform designed for AIGC data cleaning use cases. This platform offers quick startup and shutdown capabilities, is easy to use, and provides elastic scalability to meet the dynamic demand of data cleaning tasks. Our AI Hanhai application platform is aimed at addressing the needs of AI application development in different use cases, helping to accelerate the creation of AI applications through low-code solutions. Additionally, in an industry report published by the domestic authoritative institution CCID, Kingsoft Cloud's Model as a Service is recognized in the Market Leaders' Quadrant.

[Foreign language]

In summary, after two years of steadfast implementation of the high-quality and sustainable development strategy, Kingsoft Cloud's fundamentals have entered a phase of healthy upward growth. Looking forward, we will continue to enhance our profitability and cash-generating capabilities, deepen cooperation with the Xiaomi 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, Henry, to go over our financials for the third quarter of 2024. Thank you.

Henry He (CFO)

[Foreign language] Thank you, Mr. Zou, and thank you all for joining the call today. I will now walk you through our financial results for the third quarter of 2024. I would like to highlight the three areas of progress regarding the performance of this quarter. First of all, in this quarter, the company achieved a double-digit year-over-year growth in total revenue, reaching 1,885.6 million RMB, which is two times of the high single-digit average growth rate of the industry. Restoring the high-speed growth of the revenue, there are three aspects we would like to highlight. First, thanks to the first-mover advantage of our revenue structure adjustments starting from 2022, it differentiated us from the situation of our competitors in the market. Both of our public cloud and industry cloud have already benefited from the development trend of AI business, achieving double-digit year-over-year growth, respectively.

This has laid out a solid foundation for the balanced growth of the future business. Second, in this quarter, our AI gross billing reached RMB 362 million, accounting for as high as 31% of the public cloud revenue. It has achieved a three-digit year-on-year growth for five consecutive quarters, far exceeding the industry average level. Third, we have repositioned the business strategy of the company regarding the strong performance of Xiaomi's new EV cars, as well as Kingsoft Games and WPS AI. The ecosystem business progress has exceeded market expectations. Thanks to the excessive demand of customers within the Xiaomi and Kingsoft ecosystem, the revenue growth of our ecosystem customers in a single quarter has exceeded 36% year-on-year, laying a good foundation for the growth of ecosystem customers in the future. The proportion of public cloud revenue contributed by the ecosystem clients in this quarter has already reached 28%.

Second, in terms of profit, the expansion of our gross profit and EBITDA profit far exceeds the industry average. Compare with adjusted gross profit margin of only 3.6% in the quarter before the company carried out business structure adjustments and AI transformation in Q2 of 2022. Today, we have reached a 4.5 times growth of the margin expansion to 16.3%. The adjusted EBITDA profit margin has been significantly improved from a loss of 8.6% in Q2 of 2022 to a profit of 9.8%, with an increase of 18.4 percentage points. The company revenue structure adjustments and AI strategic transformation have achieved remarkable results. Thirdly, due to the effective progress of high-quality business and a strong cash flow contribution brought about by the successful transformation of AI business in this quarter, we have achieved a net inflow of operating cash flow reaching CNY 228 million.

In terms of the outlook, we have achieved a turning point for our successful AI strategy and also Xiaomi Kingsoft ecosystem strategy. Going forward for the fourth quarter of 2024, we are happy to provide the following guidance for the performance of Q4. First of all, thanks to the parallel two drivers of both public cloud and enterprise cloud, we will continue to deliver healthy growth for Q4. We expect to achieve accelerated growth rate for the total revenues in Q4 2024, exceeding the average growth rate of the industry. Second, we expect our profitability will continue to improve. For the adjusted operating profit, we expect to deliver significant accelerated improvement in Q4. Third, for the AI business and the Xiaomi Kingsoft ecosystem strategy, we believe the revenue contribution will continue to grow. As a result, we will continue to take more market shares from competitors going forward.

Meanwhile, given the promising growth of AI and cloud demand from both Xiaomi and Kingsoft Group for the upcoming connected party transaction applications with our shareholders and the stock exchange in Hong Kong, we are applying for revenue to be generated from Xiaomi and Kingsoft Group for the next three years with a cap of CNY 11.3 billion, ten times over the historical revenue of CNY 1.1 billion in the financial year of 2023, providing solid support for company revenue and profit growth. Now, let's dive into the details of our financial results. Total revenue of this quarter was CNY 1,885.6 million, reflecting a 16% year-over-year increase, of which revenues from public cloud services were CNY 1,175.5 million, up 15.6% from CNY 1,016.6 million in the same quarter last year.

This growth was primarily driven by a significant increase in AI-related revenues, which reached CNY 362 million, partially offset by the scaling down of CDN services due to higher bandwidth costs and price adjustments with certain customers. Revenues from enterprise cloud reached CNY 710 million, up from CNY 608.5 million in the same quarter last year, primarily driven by increased demand in selected verticals and a growth in Camelot's IT solutions. We have continued to enhance our cost control by expanding our supply base and optimizing procurement cost, which has improved both service quality and pricing. Total cost of revenue was CNY 1,582.2 million, up 10.7% year-over-year, but remained stable quarter- over-quarter. IDC costs dropped significantly by 8.7% year-over-year from CNY 737.7 million to CNY 673.8 million this quarter, reflecting the strategic scaling down of our CDN services and the better rack utilization.

Depreciation and amortization costs increased from CNY 200.4 million in the same period of last year to CNY 297.5 million this quarter, mainly due to the depreciation of newly acquired GPU servers. Solution development and service costs rose by 70.3% year-over-year from CNY 425.3 million to CNY 499 million, driven by expansion in Camelot personnel to support revenue growth. Fulfillment costs and other costs were CNY 59.5 million and CNY 52.3 million this quarter, respectively. Our adjusted gross profit for the quarter was CNY 307.6 million, a 56.7% increase year-over-year, with an adjusted gross margin of 16.3%. On the expenses side, excluding share-based compensation and impairment of long-lived assets, our total adjusted operating expenses were CNY 491.2 million, a decrease of 2.6% year-over-year and 11.5% quarter-over-quarter, of which our adjusted R&D expenses were CNY 232.3 million, up 16.1% from last quarter due to higher personnel costs.

Adjusted selling and marketing expenses were CNY 110.6 million, down from CNY 117.5 million last quarter, representing 5.9% of total revenues. Adjusted G&A expenses were CNY 148.3 million, significantly lower than CNY 237.7 million last quarter, reflecting strong cost control and a reduction in credit losses. As of September 30, 2024, our cash and the cash equivalents totaled CNY 1,617.9 million, providing a strong liquidity position to support operations and AI investments. Our capital expenditure and assets obtained through the financial leasing reached CNY 1.22 billion, the majority of which are used to invest in servers to support AI business. Looking ahead, we remain committed to the principle of high quality and sustainable development. We expect ongoing revenue growth driven by deeper collaborations with Xiaomi and the Kingsoft ecosystems, further expansion of AI-related gross billings, and a continued reduction of low-margin CDN business.

We also expect to achieve another milestone in adjusted operating profit in the near future. Thank you.

Nicole Shan (Head of Investor Relations)

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

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, and the question comes from the line of Zhang Zhao from CICC. Please go ahead. Your line is open.

Zhang Zhao (Analyst covering Transportation)

Hey, [Foreign language], Henry, Tao, Nicole, [Foreign language]Thanks, Manager, for taking my questions, and I've got two questions here. First of all, the revenue contribution from Xiaomi and Kingsoft Group has been continuously increasing over the past quarters. Could you please share with us your views on the growth potentials of those strategic customers as well as your service strategy? And secondly, could you please share your outlook on adjusted EBITDA margin as well as operating margin taking into consideration the depreciation and amortization expenses and the rising AI-related CapEx? Thank you.

Tao Zou (Vice Chairman and CEO)

[Foreign language]

So I will just very quickly translate what Mr. Zou said. So yes, as you have seen, the business opportunities coming from the Xiaomi and Kingsoft ecosystem has been increasing very quickly and steadily. This is thanks to the unprecedented AI opportunities since last year, since the AI opportunities. And of course, the AI-related business opportunity itself with the Xiaomi and Kingsoft Corporation has been developing fairly fast. As you would have seen from the Xiaomi results released yesterday, which is set to be historically strongest results, the Xiaomi EV delivery has been very strong. So therefore, the cloud service utilization and use cases centered around the growth of Xiaomi has a solid foundation to grow.

And also, I have mentioned that on the WPS office side, where they have been centered around AI capabilities to promote new AI-related functions, as well as the solid growth in paid customers for AI functions. This all have been driving the cloud usage on the cloud side, which is our revenue. So the conclusion is the solid growth of the Xiaomi and Kingsoft ecosystem; their business laid solid foundation for the revenue growth and for the business opportunity of Kingsoft Cloud. And we believe that we are still in this very good business momentum to further grow. Thank you.

Henry He (CFO)

Thank you, Zou. Thank you, Zhang. I probably will comment on the second question regarding the margin expansion. So as I mentioned in my prepared remarks, I think the sequencing we are seeing is our continued expansion from the gross margin to the EBITDA margin, then drop to the operating profit. So back in 2022, at that time, our gross margin was as little as only around 3%. And this quarter, we are reaching to a certain level. We think it's getting even closer to the top tier player in the market in terms of the gross margin in the near term. And for the EBITDA margin, you can also notice that the EBITDA margin has converted from a loss of 8.6% in Q2 2022 to a positive around 10% this quarter.

I think the expansion, the speed of expansion of EBITDA margin will be faster than the gross margin expansion. In addition, I think our EBITDA margin, given the AI, has already contributed around one third of the total public revenue, which is also higher than the major peers on the street. I think given that reason, our EBITDA margin will continue to deliver a much higher expansion speed compared with the peers in the industry as well. In addition, as you speak about the operating margin, as you notice, our expense control and the cost cutting in terms of operations, as well as improving efficiency in operations, all contributed to the operating line as well. I think in the near term, we can deliver a positive surprise to the shareholders.

Yeah, you may see accelerated and a significant improvement of the operating profit in a very near term, and hopefully, we can keep that track after we made a break even in the near term. But at this moment, we're not providing formal guidance for the timing, but hopefully, we can keep the speed and expansion from the gross margin to EBITDA and then to the operating profit as a trend you may observe. Thank you.

Operator (participant)

Thank you. We will take our next question. And 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)

[Foreign language]Thank you, management, for taking my questions. I have two questions here. The first is regarding the margin profile of your AI business as well as the revenue from Xiaomi and Kingsoft Group. So just wondering how the margin compares to the overall margin profile of public cloud. And secondly, just wondering on your outlook for the CapEx for this year and next year, and how we plan to utilize the resources either on the balance sheet or off balance sheet to meet the funding resources demand, you know, to grow our business, and especially the AI business. Thank you.

Henry He (CFO)

Thank you, Tim. So happy to take on those two questions.

The first question, as you know, we are not disclosing the separate line of gross margin for each of the product line, given, as you know, sometimes each customer, they may use multiple different business segments. So it's a bit difficult to separate that. But I'm happy to provide some high-level guidance on that. Overall, the AI-related computing related products are delivering much higher gross margin compared with the traditional public cloud services, including the traditional storage and networking. And our entire public cloud gross margin is higher than enterprise cloud in most cases. But however, as Mr.

Zou also mentioned in his prepared remarks, the reason why this quarter we're delivering much stronger and robust top-line growth as well as the margin expansion is our both public cloud and enterprise cloud have achieved double-digit YoY growth, which is unlike other peers on the market, because we actually did our business strategy adjustments much earlier back in two years ago. So we do see both parallel growth driver has been very solid for this quarter. So coming back to your margin question, I think if we want to pack in order the different product lines, I think the current revenue contribution for the incremental revenue, especially the AI, deliver a double-digit gross margin and a double-digit EBITDA margin. And the traditional public cloud also deliver a decent gross margin as well.

But when you look at the EBITDA margin, I think the AI is also dealing with very good margin as well. Our traditional non-public cloud services, especially for the CDN, as you know, we have already planned out the scaling down as planned, which we actually execute very effectively. So for the margin contribution from CDN has been very effective and well on our budget. So we deliver very in line of the budget. So these are the first question I probably want to mention. The second part is given the CapEx, I think the one part I want to mention is we actually have already secured many of the additional CapEx resources, including the banks, financial leasing companies, as well as the state-owned enterprises, which actually can cooperate with us to invest together into the GPU and AI investment.

But more importantly, as I mentioned also in my prepared remarks, for the next three years, we are currently applying for the cap of the related party transaction from both Xiaomi and Kingsoft around CNY 11.3 billion for next three years, which is about 10 times over this year's number. So from that budget, we are going to look into more closer financial support from shareholders. And we are confident we will not dilute the public shareholders in terms of the additional share issuance or the potential transactions that may be diluted to the public shareholders. We'll keep that in mind. And the strong support from both business and CapEx from the major two shareholders will be very important for our company growth as well as the margin expansion and the robust financial position for the next few years.

We have our internal discussion for the annual budget meeting as well. I think we will talk about that in the later quarter. You may find that we will maintain a very robust way to managing both leverage as well as the investment speed to the AI investment. Thank you.

Operator (participant)

This concludes today's question and answer session. I will now hand back to Nicole Shan for closing remarks.

Nicole Shan (Head of Investor Relations)

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

Operator (participant)

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