Q1 2023 Kingsoft Cloud Holdings Ltd Earnings Call

Participants

Haijian He; CFO & Director; Kingsoft Cloud Holdings Limited

Nicole Shan; IR Officer; Kingsoft Cloud Holdings Limited

Tao Zou; Vice Chairman of the Board & Acting CEO; Kingsoft Cloud Holdings Limited

Brian Gong; Assistant VP & Equity Research Analyst; Citigroup Inc., Research Division

Xiaodan Zhang; Analyst; China International Capital Corporation Limited, Research Division

Presentation

Operator

Ladies and gentlemen, thank you for standing by, and welcome to Kingsoft Cloud's First Quarter 2023 Earnings Conference Call. (Operator Instructions)
I would now like to hand the conference over to the IR Manager, Nicole Shan. Please go ahead, Ma'am.

Nicole Shan

Thank you, operator. Hello, everyone, and thank you for joining us today. Kingsoft Cloud's first quarter 2023 earnings release was distributed earlier today and is available on our IR website at ir.ksyun.com as well as on global newswire services. On the call today from Kingsoft Cloud, we have our Vice Chairman and CEO, Mr. Zou Tao; and our CFO, Mr. He Haijian. Mr. Zou will review our business strategies, operations and the company highlights, followed by Mr. He, who will discuss the financials and guidance. We will be available to answer your questions during the Q&A session that follows. There will be consecutive interpretation. Our interpretations are for your [covenants] 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 mandated and as defined in the U.S. Private Security Litigation Reform Act of 1995. These forward-looking statements are based upon management's current expectations and current market and operating conditions and relates to (inaudible) known or unknown risks, uncertainties and other factors, all of which are difficult to predict and many of which are beyond the company's control, which may cause the company's actual results, performance or achievements to differ materially from those in the forward-looking statements. Further information regarding these and other risks, uncertainties or factors are included in the company's filings with the U.S. SEC. The company does not undertake any obligation to update any forward-looking statements as a result of new information, future events or otherwise, except as required under applicable law. Finally, please note that, unless otherwise stated, all financial figures mentioned during this conference call are denominated in RMB.
It is now my pleasure to introduce our Vice Chairman and CEO, Mr. Zou. Please go ahead. Thank you.

Tao Zou

[Interpreted] Hello, everyone, and thank you all for joining Kingsoft Cloud's first quarter 2023 earnings call. We continue to uphold the principle of high-quality and sustainable development, build success based on technology and innovation, forge our reputation throughout the entire business process with customer-centricity and enhance our business and operations management. During the quarter, our profitability further improved. Revenue reached RMB 1.86 billion, in line with our guidance. Adjusted gross margin increased to 10.4%, a historical high and 6.6 percentage points higher than the same period last year. This is also the fourth consecutive quarter that we have recorded a sequential improvement in adjusted gross margin. Adjusted gross profit reached RMB 194.4 million, a historical high and up 133% year-over-year. Normalized adjusted EBITDA margin was negative 5.9%, which is a significant improvement of 4.2 percentage points higher than the last quarter.
Interpreted Now, I will provide some updates on our progress across 4 key areas: public clouds, enterprise clouds, product and technology and latest business updates. I'll start with public cloud services. Revenue was RMB 1.15 billion with a gross margin of 2.1%, significantly higher than the negative 3.4% gross margin in the same period of 2022. Upholding the overall strategy, we emphasized 3 main goals for public cloud services, namely: supporting the Xiaomi and Kingsoft ecosystems; optimizing our customer structure; and improving our cost and efficiency profile. On the first point, we are committed to our original vision and fundamentals of firmly supporting the Xiaomi and Kingsoft ecosystems with first-class products and technologies that help drive sustainable revenue, profit and reputation. In this quarter, revenue from the Xiaomi and Kingsoft ecosystems increased year-over-year, represented an increasing portion of our total revenues and with a healthy margin. To ensure that we maintain our respective reputation, we proactively reached out to customers to better understand how we can improve services experiences and adjust our services accordingly.
Second, optimizing our customer structure is a critical component of our strategy to build differentiated business approach and boost profitability. We have focused on expanding our customer base among medium-sized businesses, strategically withdrawing from loss-making projects for larger customers. During the quarter, we negotiated or signed deals with dozens of medium-sized customers, including growth factor companies such as EV vehicle-to-everything, also known as V2X technology service provider, for example, (inaudible) Black Sesame.
Third, we implemented strong cost reduction and efficiency improvement initiatives and enhanced supply chain management. During the quarter, we increased our resource utilization rate by eliminating redundancies, reducing rigid minimum bandwidth commitments and relocating and consolidating IDC racks. We also leveraged our diverse channels to build a computing power resource pool that relies on a combination of directly owned and leased assets, enabling us to nimbly match the demand elasticity of different clients while protecting our profitability. These initiatives provided a strong foundation for improving the financial performance of our public cloud business for this quarter.
Interpreted Moving on to enterprise cloud services. Revenue was RMB 710 million with a gross margin of 24%, a significant improvement from 16% in the same period last year. We continued to implement strict project management measures in terms of customer quality, business sustainability, accumulation and reuse of core capabilities and profit margins. Our public services cloud businesses expanded further. During the quarter, we renewed the contract for the Beijing Public Service Cloud for the [ninth] year and expanded our footprint to Shandong, Shanghai and other regions. After years of development, we have gradually built a mature business model of public services cloud that generates healthy and sustainable margins and a wealth of opportunities for value-added data projects.
In digital health, we are strengthening the 5 business models we deploy, namely: the regional health care cloud model; the medical image cloud model; the integrated health care organization model; the regional integrated model; and the smart hospital model. These models allow us to tap into market opportunities with differentiated approach, accumulate and reuse our capabilities. During the quarter, we made milestone progress in our DaaS, also known as Data-as-a-Service product portfolio, penetrating the hospital market through our data management platform, adapting to made-in-China systems and leading a major national R&D project on biology and information integration. Looking ahead, we expect to leverage such technical and product strength in our business endeavors in the health care space. In the finance sector, we completed and delivered big data platforms for major financial institutions such as Industrial Bank and CITIC and [China Citibank], helped existing clients solve new challenges and focused on technical areas where we have unique advantages such as big data.
Interpreted In terms of product innovation, we live up to our model of building success based on technology and innovation by constantly and rapidly iterating on our products and providing a best-in-class customer experience across our core offerings. In cloud computing, our container [incentives] officially started to support the elastic scaling of container clusters hosting customers' own data centers, enabling unified management of on- and off-cloud resources, ensuring a smooth scaling into the cloud during spikes in usage. This solution can reduce on- and off-cloud [benefit] costs by around 80%. For such achievements in cost performance and efficiency, it is honored as one of InfoQ's top 10 cloud native innovation solutions.
In cloud storage, our object storage product is gaining more and more recognition from the market, jumping to fourth place in the fourth quarter of 2022, in China's software-defined storage report published by IDC Research, with its market share doubling compared with 2021. We also launched an all-flash array object storage product, which doubles read and write performance, particularly well suited to application scenarios such as AIGC and the separation of computation and storage in big data, providing tiered storage solutions with top-of-the-line performance at a high cost efficiency. In the enterprise cloud space, we upgraded Galaxy Stack to solve cloud usage and management pain point for enterprise customers. The result is a more unified, convenient and enriched resource management view across multiple availability zones that provides a better customer experience in terms of usability, safety and intelligence.
Interpreted In particular, I would like to address the recent developments in China's AI sector, which has continued to be heated since the debut of GPT 3.5 in the first quarter. We have kept a close eye on this space and have proactively deployed resources to comprehensively respond to market trends. First, as the only cloud platform in the Xiaomi and Kingsoft ecosystems, we approach AI strategically with Xiaomi and Kingsoft Cloud ecosystems companies in a strategic and coordinated manner, providing support for key programs, including Kingsoft Office's WPS AI. Second, we stand strictly neutral in large language model space. This position enables us to retain the full trust and preference of the many independent AI companies that use our platform. Third, with the combination of directly owned and leased assets, we are able to offer sufficient GPU server resources to meet our customers' needs.
Interpreted In summary, our results over the past few quarters demonstrates that our strategy is yielding results. As we prepare to meet future opportunities and challenges head on, we will nimbly execute on this strategy to create value for our customers, shareholders, employees and society.
Interpreted I will now pass the call over to our CFO, Henry, to go over our financials for the first quarter of 2023. Thank you.

Haijian He

Thank you, Zou Tao, and welcome, everyone, for joining the call. Now I will walk you through the financial results for the first quarter of 2023. Guided by the high-quality and sustainable development strategy, we are pleased to see that our profitability further improved steadily in the first quarter. Our adjusted gross profit continued to grow for the fourth consecutive quarter and achieved a record high of RMB 194.4 million, increased by 133% year-over-year, representing adjusted gross margin of 10.4%. Along with our strict expense control, our normalized adjusted EBITDA margin improved from negative 6.6% in the same period last year and a negative 10.2% in the last quarter to a negative 5.9% this quarter.
Our total revenue were RMB 1,864.4 million this quarter, which were in line with our previous outlook. Within that, revenue from public cloud services was RMB 1,153.7 million compared with RMB 1,380.8 million in the same period of last year. The decrease was mainly due to our proactive adjustment of CDN business as well as impact from our clients' structure adjustments.
Revenue from enterprise cloud was RMB 710 million compared with RMB 792.5 million in the same period of last year. The decrease was mainly due to the January infection of COVID-19, seasonality impact and the product quality control. We continue to enhance our cost control measures. Total cost of revenue decreased by 20.2% year-over-year to RMB 1,670.2 million. IDC costs decreased significantly by 21.4% year-over-year from RMB 1,110.3 million to RMB 872.4 million this quarter. Depreciation and amortization costs decreased by 8.7% from RMB 246.1 million in the same period last year to RMB 224.6 million this quarter. Solution development and services costs decreased by 11% from RMB 476 million to RMB 423.6 million this quarter. Fulfillment costs and other costs were RMB 122.7 million and RMB 26.9 million this quarter.
Adjusted gross profit of this quarter increased by 133% to RMB 194.4 million, representing adjusted gross margin of 10.4% compared with 3.8% in the same period of last year. The significant margin improvement demonstrates the success of our strategic adjustments of our revenue mix, optimized enterprise cloud product selections and efficient cost control measures and reaffirm our strong commitment to improving our profitability and delivering high-quality and sustainable development.
To help the market and investors better understand our business and our path to profitability, we separately disclosed the gross margin and gross profit for public cloud and enterprise cloud in order to better reflect our business nature. Within our business line, gross profit of public cloud services was RMB 24.8 million, which was significantly improved from the gross loss of RMB 47.2 million in the same period of last year. Gross margin of public cloud services were 2.1% compared with negative 3.4% in the same period of last year. The improvement was mainly due to the proactive scaling down of CDN services and adjustments of our clients' structure. Gross profit of enterprise cloud services was RMB 169 million compared with RMB 127.4 million in the same period of last year. Gross margin of enterprise cloud services was 23.8%, improved from 16.1% in the same period last year. The improvement was mainly due to our more stringent enterprise cloud product selection strategy.
In terms of expenses, excluding share-based compensation and impairment of long-lived assets, our total adjusted operating expenses were RMB 595.8 million, decreasing by 18.3% from RMB 729.6 million last quarter. Within that, adjusted R&D expenses was RMB 202.6 million, decreasing by 15.4% from last quarter. Adjusted selling and marketing expenses was RMB 104.2 million compared with RMB 118.4 million last quarter. Adjusted G&A expenses decreased largely by 22.3% from RMB 371.9 million last quarter to RMB 289.1 million.
As of March 31, 2023, our cash and cash equivalents and short-term investments amounted to RMB 4.5 billion, providing us a significant and sufficient liquidity for operations. The capital expenditures for this quarter was RMB 44.6 million, which primarily consists of payments for service. We have been taking control of our procurement of traditional service such as the ones being used for CDN business, while for high-performance service, especially in the recent popular AIGC areas, we've been actively cooperating with our suppliers in various ways to access the resources needed. Including, but not limited to capital expenditure model, we're also in operational leasing, which as payments will not be included in our CapEx but amount will be in OpEx model. Meanwhile, due to the payment schedule, certain cash payments for several purchases, including the servers, will be used for AIGC business, which we ordered earlier this year, will be gradually reflected sequentially in the following quarters.
Lastly, we have recently released our ESG report for 2022 to present a very in-depth review of the company's progress in the last year in ESG practice. We have also noticed that recognition from rating agencies and [scaling] of the company increased from certain well-known ESG agencies. We have taken great pride in advocating the highest ESG standards. We will continuously strengthen our ESG governance and engage with our partners to amplify our positive impact in the cloud industry and society, thereby delivering long-term value for our shareholders.
Looking ahead, we will continue to pursue our high-quality development strategy and unlock synergies within the Xiaomi and Kingsoft Group ecosystems, while staying agile to capture new opportunities in the new era of AI technology advances.
We expect our total revenue to be between RMB 1.85 billion to RMB 2.0 billion for the second quarter of 2023. While this forecast or comments are based on our current and preliminary views on the market and operational conditions, which are subject to change, with which we firmly believe that, given the time, the effect of our ongoing strategy initiatives and the new business opportunities, especially in the AIGC areas, will continue to amplify and reflect our financial results in the mid- to long term. Thank you.

Nicole Shan

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

Question and Answer Session

Operator

(Operator Instructions) And the first question from Xiaodan Zhang from CICC.

Xiaodan Zhang

[Interpreted] So my first question is on our pricing strategies. We noticed that several cloud service providers have announced their price cuts on their products in the past few months. So could you please share your views on the price trend going onwards? And are we going to make adjustments to our pricing strategies accordingly? And my second question is on our GP margin. We have seen a meaningful sequential improvement in the gross profit margin for the first quarter. So is this improvement sustainable? And what is your expectation for the segmental gross profit margins in the mid- to long-term?

Tao Zou

[Interpreted] Okay. So indeed, we have noticed our peer players' so-called large-scale price cuts, and we have analyzed it carefully. In terms of conclusion, I would say that its impact to our current products and services are limited and there's actually no material impact to our current offerings of products and services. Now as to in the future, whether we have anything similar in terms of pricing strategy, we should say that the peer players' catalog price cut is actually limited if we just take a close look at the specific products that are included in this action. And we also do not think that it has any material impact to the industry as of now. So our feeling is that this action is more geared towards PR purposes. Thank you.

Haijian He

Thank you, [Zou Tao]. Happy to take on the second question regarding the gross profit. As you mentioned, we are very happy to see that, especially starting from the second half of last year, the company has adopted quite important initiatives to expanding our gross profits, which you probably can see in the recent results, have achieved very positive results. But also, I want to put the data into context in the past 6 quarters, actually. If you remember, the lowest point on gross margin was back in Q4 of 2021. At that time, if you remember, our gross margin on a company level was only about 1.2%. And in the past 6 quarters, especially the second half of last year, we're sequentially increasing the gross margin to today about 10.2%, which is actually almost 7% to 8% -- 7 to 8x higher than Q4 2021. It's reflecting a combination of a few important reasons and drivers.
First is really the better mix of the products, including our efforts to cutting back certain low-profit margin products and also increasing the diversification of the top clients and medium-sized clients as well, which are actually giving Kingsoft Cloud a better positioning in terms of the pricing power and the terms -- and the commercial terms we negotiated with our customers. And second is our efforts to cutting back certain resources from servers, the bandwidth and lower utilized cabinets as well. So all those efforts are coming as a combination of those impact to our gross margin. But more importantly, it's really our internal strategy and management quality in terms of how we control, how we deliver, how we execute the enterprise cloud projects and how we make sure in terms of the [PMO] office can actually take a very good role in managing the cost and the efficiency of enterprise cloud. That's why on this quarter, we have, first time, separated the gross margin of enterprise cloud and public cloud. As you can see, both business lines is making a positive gross margin, and we're happy to see that trend going forward.
On the second point, you're asking, I think the key trend we're trying to see is [2 things]. First of all, on a combined basis, we're happy to see and hopefully, the gross margin of Kingsoft Cloud as a company will improve sequentially on a quarter-over-quarter basis. So I think we are confident to see that the trend going forward, given the few things we already see the good result, will continue to do that. Second, I think the potential of the gross margin expansion of the public cloud will be more propelled compared with enterprise cloud. So we're going to make sure the potential of the margin expansion on public cloud, we're taking a more obvious role in terms of margin expansion of the company, but also at the same time, we want to make sure the gross margin of enterprise cloud will keep a sustainable basis and will expand on a relatively rational pacing as well. So by doing 2 things, hopefully, we can keep the gross margin on the company level will continue to grow as well.
And the last point, I think, we'll also take a very, very careful view regarding the growth versus the profitability. So we don't say that margin is the only one factor we're trying to keep the focus, but also on balancing the growth opportunities in terms of, for example, the recent AI opportunities, we'll make sure we have enough resources to invest. And at the same time, we're going to make sure our gross margins can continue to improve. And our CEO has also mentioned, we will make a very rational decision and are not going to follow any un-rational trend in terms of pricing cuts and other things that are reflecting the potential risk of our gross margin. Thank you.

Operator

And the next question from Brian Gong from Citi.

Brian Gong

[Interpreted] Just a follow-up to Henry's point that Kingsoft Cloud will balance growth versus profitability ahead. When should we see public cloud and enterprise cloud growth to accelerate again in the future? And also Zou Tao just mentioned the impact from AI on Kingsoft Cloud. Can management elaborate? Have we seen any large language model from third-party already on our cloud? And also, do we have enough GPU chips to meet the demand in the future?

Tao Zou

[Interpreted] So I'm going to answer your question separately since you mentioned for both public cloud and the enterprise cloud. In the public cloud space, as you know, we mainly serve Internet customers or quasi Internet customers. And as you also mentioned in the second question, the current wave of AIGC or AI is in itself a very good wave of opportunities for us. As we have commented, we'll continue to leverage our neutrality positioning, which is well manifested in the fact that we're able to engage with a large number of independent AI developers. And also the effect of our coordinated and strategic approach with Kingsoft and Xiaomi ecosystem is also very good. So this is about our public cloud opportunities.
In terms of enterprise cloud, because we have 3 basically different major verticals, namely: public cloud -- public services, digital health and finances, I'm going to answer to you separately. So in the first part is the public services cloud. Our overall strategy in this line of business is to actually shrink and to focus a little bit in terms of geographical locations first. So in terms of project number, you might see the number of projects decreasing, but the profitability will be increasing, and we'll be focusing on the core -- some of the core regions, for example, Beijing and Hubei provinces. We believe that in the medium to long term, such approach, which namely is to shrink and to enhance our technology capabilities and services first, and then to expand, is a healthier way of growth. And secondly, in terms of digital health, as we commented in the prepared remarks, we are enhancing and we are pushing forward the 5 models of digital health business. We see it's accelerating, not only in terms of profitability but also in terms of revenue scale. So that's basically about the enterprise cloud side.
Interpreted As to your second question as to how many large language model providers or companies are running on our platform, I have to say that I apologize, we cannot answer your question in detail. And this is due to the fact that, first of all, confidentiality consideration for our customers, and secondly, currently, we still have a large amount of such companies that we are in the negotiating stage for potential transactions.
Interpreted As to your third question about our GPU chips reserve, the short answer in conclusion is it's definitely good to have more. We have been seeing great enthusiasm from such customers and expecting to expand the AI-related business. As you know that in the market, A100 has been essentially banned by the U.S. side. And we also see a very tight supply on A800 market. But as I commented earlier, we are adopting a flexible and combined channels to satisfy such needs, and that will include, first of all, directly owning such chips for GPU servers and secondly, in terms of leasing such assets. So what we can say is that we definitely try our best to meet such needs and to satisfy our existing and potential customers' needs in that regard.

Haijian He

Thank you, Zou Tao. Brian, thanks for the question. Just to add only 2 points. First of all, today, we are tabulating our Q1 results. If you remember, back in Q1, AIGC topic was emerged actually in early part of April, so definitely not in the current quarter's results. And we actually feel quite positive regarding the growth prospects, given in Q1, as you know, part of China was affected in COVID and many of the bidding process, during the 2 sessions, if you remember back in March, was affected as well on the timing. So as we actually promised, probably 1 or 2 quarters earlier, so on this quarter, we had a first step, where we separately disclosed our gross margin of public cloud and enterprise cloud. And as a second step, hopefully, in the coming quarters, we are going to also disclose our backlog numbers and other things. So I think we are going to see some growth potential and the timing and the pacing of those growth opportunities in the coming quarters as well, which are going to be a combination of the AIGC opportunities and the money we spend and how we actually control the balance of the growth and profit.
The second point is, maybe some of you also noticed that in Q1, our CapEx number was a little bit low. I think that's also not reflecting implication on our growth in terms of the spending because on cash flow category, we actually haven't -- we ordered the servers, but the timing of those payments has not hit accounts on the cash flow items in Q1. And many of the new opportunities are coming in April and May. Actually we are working on those opportunities as well. So I think these are the 2 points that hopefully can be helpful for you. For the next quarter, hopefully, we can give you more color regarding the backlog, and you can see the growth opportunities in a more kind of quantitative way coming forward. Thank you.

Operator

There are no further questions. I will hand back the conference to Nicole Shan for closing remarks.

Nicole Shan

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

Operator

That concludes the conference for today. Thank you for participating. You may all disconnect.
[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]