Kingsoft Cloud Holdings Limited (NASDAQ:KC) Q4 2022 Earnings Call Transcript

Kingsoft Cloud Holdings Limited (NASDAQ:KC) Q4 2022 Earnings Call Transcript March 29, 2023

Operator: Good day, and thank you for standing by. Welcome to the Kingsoft Cloud Fourth Quarter and Full Year 2022 Earnings Conference Call. Please be advised today’s conference is being recorded. I’d now like to hand the conference over to your first speaker today, Nicole Shan, IR Manager. Please go ahead.

Nicole Shan : Thank you, operator. Hello, everyone, and thank you for joining us today. Kingsoft Cloud’s fourth quarter and full year 2022 earnings release was distributed earlier today and is available on our IR website at ir.ksyun.com, as well as on the GlobalNewswire services. On the call today from Kingsoft Cloud, we have our Vice Chairman and CEO, Mr. Tao Zou; and our CFO, Mr. Henry He. Mr. Zou will review our business strategy, operations and the company highlights, followed by Mr. He, who will discuss the financials and the guidance. They will be available to answer your questions during the Q&A session that follows. There will be consecutive integration, our integrations are for your covenants and reference covers only.

In case of any discrepancy in management statement in our 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 demand 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 related to on that well known or unknown risks, uncertainties and other factors, all of which are difficult to predict and many of which are beyond the company’s control, which may cause the company’s actual results, performance or achievements to differ materially from those in the forward-looking statements.

Further information regarding this and other risks, uncertainties or factors are included in the company’s filings with the U.S. SEC. The company does not undertake any obligation to update any forward-looking statements as a result of new information, future events or underlie except as required under attributable by law. Finally, please note that an otherwise stated, all financial figures mentioned during this conference call are denominated in RMB. It’s now my pleasure to introduce our Vice Chairman and CEO, Mr. Zou. Please go ahead.

Tao Zou : Hello, everyone, and thank you all for joining Kingsoft Cloud’s Fourth Quarter and Fiscal Year 2022 Earnings Call. 2022 was an extraordinary year in many ways, and we’re pleased to have successfully navigated the various challenges we faced in the complex and dynamic environment. As I took on the CEO role, we have remained committed to our strategy for high-quality, sustainable growth while continuing to building success based on technology. We have also implemented cost reduction and efficiency initiatives, which have resulted in steady improvements to our profitability. I am pleased to highlight some of our notable results with it. In Q4, we saw a remarkable increase in our adjusted stock profit, reaching RMB 169 million, representing a fourfold increase year-over-year.

Adjusted gross margin increased to 7.9%, rising by a significant 6.7% from the same period last year. Furthermore, our net operating cash inflow amounted to RMB 370 million, marking the third consecutive quarter of positive net operating cash flow since Q2 of last year. We also recorded a quarterly free cash inflow for the first time, which is an important milestone for us. These impressive results demonstrated our strong business resilience and provided a solid foundation for us to stabilize restarts and emerge even stronger. Now I would like to provide some updates on our progress in 3 areas, namely public cloud, enterprise cloud and research and development. I’ll start with public cloud services. In Q4, revenues from this business remained stable at RMB 1.35 billion, representing a slight increase from the third quarter.

We fine-tuned our positioning and incremented differentiated strategies for key account customers and midsized customers with key account partners, we strive to maintain a balance between revenue and profitability While delivering the ultimate service experience to establish a superior word-of-mouth reputation for our full stack solutions. We leveraged this strong reputation and the scalable core capabilities we have developed to serve key account customers to expand our cost business opportunities with midsized customers. This approach allowed us to gradually reduce our dependence on key account customers while driving revenue growth and profit enhancement in our public cloud business. During the past half year, we carried out a systematic review of more than 200 companies from above 10 industries and signed more than 30 new midsized customers with high growth potential.

Thanks to these strategies, the revenue contribution from our top 3 public cloud partners has been not declined, while the revenue contribution from midsized customers continues to increase steadily. As a result, we have improved our customer mix while maintaining stable revenue growth in the public cloud business. Moving on to Enterprise Cloud Services. Revenue increased by 26.4% quarter-over-quarter to RMB 790 million in Q4. We remain steps in executing our high-quality and sustainable growth strategy and further clarified and institutionalized our project management best practices will fundamentally enhance our enterprise cloud business quality. This effort centered on 4 key initiatives. First, we focus on accumulating and enriching our core offering of proprietary products and solutions capabilities.

Second, we continued to enhance the revenue share of our proprietary products and solutions across our projects. Third, we targeted industries and customers with high potential lifetime value catering to their evolving needs and grow with them. Lastly, we further enhanced our project execution to improve customer experience and reduce costs. These initiatives not only generated a relatively high estimated margin for enterprise cloud projects in the current financial period, but will also drive sustainable margin expansion in the long run. Taking the public services sector, for example, we focus on the public service cloud model and developed a benchmark system consisting of cloud products, services and operations. In Q4, we completed a smart city upgrade project for the Public Services and Big Data Management Bureau of municipality for the province in which we deployed our core proprietary enterprise cloud solution, Galaxy Cloud.

We are also carrying out a number of other projects, including the Beijing Water Authority Public Services Cloud and the Public Cloud, further sharpening our competitive advantages and business scale in public services. In the health care sector, we continued to enhance our 5 major models, namely the regional health care cloud model, medical image cloud model, integrated health care organization model, regional integrated model and smart capital model. During the quarter, we completed the second phase capacity expansion projects for the health care cloud in the new area and the medical image file of the Chongqing Health Commission. This showcases our ability to provide continuous ongoing support for enterprise cloud partners using our market-leading products, solutions and services.

In the financial services sector, we further deepened cooperation with state-owned banks and major commercial banks by focusing on providing financial big data support and operational capabilities. In addition, while retaining a stable existing customer base, we strengthened our project deployment partnership with Kaman, particularly enhancing our synergies and cross-selling in the banking segment. In terms of technology, we continued to advance our core strategy of building success based on technology. In third quarter of 2022, we developed the Beijing Wuhan dual research center strategy, and we executed well in the fourth quarter. We aim to sustainably enhance our R&D capabilities while maintaining a disciplined R&D budget. We doubled the number of R&D funds in the Wuhan Research Center within just 3 months of its launch in December 2022, and we expect to grow the headcount there to more than 1,000 over the next 3 years, injecting momentum into our R&D initiatives and helping cement our industry leadership.

We strive to deliver the ultimate user experience across our core products and technology categories, including cloud holds cloud-native enterprise cloud infrastructure, enterprise storage and big data cloud platforms, and we benchmark ourselves against the top-tier players in the cloud industry. For example, we recently launched our seventh-generation cloud host, as well as new versions of our container services and serverless cloud functions, delivering significant performance improvements. We added 79 key operating features, including various , test solutions and operational management assumptions to the upgraded version of Galaxy Cloud, significantly enhancing the competitiveness of our flagship enterprise cloud product. We also upgraded the data collection, data integration and hybrid architecture deployment capabilities of our big data cloud platforms and engine solutions.

In addition, we significantly enhanced our product compatibility with various operating systems, databases and chips. Since the debut of GPT 3.5, we have been closely following its development and actively exploring relevant business opportunities. First, GPT models require massive computing power and vast group of data making cloud computing a natural fit for this technology and an essential enabler for use cases, including both training AI models and applying them to various scenarios. The years of collaboration with leading AI companies we have developed a market-tested solutions that can be rapidly deployed on demand. Second, major Internet cloud service providers generally are developing their own CPG businesses, whereas we remain a neutral player.

This means we can serve a wider range of partners and a natural advantage that the market is beginning to recognize. Third, the application of GPT models, especially in traditional industries, which relatively underdeveloped IT capabilities will require extensive preparation work unique to each company, including consulting and planning, process reengineering, customized development, installation and deployment and ongoing maintenance. Our strong and wide-ranging IT support and deployment capabilities will enable us to capitalize on such huge opportunity in this market. Overall, looking back at the challenges we faced in 2022, we are gratified that our proactive strategic adjustments enabled us to achieve positive initial results and strengthening our conviction that we are on the right track.

Looking ahead, in the face of new challenges and opportunities, we will pursue high-quality and sustainable development no matter how the environment changes and roll up our sleeves to create sustainable 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 quarter and full year 2022. Thank you.

Henry He : Thank you, Tao Zou, and welcome, everyone, for joining the call. Before diving into the financial details, I will walk you through a quick summary for the fourth quarter 2022. First of all, with our strong commitment to improve profitability, we have taken comprehensive measures from all sectors, including proactive adjustments to our CDN services, strategic restructuring of customer mix, prudent sanitized cloud selection and a strict control of fixed assets and operational expenses. Since the third quarter of 2022, our adjusted gross margin has been increased for 5 consecutive quarters, increasing from 1.2% in the fourth quarter in 2022 to 3.6% in the second quarter last year, 6.3% third quarter and a further to 7.9% this quarter.

Adjusted gross profit increased by 408% year-over-year to RMB 168.5 million this quarter. We disposed certain underutilized service based on the current customer demand and record loss on disposal of properties and equipment. However, we believe this is helpful for our long-term development and gross margin expansion. Non-GAAP EBITDA margin profit was negative RMB 245.1 million, impacted by nonrecurring Hong Kong IPO listing expenses of RMB 94.9 million and a loss of disposal of properties and equipment of RMB 208.8 million. Non-GAAP EBITDA margin was negative 11.5%. However, it’s excluding the IPO expenses and the loss of disposal of properties and equipment expenses, our non-GAAP EBITDA margin would have been negative 5.7%, compared with negative 10.3% last quarter and a negative 4.7% in the same period of 2021.

Second, our operating cash flow has been positive for the past 3 quarters consecutively, and we have achieved RMB 370.4 million net operating cash inflow this quarter. Thanks to our prudent control over capital expenditures, free cash flow, as measured in net cash generated from operating activities minus capital expenditures, was RMB 259.6 million, marking the first quarter of the positive free cash flow, demonstrating our strong commitment and the successful execution of our cash management. Third, our cash and cash equivalents and short-term investments was RMB 4.7 billion by December 2022. Considering the improvement of our profitability, our scaling down of capital expenditures and cash inflow of operating cash flow, our cash reserve is well positioned and sufficient to support us walking through the challenge here and provide flexibility to further business development.

Lastly, our total revenue was RMB 2,131 million this quarter. Revenue from public cloud services was RMB 1.34 billion, remained stable compared with last quarter. Revenue from Management Cloud was RMB 785.9 million, increased by 26.4% quarter-over-quarter. With a more balanced and healthy business mix, we believe we are well positioned to start a new journey for our sustainable long-term development, being able to allocate more resources to expand our mid- to long-tail customer basis and high-quality non-Internet companies. Now I will go through our financial in detail. Our total cost of revenue decreased by 25.2% year-over-year to RMB 1,969.1 million. IDC costs decreased significantly by 20% year-over-year from RMB 1,321.9 million to RMB 1,057.6 million this quarter.

Depreciation and amortization costs increased by 6.4% from RMB 227.2 million in the same period last year to RMB 241.7 million this quarter. Solution development and services costs decreased from RMB 497.2 million to RMB 465.8 million this quarter. The decrease was mainly due to the synergies from overlapping headcount reduction within catalog and into cloud on the COVID-19 impact and other synergy initiatives on the demand side in last December. Fulfillment costs and other costs were RMB 155.6 million and RMB 48.3 million this quarter. Adjusted gross profit of this quarter increased by 400.08% to RMB 168.5 million, representing adjusted gross margin of 7.9%. The significant gross margin improvement was mainly due to the impact of cost-control measures and the strategic adjustments of our revenue mix.

In terms of expenses, excluding share-based compensation, our total adjusted operational expenses was RMB 729.7 million. However, still impacted by Hong Kong IPO exiting expenses of RMB 94.4 million. The disposal of fixed assets of RMB 28.8 million. Within that, adjusted R&D expenses was RMB 239.4 million, remained relatively stable compared with RMB 231.6 million from last quarter. Adjusted selling and marketing expenses was RMB 118.4 million, compared with RMB 125.5 million last quarter. Excluding the lifting expenses and disposal of fixed assets of RMB 123.7 million, adjusted G&A expenses increased slightly from RMB 219.9 million last quarter to RMB 248.2 million. We have taken various measures to cut down expenses, including, but not limited, to the following aspects.

First of all, we will review weekly the variable operational expenses, especially in marketing and administrative expenses. Second, we streamlined headcount management within the firm and review our cost strategy and adjusting for fees and other structure of personnel. Third, along with the scaling down of certain customer CDS services, we probably may improve the efficiency of underlying resources. We also did post certain fixed assets and scaling down benefit costs as well. Net loss margin was negative 24.5% this quarter, and adjusted net loss margin was negative 25.9%. The adjustment was mainly due to the foreign exchange gain of RMB 132.3 million caused by fluctuation of U.S. dollar RMB exchange rates, which is a noncash impact. As of December end 2022, our cash and cash equivalents and short-term investments was RMB 4.7 billion, providing us sufficient liquidity operations.

During the fourth quarter, we have repaid certain loans within the group and the banks to reduce our interest costs. The capital expenditure for this quarter was RMB 110.8 million, which primarily consists of payments for service. In terms of share repurchase, regarding our USD 100 million share repurchase program within a 12-month period as approved by the Board of Directors announced in March 2022. Since the release of our second quarter results up to the year-end of 2022, we bought a total of 12.3 million ADR shares for the cost of roughly USD 29.2 million. Going forward, we still have authorization from the Board of Directors and the flexibility to continue execution from time to time as way to the mandated repurchase program. These efforts fully demonstrates our Board and management’s strong commitment and confidence in the long-term business development of the company.

Finally, we have successfully finished the new primary listing on the main board of Hong Kong Stock Exchange by the way of introduction on December 30, 2022. In March 2023, we have been selected and included into Hong Kong Composite Index, Shanghai-Hong Kong Stock Connect and Shentel-Hong Kong Stock Connect at the same time. Private listing in Hong Kong has helped us broaden our investor base and open up new investment channels. Our teams have been communicating more frequently and broadly with domestic investors, and we have seen more active trading patterns since we joined Hong Kong Stock. Looking ahead, although we are still implementing our strategic initiatives, including business repositioning and cost control efforts on an ongoing basis, such adjustments have already yielded positive preliminary results as reflected in a clear improvement of profit margin in Q3 and Q4.

We expect our total revenue to be between RMB 1.85 billion and RMB 2.05 billion for the fourth quarter of 2023. While the forecast and comments are based on our current and preliminary views on the market and operational conditions, which are subject to change. We firmly believe at given time, our potential positive impact of our ongoing strategic initiatives will continue to amplify and reflect our financials in the mid- to long term. Thank you.

Nicole Shan : This concludes our prepared remarks. This answer contains both Mandarin and English, if possible. Operator, please go ahead.

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Q&A Session

Operator: We’ll now take our first question. This is from the line of Brian Gong from Citi.

Brian Gong : I will translate myself. I have 2 questions. First is regarding the enterprise cloud. Regarding the 3 verticals, how should we see the demand this year? Last year, the delivery was impacted by cold wave. So this year, should we see faster growth? And how should we balance the growth — revenue growth and the margin? And the second question is about China GBT. The total trust mentioned as individual cloud provider, we have some advantages in China. But in China, for those Internet giants who have capability to develop large language models, they all have their own cloud service. So if the auto price users, they use their language, large language model, will those users more — have more intention to use those cloud services?

Tao Zou : So as you rightly pointed out, so we are noticing that right now, we are going through the opening up phase after the COVID period. And the country is also reverting back to the model of business development. And admittedly, last year, they had the COVID situation and relevant restrictions did have impact to our deployment and delivery of our industry of our enterprise cloud business, and some of the planned deployment that was originally planned to be completed in Q4 last year were actually delayed this year. But if you look at the situation now, although we haven’t disclosed the particulars and the concrete numbers of the specific 3 verticals that you mentioned, we do remain highly confident about our operating metrics in our enterprise cloud, including revenue, including gross profit and including our operating margin, and we expect to have significant improvements in those metrics.

And secondly, I would like to clarify in our pursuit of high-quality and sustainable growth does not necessarily mean that we do not pursue growth. For every customer and for every project, what we do is to evaluate whether that customer and that project centered around the core cost business and whether that brings about profitability to us. In other words, if some of the customers and projects, even if we evaluate them from a longer time period, and it will not bring about profitability to the company, and this is actually not a high-quality project and not high-quality development. So the point I would like to mention, and I would like to highlight is that in the past, we have been overly of emphasizing the growth. And now what we need to do is to replace that overly emphasis on growth to high-quality and sustainable growth, which is of strategic value to us.

Just to briefly hand it to CEO. So we have announced in the sense of and the facility companies that we will not send a lot of general resources or working on the big language model ourselves. Because we have a very clear value proposition, which is we’re providing solutions to our TV customers. And therefore, working on cash model is not significant strategic value to us. However, the platform companies or the platform Internet companies, they have the core capability and they have development numbers and therefore, a more curable studio of such big models. However, in relation to your question, who use our services and products, I have 2 main things. One is that, although the larger technology companies, the technology giant, have their relative advantages we mentioned just now, but it does not necessarily mean that those models need to be developed the research and developed by such giants.

OpenAI is a good example, which is not a technology giant. However, generated the best in class such model. And then the second is that — so as — also as we discussed in the prepared remarks. Because of our neutrality, these venture teams that are in smaller companies because of the potential contract interest with major Internet clients. We also choose the service of us relevant those Internet-based Internet giants based to cloud service providers. And then the second proposition I would like to say is that although in the short period of time, we do think that it is unlikely that the big language model, the GPT in China to develop to a level similar to that of the GPT 4.0 in the United States. However, it does not necessarily mean that smaller models that do not present real value and applications in the wide industries in China.

For example, we’re already seeing a lot of small models with parameter number amounting to 6 — RMB 10 billion, having very vivid and comfort applications in various industries. And for those application scenarios are basically also our potential business opportunities. So to sum up 2 of the potential business opportunities that is the current weight activity process for us. One is the venture teams from smaller companies who work on those models. And secondly is the application of such models and small models, which we might also call industry models their application into the traditional companies with relatively underdeveloped IT capabilities, which will help them to apply such models in their day-to-day operations.