Kingsoft Cloud Holdings Limited (KC) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Kingsoft Cloud First (sic) [ Second ] Quarter 2020 Earnings Conference Call. [Operator Instructions] Please be advised that this conference is being recorded today. I would now like to hand the conference over to your speaker today, Ms. Nicole Shan, Investor Relations Manager of Kingsoft Cloud. Thank you. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining us today. Kingsoft Cloud's second quarter 2020 earnings release was distributed early 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 CEO, Mr. Yulin Wang; and our CFO, Mr. Haijian He. Mr. Wang will review business operations and company highlights followed by Mr. He, who will discuss financials and guidance. They will be available to answer your questions during the Q&A session that follows. 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 expectation of 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 achievements to differ materially from those in the forward-looking statements. Further information regarding these other risks, uncertainties or factors are included in the company's filings with the U.S. SEC. The company doesn't 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 figures mentioned during this conference call are in renminbi. It is now my pleasure to introduce our CEO, Mr. Yulin Wang. Please go ahead.

[Foreign Language]

[Interpreted] Thank you, and thank you all for joining our second quarter 2020 earnings call. During this quarter, we continue to focus on using technological innovations to improve our operational and financial performance. Growth of China's cloud market continue to gain momentum, fueled by supportive government policies to broader digitalization trends and technology development. According to our IDC report published in May 2020, the size of China's public cloud market is expected to reach USD 18.05 billion in 2020, up 45.5% year-over-year. As a leading independent cloud service provider, we will further solidify our leading position in the industry, leveraging the growing demand for cloud services and the trend towards multi-cloud deployment. We will further focus on select Internet industries such as video and game, and traditional industries, such as public service, financial service and health care. With our premium customers focused and select vertical expansion, we are well positioned to capture the opportunities in cloud service market.

[Foreign Language]

[Interpreted] Now I will show you recent updates across various verticals. I'll first touch on the Internet sector. During the quarter, overall usage of our public cloud services by existing customers grew steadily. In terms of technical innovation, we integrated VR and 8K technologies into our recently launched live streaming solutions, leveraging our delivery network and cutting edge live streaming technologies. Our one-stop solution provides VR video, including storage, distribution and many other functions. Combined with smart HD technologies, this solution effectively lowers bandwidth usage without compromising image quality and resulting in significant bandwidth cost savings. We have already partnered with certain well-known live streaming platforms to improve their users' VR video experience. In addition, we released Match [indiscernible] platform in June. It simulates a user's actual living experience and provides further suggestions from experienced advisers. Through the dashboard, customers can evaluate and improve image quality. The platform has been widely used by video editing applications.

[Foreign Language]

[Interpreted] We continue to expand our foothold across various subsectors in the Internet industry, including education and e-commerce. Our one-stop cloud solutions for e-commerce enable customers to access low latency, high-definition and smooth audio and video services. During the 618 Carnival, the largest midyear online shopping festival in China, we provided elasticity and the security solutions to a number of customers, including Xiaomi Corporation, ensuring a robust operational continuity of their campaigns. For game sector, we accelerated business development of our cloud-based game platform. In June, we signed a partnership agreement with [indiscernible] Interactive Entertainment, the exclusive digital content game platform at China Mobile. The partnership allows [indiscernible] and us to conduct in-depth development around cloud-based games in terms of 5G technology distribution channels and other areas. Kingsoft Cloud will provide advanced technologies at both PaaS and IaaS levels. In addition, at the recently held 2020 APAC Content Delivery conference, our advanced edge computing technology won the best edge computing platform award. In leveraging full-scale of edge network and scheduling management capabilities, our edge computing technology provides customers with efficient and stable computing services and has the recognition of customers and the APAC, CDN and industry alliance.

[Foreign Language]

[Interpreted] In relation to financial service sector, we launched dedicated cloud solutions, big data solutions and distributed database solutions to meet the digitalization demands in the sector. During the second quarter, we successfully implemented our Galaxy Stack cloud system for Zhejiang Chouzhou Commercial Bank. This helps the bank rapidly deploy cloud solutions to user management and network security management, providing the bank with flexibility and scalability that matches the performance of public cloud solutions. We also entered into a strategic agreement with Hua Xia Bank, a leading bank with a total assets of RMB 3.0 trillion. To build a strong line, our big data and database products will be incubated and deployed at Hua Xia Bank. Now moving to the public sector. We continue to invest in the sector and execute our flagship projects. In March 2020, we collaborated with major municipal government of Guangdong Province to kick off the construction of cloud-based industrial Internet platform. In May, the secondary note project for its Ivy resolution system launched successfully. The system focused on 5 applications, including device management, intelligent applications, big data analysis, collaborative office and the robotics, helping enterprises to transform to intelligent manufacturing. In addition, we won 2 bids for 2 central administrative projects in the era of artificial intelligence, further demonstrating our technology and service capabilities.

[Foreign Language]

[Interpreted] To sufficiently meet the growing demand for cloud-based services, we continue to upgrade our infrastructure. In the second quarter, we got approval on the energy consumption by Tianjin government for our own data center. The new data center meets [indiscernible] and the national level standards and has a capacity of up to 6,600 RECs, which will supplement our REC reserves in Beijing. Going forward, we will continue to focus on public service, financial service and health care industries and enhance our technology and human resources to develop more index solutions. We will further optimize our technology and expertise in cloud computing to provide high-quality services to our customers and continue to improve operational efficiency to achieve sustainable growth.

[Foreign Language]

[Interpreted] I will now pass through the call over to our CFO, Henry, to go over our financials of the quarter. Thank you.

Thank you, Yulin, and thank you, Nicole. Hello, everyone, I will now discuss our financial performance of the second quarter. Please be reminded that all numbers quoted here are in RMB. Please also be -- refer to our earnings release for detailed financial results. I would like to highlight the following 3 points. First of all, our previous guidance for the second quarter ranged from RMB 1.5 billion to RMB 1.54 billion. The total revenue during the quarter came in at the top end of the previous guidance at RMB 1.535 billion, representing an increase of 64.1% year-over-year. Our enterprise cloud service revenue were RMB 246.1 million. Despite the impact of the second wave of the pandemic in June, enterprise cloud service revenue achieved a significant growth of 259.3% on a year-over-year basis and 35.5% on a quarter-over-quarter basis. Second, we generated a positive growth profit for the fourth consecutive quarter, and our adjusted gross margin has now improved for 8 quarters in a row. In particular, the adjusted gross margin increased from negative 1.8% in Q2 2019 to 5.5% in Q2 2020, representing an improvement of 7.3 percentage points. Third, excluding the onetime IPO-related expenses, our normalized adjusted EBITDA margin increased from negative 12.6% in Q2 2019 to negative 1.7% in Q2 2020, representing an improvement of 10.9 percentage points. Adjusted EBITDA margin has now steadily improved for 8 consecutive quarters. Despite uncertainties in the macroeconomy, we are pleased to see that we are consistently delivering faster revenue growth than the general public cloud market in China and continue to improve the bottom line performance. As we are achieving great economics of scale, it demonstrates our ability to provide quality services to our customers even in a very challenging market conditions. Now I'll go through the detail of the financial results. Our public cloud service revenue increased by 48.6% year-over-year to RMB 1.287 billion. Although people returned to work in the second quarter, the usage of our public cloud customers kept growing. The performance of our premium customer space remained very strong, and we expanded into online education, e-commerce and the remote work verticals. Enterprise cloud service revenues accounted for 16% of our total revenue in the second quarter, up from 7.3% in the same period of 2019. Cost of revenue increased by 52.2% year-over-year to RMB 1.454 billion. IDC costs increased by 31.6% year-over-year to RMB 978.4 million, but as a percentage of total revenue, decreased from 79.5% during the Q2 last year to 63.8% in the second quarter this year. Depreciation and amortization costs increased by 59.1% year-over-year to RMB 217.5 million. As a percentage of total revenue, D&A costs decreased from 14.6% during the same period last year to 14.2% in the second quarter of 2020. Other costs consist of third-party software purchase, outsourcing costs and the channel costs associated with both public cloud and enterprise cloud as well as other equipment costs in relation to enterprise services. Other costs were RMB 244.9 million, and the staffing costs were RMB 13.2 million. As we continue to improve efficiency of the IT resources, we expect IDC and the D&A costs as a percentage of total revenue will gradually decline. Adjusted gross profit was RMB 83.8 million compared with adjusted gross loss of RMB 16.5 million in the same quarter of 2019. The adjusted gross margin began to breakeven from the third quarter of 2019, and it continued to improve to 5.5% in the second quarter this year. Thanks to economical scale and operating leverage, we are pleased to see that our profitability improved. Total operating expenses increased to RMB 511 million, up 80.4% from the same period 2019. The increase was mainly due to onetime IPO-related share-based compensation expenses. Total share-based compensation in operating expenses was RMB 172.1 million, representing a 289.7% increase year-over-year. Our share-based compensation help us retain and attract talents. Excluding the impact of share-based compensation, operating expenses as a percentage of total revenue continued to decline from 25.6% in Q2 last year to 22.1% of this quarter. Our operational efficiency continued to improve. Excluding share-based compensation, adjusted R&D expenses as a percentage of revenue declined from 13.5% of last year Q2 to 12.3% this quarter. Adjusted selling and marketing expenses as a percentage of revenue decreased from 6.8% for the same period last year to 5.1% this quarter. Adjusted G&A expenses as a percentage of revenue decreased from 5.3% for the same period last year to 4.8% this quarter. Excluding the onetime IPO-related expenses and other non-GAAP adjustments, our normalized adjusted EBITDA reached negative RMB 26.8 million compared with negative RMB 117.6 million in the same period of 2019. Normalized adjusted EBITDA margin also improved steadily, reaching negative 1.7% in the second quarter last year from negative 12.6% in the same period of 2019. As of June 30, 2020, we had cash equivalents and short-term investments of RMB 5.76 billion. We will continue to be very prudent in managing capital expenditures and maintaining a healthy balance sheet. During this quarter, capital expenditures were RMB 432.2 million. In addition, we were granted RMB 750 million line of credit by Beijing Commercial Bank and other banks. Moving to our outlook. We are currently expecting net revenue for the third quarter of 2020 to be between RMB 1.67 billion and RMB 1.74 billion, representing a year-over-year increase of 67% to 74%. However, this outlook is based on the current market conditions and reflects the company's preliminary estimates, which are all subject to change as we all understand the uncertainties as a result of COVID-19 are still in effect.

This concludes our prepared remarks. Thanks for your attention. We are now happy to take your questions. Operator, please go ahead.

[Operator Instructions] First question is from the line of Alex Yao of JPMorgan.

[Foreign Language] I have 2 questions. Number one is that regarding the second half revenue outlook. Based on your revenue guidance, the third quarter revenue growth rate will accelerate versus the second quarter. What is the key driver that's leading to the acceleration in top line growth? Second question is regarding the development of cloud gaming in China. In your view, what is the development stage of cloud gaming in China? What have you done to position yourself in the industry development. And lastly, when do you expect the commerciality of cloud gaming will hit the inflection point in China?

[Foreign Language]

[Interpreted] As Henry has said, we have brought our outlook for the third quarter at RMB 1.67 billion to RMB 1.74 billion. And we also said some seasonality in our revenue growth. For the quarter-on-quarter revenue increase, we are very consistent during the past several quarters. And we also see the detailed number of last year. The third quarter of last year is a little bit low. So we grew from a comparatively low base into the third quarter this year. And we believe the revenue growth will maintain stable quarter-over-quarter in the future. Our revenue growth mainly contribute to the cloud market development and also, thanks to our premium customer focus and the [indiscernible] industry focus, we believe we can deliver a higher revenue growth than other peers in this industry. And for your second question, we believe Kingsoft Cloud, our cloud-based game solution is among top of the cloud-based technologies. And we have already well developed cloud-based solutions. We believe the cloud-based game market is in the second phase. For the first phase, most of the service providers are still in the testing phase. And for now, we have seen some smart game has transformed to the cloud. We have already cooperated with most of the top game providers to develop into this industry. However, we think the commercialization of the cloud-based games still takes time. We think, generally, it takes 6 to 18 months to make a game available to the public. So the cloud-native games, we think is still under research and will be -- go public in 1 year. However, the cloud-based gaming industry is growing from a comparatively low base. So the growth rate is very fast. And we think the big scale of cloud-based games will come in compared to a longer time after this.

Next question is from the line of Thompson Wu of UBS.

[Foreign Language] My first question is, how should we think about the impact of Microsoft and TikTok's situation right now in the U.S. on your China business? And two, should we expect some impact from COVID on your third quarter guidance?

[Foreign Language]

[Interpreted] As for the first question, we think that TikTok even had no direct impact on our overseas business. As we haven't [ collaborated ] with TikTok in America business. However, we will keep an eye on the macroeconomy and the geopolitical issues to see that if there will be further impact on our potential overseas opportunities. And for the second quarter, we have -- for the second question, we have talked about the issue last quarter. We think the pandemic has a good chance on our online business as people spend more time at home. So video consumption and e-commerce consumption has increased, which is built well for our public cloud service usages. But for the offline business, there is still some impact on their own business. The digitalization trend is huge. However, there is some time gapping. There is -- secondly, we -- secondly, on the pandemic in Beijing, we can't deliver some of the projects offline. However, from now, we haven't seen a meaningful impact on our business in this quarter, but we will keep an eye on the macroeconomy trend to see if there will be a direct impact on the economy by the pandemic.

[Operator Instructions] Next question is from the line of Kyna Wong of Crédit Suisse.

[Foreign Language] My 2 question is actually then -- because we also expect around 20 to 30 premium clients in the quarter -- to add in the quarter. But can we identify that how much is actually from the enterprise or like from the public cloud and which was actually driving the fast growth? And the second question is about the multi-cloud strategy that we see this side getting more popular. And how much of the new clients actually from the multi-cloud and they are already using AliCloud, [ as a comp ] for new customer gains?

Thank you, Kyna, for your question. Happy to address that. Regarding the first question about the premium customer strategy, we are pleased to see that we're very robustly continue to execute our premium customer strategy. Although you understand that we are not planning to disclose a number of the premium customers on a quarterly basis. But based on our internal management accounts, we are happy to see that on a year-over-year basis as well as on a quarter-over-quarter basis, the number of the premium customers from both public cloud as well as enterprise cloud has continued to improve. And I would say probably in terms of the quality, maybe the number of customers is increasing to a kind of probably greater level compared with the number you just mentioned. So in addition, when we track our net dollar retention number as well as the attrition number, I think these 2 important internal KPI to measure how the premium customer perform on both quarterly and year-over-year basis has been robust and improving as well. The second question regarding the verticals, I will say, especially in the prepared remarks, we mentioned that in the public cloud market, we are seeing the great potential in online education, remote work collaboration as well as the different diversified e-commerce space. In those verticals, these are the 3 major verticals we are attracting in new premium customers as well. So to your second question regarding the multi-cloud. As you know, the few verticals I just mentioned, they have been kind of growing very -- in a very attractive rate in the past few years. As you can expect that many of our customers, they have been working with different players in the public cloud space. And the way we are engaging with them is, not only we're engaging them as a new premium customers, but also we continue to expand our wallet share into those customers, which means that we are one of the multi-cloud provider into those premium customers. And I think especially when you look at the premium customer, many of them, they already [ as a ] top-tier clients in their own verticals, which means the technology requirements and the technology will come regarding the stability and the data security also pretty high in their own measures. That's why the multi-cloud provide very natural route for them to resolve the technology standard and deliver the business performance they require. So I think that's probably a few color for the question you ask. Thank you.

Next question is from the line of Liping Zhao of CICC.

[Foreign Language] I'll translate it by myself. I have 2 questions here. My first question is about the market competition. We noticed some smaller players in the market also started to expand their cloud delivery service, will this bring pressure on our pricing? And what's the GP margin level for our delivery business segment right now and our future strategy on this segment? My second question is in regards to the CapEx plan for this year because we noticed the company has planned to build up their sales operators IDCs in Tianjin District and also due to the U.S. and China tension, will the company change the server CapEx plan for this year and next year?

[Foreign Language]

[Interpreted] We have noticed some small cloud service providers. They have launched their IPO programs. However, as we have already been top of the cloud service providers, solidifying our position in terms of the scale and also the premium customers relations, there is a little impact from the small players in the market. And we think the price of our CDN business is very stable in the recent years. For the top cloud service providers, they all have considered their profitability in the recent quarters. And for our own, we have delivered our profitable -- profitability improvement as we schedule in the IPO. And for the second quarter, our Tianjin data centers have been planning for a while and the investment also the capital expenditure has been included in our budgets. And for the servers, we haven't seen a significant impact from the geopolitical issues on the supply chain. But we will keep an eye on the policies to see if there will be further impact on our business. In this quarter, as the public cloud service increased very fast, we had purchased is more servers than we expected beforehand. But you can see the meaningful impact on our financials. We still deliver the results as we scheduled.

Next question is from the line of Elsie Cheng of Goldman Sachs.

[Foreign Language] And just to follow-up on the -- in terms of the project categories. If we look into the IaaS and PaaS products, can management share a little bit more color into the revenue mix change and outlook in this space?

[Foreign Language]

[Interpreted] For the IaaS and PaaS services, different workflows have different features. For Internet industries, as we have mentioned, in the video sectors, we have launched our VR and 8K technologies. Also our encoding technology is very popular and widely used by our customers. As we also mentioned that our edge computing has been recognized by the APAC edge Alliance -- CDN Alliance and our customers. But for other products, the performance is maintained at a normal level, the usage keeps increasing but -- keeping increasing rapidly. For other sectors, the services are not quite widely into PaaS and IaaS levels. We provide our one-stop solutions to the customers, especially in the financial services sector and Internet -- industry Internet sector and health care sectors. They integrate most of our enterprise technology in user solutions. So in different sectors, we provide different featured products.

Next question is from the line of Jian Huang of Macquarie.

[Foreign Language] First question is, so we heard that ByteDance is actually using GDS for their own data centers. Do management expect any negative impact from the move of your largest client? And secondly, can management share some colors on which subsectors is going to be -- provide the most majority of the new key customers in 1 year forward?

[Foreign Language]

[Interpreted] For the ByteDance [indiscernible], it has always had their own IDC corporation. They have ran some computing services on their own IDC. So there is no direct impact on our corporation. ByteDance, as our largest customers, we have maintained a very stable relation with them for very a long time. And for your second question, we haven't disclosed the numbers of customers in different sectors. But overall, all sectors have delivered good performance. The number of customers has increased steadily. We will disclose more numbers in our annual report. But to sum up, there is no significant change in the sector diversification.

There are no further questions at this time. I would now like to hand the conference back to today's presenters. Please continue.

Thank you, everyone. Thank you for your participation. This concludes our conference call. See you next time.

[Foreign Language]

[Foreign Language] Thank you, everyone.

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. [Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]