Good day and thank you for standing by. Welcome to Kingsoft Cloud's Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Wayne Wong, Investor Relations Manager of Kingsoft Cloud. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining us today. The Kingsoft Cloud's third quarter earnings release was distributed earlier today and is available on our IR website at ir.ksyun.com, as well as our GlobeNewswire services. On the call today from Kingsoft Cloud, we have our Vice Chairman and CEO, Mr. Tao Zou; and CFO, Mr. Haijian He. Mr. Zou will review our business strategies, operations, and the Company highlights; followed by Mr. He, who will discuss the financials and guidance. They will be available to answer your questions during the Q&A session that follows. And there will be consecutive interpretations. All interpretations are for your convenience and reference purposes only. In case of any discrepancy, the management's statement in the original language will prevail. Before we begin, I would like to remind you that this conference call contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 as amended and as defined in the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements are based upon management's current expectations and current market and operating conditions and relate to events that involve known or unknown risks, uncertainties, and other factors, all of which are difficult to predict and many of which are beyond the Company's control, which may cause the Company's actual results, performance, or 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 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 CEO, Mr. Zou. Please go ahead.

Hello, everyone, and thank you all for joining Kingsoft Cloud's Third Quarter 2023 Earnings Call. During the quarter, we continued to uphold the principle of high quality and sustainable development, build success based on technology and innovation and forged our reputation throughout the entire business process with customer centricity. We have enhanced our operation's management and proactively embraced the new AI era. This quarter, our profitability further improved. Total revenues reached RMB1.63 billion. Adjusted gross margin increased steadily for the fifth consecutive quarter to 12.1%. Adjusted gross profit reached RMB196 million, increasing by 57.5% compared with the same quarter last year. Normalized adjusted EBITDA margin was negative 2.7%, which represents a significant improvement of 7.6 percentage points from the same quarter last year and 0.6 percentage points from the previous quarter. In terms of public cloud services, revenues were RMB1.02 billion with a gross margin of 4.7%, significantly higher than the negative 1.6% compared with the same quarter of last year. We continued to focus on three priorities for public cloud services, namely the Xiaomi and Kingsoft ecosystem, AI business and CDN strategic adjustments. First of all, we continued to serve Xiaomi and Kingsoft ecosystem well and coordinate enterprises within the ecosystem to systematically sort out their cloud planning and fulfill their cloud demand. This quarter, Xiaomi and Kingsoft contributed 17% to our revenue, an increase of 2.2 percentage points quarter-on-quarter and 3.6 percentage points year-on-year. Among them, driven by Xiaomi business, the capacity of its dedicated cluster has expanded significantly and Xiaomi has become our largest customer. Kingsoft Office's revenue in September increased by nearly 50% compared to January, driven by its AI business. Secondly, we proactively developed our AI business. Currently, there is a strong demand for AI business with tens of customers who have signed contracts with…

Thank you, Mr. Zou, and welcome, everyone, for joining the call. Now I will walk you through the financial results for the third quarter of 2023. Under the strategy of high-quality and sustainable development, we are pleased to deliver another quarter of steady profitability improvement. Our adjusted gross profit continued to grow for the fifth consecutive quarter and achieved RMB196.3 million, increased by 57.5% year-over-year, representing adjusted gross margin of 12.1%, which is a record high for the Company. Our normalized adjusted EBITDA narrowed from negative RMB202.0 million in the same period of last year and a negative RMB59.9 million in the last quarter to negative RMB44.1 million this quarter. As a result, normalized adjusted EBITDA margin further narrowed from negative 10.3% in the same period last year and a negative 3.3% in the last quarter to negative 2.7% this quarter, making another solid step towards EBITDA breakeven. Our total revenue were RMB1.625.2 billion this quarter, of which revenue from public cloud services were RMB1.0166 billion, representing a decrease of 9.5% compared with RMB1.1130 billion in the last quarter. This is primarily due to the strategic scaling down of our CDN business by approximately 20% quarter-over-quarter and partially offset by non-CDN public cloud services. Revenues from enterprise cloud services were RMB608.5 million, representing a slight decrease of 2.2% from RMB622.0 million in the same period of last year as we continued to be stringent on project selection. We continue to enhance our cost control measures. Total cost of revenue decreased by 22.6% year-over-year to RMB1.4290 billion. IDC costs decreased significantly by 31.6% year-over-year from RMB1.0783 billion to RMB737.7 million this quarter. Depreciation and amortization costs decreased by 21% from RMB253.7 million in the same period of last year to RMB200.4 million. Solution development and services costs decreased by 4% year-over-year…

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

[Operator Instructions] Your first question comes from the line of Xiaodan Zhang from CICC.

So my first question is regarding our AI strategy. So Kingsoft Cloud has become the first choice for some of the industry-leading independent large language model providers when they select ICE vendors. So what is the growth trajectory for these type of clients in the recent quarters? And how would the recent supply constraints impact our AI strategy? And secondly, could management share your most recent guidance on the timing of adjusted EBITDA margin breakeven?

So the first part of the answer was provided by Mr. Zou Tao. And so the answer to your question. The customers that we have signed and engaging in business with are leading players in the AI market apart from BBAT, and they have relatively strong capital strength and business scale. Roughly, the starting point of the business cooperation usually start from 128 to 256 server units and likely to expand to 512 server units group of servers. And because their final goal is to move to the large language models and the parameters usually amounting to hundreds of billions, so the required resources of computing power are also at the level -- at the level that is above 512 server units and above. So for the uncertainties that you asked about the external environment, people have seen, as well as you have noted as well, that since October, the export control from the United States has created quite an impact to the industry, including that industry in China, and we are no exception. However, fortunately, we have foreseen -- we have actually foresaw this coming and have made some preemptive actions. So due to our preemptive planning, we have actually got only limited impact from that export control. However, how do we see this from the medium to long term? I think it depends on a couple of factors, including the performance of made in China's GPUs as well as the production capacity. So I think all in all, in the short term in the future, for example, in one or two quarters, the impact to Kingsoft Cloud should be limited. I think it's relatively under control. In the longer term, we are also actually relatively confident because we have seen some of the positive progress the Chinese chip industry has made during the past year. So as I mentioned in the prepared remarks, we are seeing both opportunities and challenges ahead in the future. Because we have obtained a larger number of independent AI customers, we are relatively comfortable with the potential impact.

I will take on the second question. So there are actually the two different drivers. First of all, some of you may remember, we actually hit quite dramatically back then back of late part of 2021, right, given the slowdown of the Internet consumer business as well as the certain impact on the enterprise cloud sectors in the later part of 2021. So at that time, our gross margin was only 1.2%. As you all notice that today, the increase from 1.2% to 12% on the gross margin side. So that actually is the fundamental result of our collective efforts around improving the efficiency of the resources we have, improving the client selections and the client quality. So putting that aside, that gave us about 10x up of the gross margin percentage. So on top of that, as you probably also noticed, that the spread between the gross margin and the EBITDA margin. I think the largest spread probably about last year were around about 19% to 20%. But this quarter, as you may see, the spread has been also narrowed from about 20% to only 14%, which means on expenses control side we also reduce significantly in terms of how we spend on research, how we spend on the travel, how we spend on the general management purposes. So putting everything together, the two fundamental driver from the business as well as how we improve the operational efficiency has given us leading to today's improvements on the EBITDA margin improvement. And so to your question, I think given all the initiatives and the strategy we're already putting to place, those impact and the results will gradually be released quarter-by-quarter. So it's not going to be a onetime off thing for this quarter. It's going to be carried out for the next few quarters steadily. And in our attention, we are hoping to improve both gross margin as well as narrowing the spread between the gross margin and EBITDA margin in the next few quarters. While as you may understand, the management team will not be giving a guidance for the formal EBITDA margin breakeven at this moment. But as you can see, the trend has been steady for the past four quarters, and we hopefully can keep that trajectory and the pacing of improving the margin. Hopefully, we can report a breakeven not only on the EBITDA margin, but also on other items in the near future as well. So just give us a bit of time, and then we can probably deliver those results to your expectation.

Your next question comes from the line of Timothy Zhao from Goldman Sachs.

I have two questions, both regarding the public cloud sector. First one is regarding the AI business. Could management share more color on the AI business in terms of its revenue contribution as well as the profitability level in either gross profit margin or EBITDA margin? And as you mentioned in the third quarter, you spent around RMB1 billion CapEx in the AI business. Just wondering if management has any guidance into your CapEx into fourth quarter and next year, including the AI business? And second question is regarding the CDN business. As we understand that there's a -- the overall competitive environment in China in the cloud segment is quite dynamic. Just wondering for the CDN, are we going to see more adjustments in the next few quarters? And after adjustment, what is management's view on the midterm normalized gross profit margin level of the public cloud business?

It's Henry here. I'll probably take on the first question and I'll translate myself briefly, and Zou can comment as well. So regarding the AI business contribution, the first point is on the CapEx. So last quarter, we spent -- in my script I mentioned it's about RMB415 million, or RMB400 million level on the third quarter. But I'll go back to your first point regarding the contribution and revenue margin, a few things to share. First of all, as you know, following very fundamental and basic economic principle, right, it's really driven by two things. One is the supply-demand balance, and the second is about the technology we offer and the products we offer, right? So as we all know that today really is about the buyers -- it's all a seller's market, right? So if you do have a very robust infrastructure and resources and can provide a very robust service and products to the clients, clients are definitely willing to pay. And for the clients, it's also giving them a cutting-edge advantage when they try to compete, training their model to a certain level, they can compete in a world-class stage. So that actually convert to a very good logic for us to have a better margin compared with other kind of resources-driven ICE services historically. So we also observed the second phenomenon is the client also willing to pay for a value-added part of the services, not only by charging them on a fundamental resource usage basis. So by giving them the best practice and giving them a value-added service and products, we can share certain value with the client, and that gets embedded into part of the pricing after a given time. So those are the two fundamental reasons that we believe the higher margin…

[Foreign Language]

Okay. So let me quickly translate. So in relation to your second question about the CDN strategic adjustments, we have actually started the adjustment in October 31 this year, and we have an internal deadline of June 30, 2024. As I can see this, we're continuing to do some adjustment according to the market conditions. Currently, we're getting CDN revenue on a quarterly basis around RMB500 million. And it might continue to scale down to somewhere between RMB300 million to RMB400 million per quarter, and thereby reaching a relatively stable status till after June 30 next year. And in relation to your question about the profit margins for the public cloud services business, it's of two components: one is CDN and one is the so-called pan-Internet sector. For the CDN sector, as mentioned, as to the third quarter next year we expect the strategic adjustments to have completed. And by then, we would hope the margin of this business line to revert to the relatively healthy level that was as of the fourth quarter of 2022. Now for the pan-Internet space, we are still seeing the margin, including both the GP margin and as well as the operating profit margin steadily and gradually improving. I mentioned one of the uncertainties is the GPU supply. And obviously, in the AI space the demand significantly outpaces that of demand -- outpaces of supply. And if that can be -- if the supply chain issue can be resolved completely, obviously, the improvement of our business as well as margin in the AI and thereby the pan-Internet space will be much faster. But even with that uncertainty, we are already seeing relatively good progress in terms of margin improvement and business scale expansion.

Your final question comes from the line of Katrina Chiu from Citi.

This is Katrina Chiu asking on behalf of Brian Gong from Citi. Can management share with us the overall revenue outlook in 2024 and whether we can expect positive revenue growth next year?

So after we relisted -- or dual listing in Hong Kong, we actually didn't publish our kind of management guidance. But have to share some color as well as we're moving towards the year end of 2023. First of all, as you know, even today, right now, we have about 25% -- 20%, 25% by different quarter. The revenue is coming from the CDN business, our CEO Tao mentioned as well. So we're kind of in the phase of some adjustment from client mix from the products we offer. And as well as we control the cost, we procure the bandwidth as well. So -- but if you look at that business, the first priority is we try to change the mix and the structure of the client products. Right? So we try to remain relatively stable, but we just the combination of the clients and the products within the business. So that's actually what we're trying to do in the next two or three quarters. Right? So that's kind of the first factor you probably can consider. But we're not going to see the dramatic changes or swings from that business, but change the better structure of that. So this the first part. The second part is, as I mentioned, the new money and the capital expenditure were spending to the AI. Right? The infrastructure we built for clients and the mass, we call the model services, the solutions, and services with developed clients as well as the value-add part of the projects we do for the clients. So those are actually combined will be one of the -- probably the one priority for next year to grow the revenue. And if you do a quick math, I put this way as every $3 or $2 spend this year,…

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

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

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