VNET Group, Inc. Q4 FY2022 Earnings Call

Hello, ladies and gentlemen. Thank you for joining us for the Fourth Quarter and Full Year 2022 Earnings Conference Call for VNET Group Inc. Participants from our management team are Mr. Jeff Dong, Chief Executive Officer; Mr. Tim Chen, Chief Financial Officer; and Ms. Xinyuan Liu, Director of Investor Relations. Please be aware that today’s conference is being recorded. I will now hand the call over to your first speaker, Ms. Xinyuan Liu. Please proceed.

Thank you, operator. Hello, everyone, and welcome to our fourth quarter and full year 2022 earnings conference call. Our earnings release was distributed earlier today, and you can find a copy on our IR website as well as on newswire services. Please note that the discussion today will contain forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. For detailed discussions of these risks and uncertainties, please refer to our latest annual report and other documents filed with the SEC. VNET does not undertake any obligation to update any forward-looking statements, except as required under applicable laws. Please also note that VNET’s earnings press release and this conference call include the disclosure of unaudited GAAP financial matters as well as unaudited non-GAAP financial measures. VNET’s earnings press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited GAAP matters. As a reminder, this conference is being recorded. In addition, a webcast of this conference call will also be available on our IR website at ir.vnet.com. I will now turn the call over to our CEO, Jeff.

Thank you, Xinyuan. Good morning and good evening, everyone. Thank you for joining our fourth quarter and full year 2022 earnings conference call. Leading with macroeconomic headwinds and COVID-related disruptions, 2022 was an extraordinary year. Amid this challenging environment, we delivered solid financial and operational results through excellent execution of our Dual-Core strategy. We achieved our 2022 delivery target by ending approximately 8,400 self-built cabinets. By the end of the fourth quarter, our total cabinets under management had grown to approximately 87,320 from 78,540 a year ago. Meanwhile, cabinets utilized by customers increased sequentially by approximately 2,500 to approximately 48,000 compared to approximately 41,700 one year ago. Our overall utilization rate was 55%. In addition, our retail MRR per company increased to RMB9,371 in the fourth quarter, up from RMB9,287 in the third quarter. We concluded 2022 with a resilient fourth quarter revenue of RMB1,881 million, an increase of 7.7% year-over-year, and adjusted EBITDA of RMB424 million. For the full year, our revenue grew 14.1% to RMB7,065 million and adjusted EBITDA increased 6.8% to RMB1,873 million. Before we get deeper into our business details for the fourth quarter, I’d like to touch on the broader macro climate in China for some context. According to the 2023 government work report issued earlier this month, the central government set a GDP growth target of around 5% for this year, up from last year’s 3%. In addition, the government will continue to accelerate the digital transformation of traditional industries and small and medium-sized enterprises. We are also supporting the development of the platform economy. Last month, the central government rolled out a plan to build Digital China by 2025, which highlights the country’s focus on expanding data resources and improving digital infrastructure. Encouraged by these supportive measures and positive signals, we expect the industry’s vitality to gradually recover and business confidence to rebound. In particular, we believe the internet giants will play to their strengths in technology to empower the development of the digital economy and unleash greater demand across the markets. As China’s leading IDC service provider, we are well-positioned to capture new growth opportunities ahead. Now, let’s take a closer look at our Q4 business updates. Execution of our Dual-Core strategy continues to prove strongly effective both in the wholesale and retail IDC markets. On the wholesale front, we continue to gain robust sales momentum with two major orders despite the macro challenges. In the fourth quarter, we extended our wholesale data center services contract with one of our largest existing customers, a leading social platform in China. This extended order will generate a capacity of approximately 33 megawatts. More encouragingly, we recently won the bid to deploy IDC services in multiple phases to support the business expansion for a new customer, one of China’s Internet giants. During the first phase, we expect to provide the customer with a capacity of over 100 megawatts through our IDC assets located in the Yangtze River Delta region. This collaboration represents a significant development opportunity for us and demonstrates our proven track record of providing IDC services to powerhouse companies across China’s Internet industry. Moving on to our retail business, we continue to make meaningful progress on our customer base expansion in the fourth quarter, supported by our premium co-location and interconnectivity offerings as well as our value-added services. We continue to extend our services to existing customers and attract new customers, meeting increasing demands from a wide spectrum of industries, including financial services, local services, mobility, online gaming, and some traditional industries. In particular, our connectivity services have tapped into a variety of sectors, including public transportation, public cloud, and healthcare, providing further testament to our industry-leading service capabilities. Next, I would like to highlight our progress on hybrid cloud offerings. In the fourth quarter, we successfully facilitated digital transformation for the Mainland China operations of Watsons, a leading Asian health and beauty retailer. We provided the customer with a one-stop infrastructure as a service, our air solution, as well as complete operations and maintenance services for both software and hardware to optimize customers’ IT architecture, enhance business reliability, and improve operational efficiency. Looking ahead, we will continue to empower our customers’ transitions into the evolving digital era by leveraging our IDC asset network and service capabilities. Turning to our ESG initiatives, we have always held our long-term commitments and responsibilities to our industry, environment, and society as a foundation of our ongoing success. Our dedication and hard work are paying off, earning the company recognition from globally renowned ESG rating agencies. We made great progress in our ESG ratings in 2022, thanks to our continuous efforts in improving our ESG performance. MSCI upgraded us to an A rating in December 2022, which represents the highest ranking today in China’s Internet service and infrastructure industry. In addition, our ESG score measured by the S&P Corporate Sustainability Assessment reached 57, ranking us in the top 10% among all companies in the IT services industry globally. We also submitted CDP’s climate change questionnaire in 2022 and achieved a B grade, which exceeded that of 96% of participating companies in China. These accomplishments and accolades clearly demonstrate the effectiveness of our ESG strategy while strongly affirming our long-term investment value and development prospects. Moving into 2023, while the economic recovery is still underway and may need time to realize a full rebound, we remain confident in the long-term growth potential of China’s market as well as the IDC service industry as a whole. As a result, we set our 2023 delivery plan in the range of 8,000 to 9,000 cabinets. We believe supportive government policies will accelerate China’s digitalization across multiple industries, and our proven dual-core growth strategy and its leading service capabilities will keep us at the forefront of the market recovery. We will remain agile as we navigate shifting market dynamics and capitalize on our future growth opportunities, creating sustainable and long-term value for our shareholders. Thank you, everyone. I will now turn the call to our CFO, Tim, to discuss our financial performance for the quarter and our business outlook.

Thank you, Jeff. Good morning and good evening, everyone. Before we start the detailed discussions of our financials, please note that we will present non-GAAP measures today. Our non-GAAP results exclude certain non-cash expenses, which are not part of our core operations. The details of these expenses may be found in the reconciliation tables included in our earnings press release. Please also note that unless otherwise stated, all the financials we present today are for the fourth quarter of 2022 and in terms. As Jeff just mentioned, we concluded 2022 with resilient operating and financial performance amidst a myriad of external challenges, which speaks to our outstanding execution. Next, let me walk you through our fourth quarter financial results. Unless otherwise specified, the growth rates I will be reviewing are all on a year-over-year basis. In the fourth quarter, our net revenue increased by 7.7% to RMB1.88 billion from the same period last year, mainly due to increased customer demand for our highly scalable carrier and cloud-neutral IDC solutions from both wholesale and retail IDC businesses as well as the continued growth of our cloud and VPN services. Gross profit was RMB328.4 million in the fourth quarter of 2022, representing a decrease of 13.6% from the same period of 2021. Gross margin was 17.5% in the fourth quarter of 2022 compared to 21.8% in the same period of 2021. Adjusted cash gross profit, which excludes depreciation, amortization, and share-based compensation expenses, was RMB740.1 million in the fourth quarter of 2022, an increase of 3.7% from the same period of 2021. Adjusted cash gross margin in the fourth quarter of 2022 was 39.4% compared to 40.9% in the same period of 2021. Adjusted operating expenses, which exclude share-based compensation expenses, compensation for post-combination, deployment and acquisition, impairment of loan receivable to potential investee, and impairment of long-lived assets, were RMB355.4 million in the fourth quarter of 2022 compared to RMB273.7 million in the same period of 2021. As a percentage of net revenues, adjusted operating expenses in the fourth quarter of 2022 were 18.9% compared to 15.7% in the same period of 2021. Adjusted EBITDA in the fourth quarter of 2022 was RMB424.3 million, representing a decrease of 8.3% from the same period of 2021. Adjusted EBITDA in the fourth quarter of 2022 excluded a reversal of share-based compensation expense of RMB7.8 million. Adjusted EBITDA margin in the fourth quarter of 2022 was 22.6% compared to 26.5% in the same period of 2021. Our net loss attributable to ordinary shareholders in the fourth quarter of 2022 was RMB64.2 million compared to a net loss of RMB27.3 million in the same period of 2021. Basic and diluted loss were both 0.07 per ordinary share and both 0.42 per ADS. Each ADS represents six Class A ordinary shares. Now turning to our balance sheet. As of December 31, 2022, the aggregate amount of the company’s cash, cash equivalents, and restricted cash was RMB2.99 billion. Meanwhile, net cash generated from operating activities in the fourth quarter of 2022 was RMB569.6 million compared to RMB664 million in the same period of 2021. Our CapEx in the fourth quarter of 2022 was RMB1.21 billion, and the total CapEx for the full year 2022 was RMB3.35 billion. Now moving to our outlook. We expect net revenues for the full year of 2023 to be in the range of RMB7,600 million to RMB7,900 million, representing a year-over-year increase of 7.6% to 11.8%, and adjusted EBITDA to be in the range of RMB2,025 million to RMB2,125 million, representing a year-over-year increase of 8.1% to 13.5%. Looking forward, we will continue to execute on our dual-core growth strategy and remain focused on our core business as well as higher quality revenues. In addition, we will continue to explore more capital resources to further strengthen our financial position. This concludes our prepared remarks for today. Operator, we are now ready to take questions. Thank you.

Thank you. Our first question comes from Yang Liu of Morgan Stanley. Please go ahead with your question.

Good morning. Thank you for the opportunity to ask questions. Two questions from my side. The first one is about the moving. Could management share the color year-to-date, what is the moving looks like from your retail and wholesale customers? And what should be the utilization rate by the end of this year, if we add another 8,000 to 9,000 cabinets? Yes, that’s the first question. And the second question is we are glad to see that the company onboard a new wholesale customer with a pretty big order size. When should we expect the financial contribution will be visible in future? Thank you.

Hi, Yang, can you hear me?

Yes, I can.

Okay. Let me take the second question, and then I’ll pass it back to Jeff and the team on the first question on the ramp-ups. For the new customer that we’ve announced just now, we’re expecting the financial contribution to take place next – basically end of this year, early next year. So obviously, it’s going to take us time to deliver the cabinets. So by the time the meaningful financial contribution takes place it will be in 2024. I hope that’s helpful. Let me pass the ramp-up in terms of what we’ve been seeing in the fourth quarter and the first few months of the first quarter to Jeff and team.

Hi, Yang, it’s Jeff. Regarding the ramp-up at the end of 2022, we will be at a 55% utilization rate. We expect more for this year. Given the – let me give you some colors on the new customers, just as Tim mentioned. It certainly is actually the large majority of the available cabinets in Q4. So, we can see, as you mentioned, moving from Internet players is very good and faster than what we expect from the cloud service providers. Given the contribution to our financials, I would say in terms of this contract, we will see by the end of this year, as over 70 megawatts next year. So, we see substantial and large financial contributions will come up by the end of this year and probably early next year.

Thank you.

One moment for our next question. Our next question comes from the line of Sara Wang of UBS. Please proceed with your question.

Hi. Thank you for the opportunity to ask the questions. So, I have one question. Would management please walk us through the financing plan and also the major cash inflows and outflows for this year, especially given one of the convertible bonds might be put for early next year? Thank you.

Thanks, Sara for the question. It’s Tim here. With regards to the overall financing plan, we have obviously started already at the end of last year going through the alternatives available to the company. We have seen positive news that the public markets are gradually opening up. As for the major sort of inflows and outflows, obviously, the business continues to generate a very healthy operating cash flow. Outflows would be mainly CapEx, and at this moment, we are expecting CapEx to be quite similar to what it was in 2022, which is between RMB3 billion to RMB3.5 billion. However, I would then point out that this CapEx is not all committed or contracted. We do have the ability to ratchet back during the course of the year, and we will do so really for two areas. One is, as we see the customer demand and also the customer requirements in terms of delivery dates shift, you have seen us also in 2022 adjust during the course of the year as required. Secondly, obviously, we are planning our overall cash flow for the potential refinancing of the convertible bond that would be in the first quarter of 2024. So, that’s something that we are keeping a very close eye on and obviously looking to various alternatives. Given where share prices are for us and our peers, we will be mainly looking at debt and convertible as the main instruments. Also something that we already mentioned last year, we continue to work on would be onshore renminbi financings both in the form of private and public reach. I hope that answers your question, Sara.

Thank you. And just a quick follow-up. On the operating cash flow for 2022, it seems it was RMB2.6 billion. So, how shall we think about the operating cash flow level for 2023? Thank you.

Yes. I would say that, look, the working capital points will not move very, very much. So, you are looking at underlying EBITDA as a good proxy. We have given some guidance on EBITDA. I think you can use that as a proxy on where directionally we expect operating cash flow to go as well.

Got it. That’s clear. Thank you.

Thank you, Sara.

One moment, please. Our next question comes from the line of Edison Lee of Jefferies. Please proceed with your question.

Thank you, Tim and Jeff, for the presentation. I have two questions. First, regarding the new customer side, I noticed you have signed up for over 100 megawatts. Based on your earlier comment, I assume the 3,000 included in your 2023 guidance is not related to this customer; I just want to confirm that. Additionally, could you provide some insights on the pricing and the potential for follow-on orders from this customer in the same region or data center companies? My second question is whether you can provide an update on your joint venture IPC fund with the government, and if that is being incorporated into your 2023 guidance, or how much of it is automatically factored in. Thank you.

Hi, Edison. Let me answer your questions. The first one, in terms of new customers. Yes, it is. We included 3,000 cabinets this year, which is from the first phase of the new customer.

Sorry, yes. So, can I confirm that this 3,000 cabinets will be delivered towards the end of the year, so that’s why the financial contribution will be seen in 2023...

Yes, that’s correct. It’s Tim here. That’s correct. We are expecting that these will be delivered at the very tail end of the year. So, I don’t expect, at least from my side, any meaningful financial contribution probably a little bit at the very beginning of it. But really, the meaningful contribution will be in 2024, first quarter.

Sorry. Can I also follow-up with just one related question? So, will this 100 megawatts be fully delivered within 2024 or is it going to go into 2025?

It’s going to be divided into the different phases. The first phase will be this year, and early next year, we will deliver like one-third – sorry, two-thirds and the remaining will be delivered in the next year.

No, sorry. The first phase, the first part is going to be mainly in 2023 into the early part. But the balance, we will need to see whether the customer will give us the heads up. If their move-in rate is very, very strong, they may give us an earlier go ahead, in which case, yes, it would be in 2024. But if not, it could actually drag into the outer years?

I am sorry, I want to further clarify because I think that’s an important point. So, this 100-megawatt contract you already signed the MOU with the customer. However, the timing of an increase is actually not specified in the MOU. Is this understanding correct?

Only part of it is specified and the balance is not. The indications that they have given us – yes, yes, correct.

Tim, let me put it this way. Edison, we will be fully delivered within the three years for the MOU with the customer.

And in the same location, right? All this capacity is in the same location?

Yes, same location. Yes.

Okay. Thank you.

Yes. In terms of the second question...

Sorry, Jeff, please go ahead.

Okay. Let me answer your questions in terms of the JV with Changzhou. We have actually – we recently signed an SPA in the Langfang area with one project, which is the largest from the identified portfolio. The JV has already committed over RMB500 million on asset proportion, and we also committed the capital. This Langfang project will achieve IT scale of about 140 megawatts and will deliver cabinets more than 17,000 cabinets in total. That’s what we have done so far. Other projects, we are also closely in discussion with Changzhou and will ramp up soon, probably by the end of this year, including Shenzhen, Dongguan, and also in Central Beijing areas.

Thank you. Just a follow-up. So, will this Langfang project be contributing profitability to VNET this year?

I wouldn’t see it contribute to VNET’s financials, but we will – it’s also divided into different phases. The Phase 1 and Phase 2 have already had customers, and we are signing the SPA on the Phase 3 and Phase 4, which is a greenfield project with a full regulatory license, hopefully will be delivered by the end of this year and ramping maybe next year.

Okay. Thank you very much.

Ladies and gentlemen, that concludes our conference today. Thank you for participating. You may now disconnect.