VNET Group, Inc. Q3 FY2023 Earnings Call

Thank you, operator. Hello, everyone, and welcome to our third quarter 2023 earnings conference call. Our earnings release was distributed earlier today, and you can find a copy on our website as well as on Newswire services. Please note that today's call 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 we announced earnings press release and this conference call include the disclosure of audited GAAP and non-GAAP financial matters. VNET's earnings press release contains a reconciliation of the audited non-GAAP measures to the unaudited GAAP measures. As a reminder, this conference is being recorded. In addition, a webcast of this conference call will also be available on our 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 call today. I'd like to start with an overview of our third quarter performance. Our solid growth in the third quarter reflects our continued focus on high-quality business opportunities. Cabinet deliveries are progressing smoothly; by the end of the quarter, we had grown our total cabinets under management to approximately 88,900 compared with approximately 82,660 a year ago. The number of utilized cabinets increased by 1,092 to 52,408 in the third quarter, driving our overall utilization rate to 59%. Furthermore, our retail MRR per cabinet during the quarter stayed high at RMB9,495. We remain dedicated to generating high-quality revenues in both the wholesale and the retail IDC market in the third quarter, with our total net revenues increasing by 4% to RMB1.89 billion and adjusted EBITDA growing by 11.6% to RMB507.9 million. With the rapid pace of large language model training and AI application deployments, computing power is becoming a new productive force to meet the growing need for computing power. China's governing authorities have recently unveiled an action plan for the high-quality development of computing power infrastructure nationwide. As the industry-leading player, we are seeing increasing demand for premium IDC services, and we remain a clear choice for customers to ride the wave of digital transformation. Now let's take a closer look at our third quarter business update. First, AI is driving increasing demand for computing power and IDC services. Our wholesale data center continues to meet the increasing AI demand, driven by our customer traffic-growing business equipped with high-power density capabilities—we empower large language model training and deployment for Internet platforms. Our core competencies, spending resources and execution capabilities enable us to support our customers' evolving and sustained business development needs. As we mentioned on our last call, in August, we won an extended order of 45 megawatts from the existing internet giant customer, which speaks to our superior wholesale service offerings and positions us well in a major competitive landscape. Moreover, our deployment execution has been stellar. During the third quarter, we successfully delivered over 2,600 high-power density cabinets in the Yangtze River Delta region to one wholesale customer and approximately 800 high-power density cabinets in the northern region of China to another wholesale customer. Throughout the delivery process, we maintained strict quality standards and offered customization options tailored to customer requirements. This execution is a testament to our commitment to timely delivery and top-notch quality, which has earned us a reputation for reliability and customer satisfaction. Our retail customers' AI-driven demand continues to rise, particularly from existing customers in industries such as local services and healthcare. We are building on this momentum to attract more retail customers from a wider range of industries such as autonomous driving and AI solutions. I'd also like to highlight our distinctive proficiency in designing and implementing our equipment upgrades for our cabinets to meet existing customers' high-power density computing needs. This capability is well-supported by our engineering experience and expertise as well as our existing high-power density cabinets, which allows us to appropriately address the growing diverse AI demand from retail customers. In addition, we further expanded and diversified our retail customer base in the third quarter, attracting new customers and securing extended contracts from existing customers in various industries, including IoT, financial services, gaming, and mobility. It's also worth noting, we recently won a new order of 1.5 megawatts from an existing customer, a world-leading consumer electronics tech brand. Now turning to our value-add services. During the third quarter, our full-stack one-stop Bare-Metal-As-a-Service solution continued to gain new customers, one of which is a pioneering Unicorn in the VR industry. We won the contract based on our flexible computing power resources that can rapidly meet this customer's specific demand during peak business hours, underpinning the rapid growth of its metaverse business. Our diverse IDC services offerings include a solid IT infrastructure, premium operations and management services, and impressive cost-efficient solutions making VNET an outstanding choice for potential customers looking for a trusted partner to support their current and future business development needs. We have also attracted a leading Chinese EV automaker for our interconnectivity services throughout our robust data center and network resources nationwide. The customer can store their business data in adjacent data centers and transmit it with low latency backhaul. This customer reaffirms our compelling value proposition and advanced interconnectivity service capabilities. In summary, our robust third-quarter results showcase our ability to effectively address both wholesale and retail business IDC needs backed by timely and strong execution. Looking ahead, AI prevalence and adoption is emerging across industries and supportive government policies will accelerate the development of computing power infrastructure in China. As a dedicated industry leader, we look forward to meeting this newest wave of demand driven by AI application and our long-term growth potential. Thank you, everyone. I will now turn the call to Qiyu to discuss our financial performance for this quarter.

Thank you, Jeff. Good morning, and good evening, everyone. Before we start the detailed discussion of our financials, please note that we will present non-GAAP measures today. Our non-GAAP results include 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 third quarter of 2023 and in Renminbi terms. Now let me walk you through our third quarter financial results unless otherwise specified the growth rates I will be reviewing are all on a year-over-year basis. In the third quarter, we continued to deliver solid results with our focus on high-quality revenues. Our net revenue increased by 4% to RMB1.89 billion from the same period last year, mainly driven by the continued growth of our mine business. Gross profit was RMB306.5 million in the third quarter of 2023, representing a decrease of 3.2% from the same period of 2022. Gross margin was 16.2% in the third quarter of 2023 compared to 17.5% in the same period of 2022. Adjusted cash gross profit, which excludes depreciation, amortization and share-based compensation expenses was RMB738.4 million in the third quarter of 2023, an increase of 4.3% from the same period of 2022. Adjusted cash gross margin in the third quarter of 2023 was 39.1% compared to 39% in the same period of 2022. Adjusted operating expenses, which exclude share-based compensation expenses and compensation for the post-combination deployment in the acquisition, were RMB264.8 million in the third quarter of 2023 compared to RMB275.1 million in the same period of 2022, as a percentage of the net revenue, adjusted operating expenses in the third quarter of 2023 were 14% compared to 15.2% in the same period of 2022. Adjusted EBITDA in the third quarter of 2023 was RMB507.9 million, representing an increase of 11.6% from the same period of 2022. Adjusted EBITDA in the third quarter of 2023 excludes share-based compensation expenses of RMB9.5 million. Adjusted EBITDA margin was 26.9% in the third quarter of 2023 compared to 25.1% in the same period of 2022. Our net loss attributable to VNET Group in the third quarter of 2023 was RMB50.5 million compared to a net loss of RMB425.2 million in the same period of 2022. Basic and diluted loss were both 0.06 per ordinary share and both 0.36 per ADS. Each ADS represents 6 Class A ordinary shares. Turning to our balance sheet. As of September 30, 2023, the aggregate amount of the company's cash, cash equivalents and restricted cash was RMB3.02 billion. Meanwhile, net cash generated from operating activities in the third quarter of 2023 was RMB454.3 million compared to RMB607.4 million in the same period of 2022. Our capital expenditure in the third quarter of 2023 was RMB964.7 million. Before I conclude, I'd like to provide an update on our financial outlook for the full year 2023. For the full year of 2023, the company currently expects total net revenue to be between RMB7,400 million and RMB7,600 million, representing a year-over-year growth of 4.7% to 7.6%. Adjusted EBITDA is expected to be in the range of RMB2,000 million to RMB2,060 million, representing a year-over-year growth of 6.8% to 10%. This compares with total net revenue previously expected between RMB7,600 million and RMB7,900 million and adjusted EBITDA between RMB2,025 million and RMB2,125 million. The outlook update is mainly due to our continuous focus on high-quality revenues to maintain the long-term sustainability of our operations. This focus reflects the company's current and preliminary views on the market and its operational conditions and is subject to change. Moving forward, we will stay focused on our high-quality growth strategy, promoting our premium IDC services to empower digital transformation across a broader range of industries. As always, we remain committed to creating sustainable growth for all our stakeholders. This concludes our prepared remarks for today. Operator, we are now ready to take questions.

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

Thanks for the opportunity to ask a question. I would like to have an update in terms of the company's upcoming convertible bond repayment in February next year. What has been done? Or what is the current progress of the asset monetization to prepare for the repayment? Both for the potential REIT issuance and also the selling of minority stakes in existing projects, et cetera, whatever you can share now. Thank you.

Yes. Thank you. I know this is the most important question for us. Managing the liability issue has been my top priority since I took the CFO position. We are busy working on two major ways to resolve the issue. One is raising new funding from new equity and debt investment, as we need to follow the NASDAQ rules. We will be dedicated to pursuing new investors, and when the right time comes, we will make a public announcement if there is any concrete progress. We are also actively engaging with our convertible bond creditors to find the best way forward. Additionally, we are working hard on operating expense management and making positive progress in other fundraising efforts, including asset disposals of minority shares and REIT issuance. Both of these have made significant progress but will take some time to close these deals. Yes, we will try our best to leverage our incoming convertible bonds, and we have a firm plan to utilize both internal and external resources. Thank you.

May I follow up with another question on the business update? For the downward revision of the revenue and the EBITDA guidance, where do you see more business coming from? Is it from the traditional retail business or more from the wholesale business? Thank you.

Yes, we made some changes to our guidance. What I want to share is that with close to 13 years of IDC industry experience and market insights, we will be navigating our business towards a more focused and profitable business in the short to midterm. For example, this year, we have converted more IDC resources to areas like the AI model-driven wholesale business line. Clearly, the booming market promotes our profit margins. So we focus on this high-profit business and aim to discontinue some low-profit operations. Therefore, if you compare the revenue and EBITDA guidance, the EBITDA guidance only decreased by a minor amount of around 2%. In addition, we're planning to implement certain dual-core value practices within this year so our ongoing financial statements could better reflect the nature and transformation of our business. We will continue to focus on high-profit businesses, for example, the wholesale and AI-driven demand business.

Thank you, Yang. Our next question comes from the line of Charlie Bai from Jefferies. Please ask your question, Charlie.

This is Charlie Bai from Jefferies. My first question is about third quarter MRR. I saw a quarter-on-quarter decline in both utilization rate and retail MRR. May I know what is the reason behind it? Thank you.

In terms of MRR, I would say that for Q3, it still remained at a high level and is in line with our expectations. There might be some fluctuations from quarter to quarter, which is quite normal. Therefore, we believe that by the end of the year, it will stabilize again, and in terms of utilization rates, we estimate that UR will be on par with the Q3 2023 level with faster growth, particularly for our wholesale customers, especially those in the short video sectors, where we expect a higher utilization rate in 2024.

Thank you. My follow-up with another question. May I have some color on the outlook of the CapEx plan this year and in 2024? Thank you.

Yes. This year, the full-year CapEx is expected to be around RMB3.8 billion, which is about 10% more than our previous guidance. The main reason is that the demand for the wholesale data center business is growing faster. Next year, we anticipate a significant increase in full-year CapEx, mainly due to the accelerated growth rate of the wholesale business and heightened AI-driven demand. We will specify the CapEx figures in the full-year guidance early next year.

Thank you, Charlie. Our next question comes from the line of Timothy Zhao from Goldman Sachs. Please ask your question, Timothy.

Sure. Thank you, management for taking my question. I want to understand more about your updated guidance for this year. Just wondering, could you share a little bit more in terms of the revenue breakdown for the full year guidance for your wholesale IDC, retail IDC, and also the non-IDC business? And you mentioned that you are going to decrease exposure to those lower-margin businesses. Could you elaborate more on what exactly those lower-margin businesses are? I believe that does include the retail business, and how much more do you expect to reduce exposure in this segment? Thank you.

Yes. The wholesale and AI-driven demand is increasing faster, so we are trying to find more resources. For example, in some retail data centers, we are shutting down and closing some businesses for traditional retail customers and then reallocating space and power supply to AI customers. This is the main reason for our reduced revenue guidance. At the same time, you can see the EBITDA impact is very minor. This is not a slowdown of our business; rather, it's a signal that our EBITDA margin and EBITDA are more positive than before.

Our next question comes from the line of Daley Li from Bank America Securities. Please ask your question, Daley.

Hi, management. Thanks for taking my question. Just one on the AI space. You mentioned more high-power deployments for your data center. Could you please share the demand trend driven by AI? Do we have any breakdown of how much demand is coming from AI for the retail or wholesale business? And looking into next year, how do we view the AI demand for our data center business? Thank you.

Okay. In terms of AI, which has become very popular this year, we have actually seen the rapid growth of AIGC in China. Dozens of large language models across different sectors have already been launched since early this year. Many of them are still being trained, with the generic models being dominated by internet giants, while verticals are led by leading players in specific industries as well as some tech start-ups. Regarding the impact on our IDC demand, I would say that from the wholesale side, the AI-driven demand from wholesale customers is mainly driven by internet giant customers, especially in the short video e-commerce business. Notably, we delivered around 3,500 high-power density cabinets during the quarter to two wholesale customers. On the retail side, we are still receiving increasing AI demand from retail customers across various industries such as local services, healthcare, and VR. Additionally, we are further exploring the demand from new economy industries such as Fintech, where we are currently in dialogue. In terms of high-power density cabinets, these have been delivered from VNET's facilities located in the Greater Beijing area, Yangtze River Delta, and the Greater Bay area. The size of these cabinets ranges from up to 40 kilowatts to over 30 kilowatts for both wholesale and retail customers. So far, we have received about 90% of the demand from high-power density areas this quarter.

Okay, quite clear. Thank you, management for your insights. Thank you.

Thank you. We have reached the end of the question-and-answer session. And with that, ladies and gentlemen, that concludes our conference for today. Thank you for participating. You may now disconnect your lines. Have a good day.