Earnings Call Transcript - VNET Q1 2020

Rene Jiang, Investor Relations Director

Hello, everyone. Welcome to our first quarter 2020 earnings call. Before we start, please note that this call may contain forward-looking statements made pursuant to the Safe Harbor provisions for the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on management's current expectations and observations that involve known and unknown risks, uncertainties, and other factors not under the company's control, which may cause actual results, performance or achievements of the company to be materially different from the results, performance or expectations implied by these forward-looking statements. All forward-looking statements are expressly qualified in their entirety by the cautionary statements, risk factors, and details of the company's filings with the SEC. 21Vianet undertakes no duty to revise or update any forward-looking statements for selected events or circumstances after the date of this conference call. I will now turn the call over to Mr. Alvin Wang, CEO and President of 21Vianet.

Alvin Wang, CEO and President

Thank you, Rene. Good morning and good evening, everyone. Thank you for joining us on our earnings call today. First and foremost, all of us here at VNET hope that you and your loved ones are staying safe and healthy. Post-IDC industry and our company continue to grow in the periods; we are acutely aware of the pandemic toll on society. Even so, we also saw some of the best in humanity as medical workers, grocery store workers, police officers, and our own employees came together in support of their communities. On behalf of the company, I would like to say a special thank you to all those fighting against the virus on the front lines. This continues to be a source of inspiration. We are all truly grateful. In the first quarter of 2020, we grew our revenues to RMB 1.091 billion, and our adjusted EBITDA was RMB 259 million, meeting both of our previous guidance ranges. Meanwhile, EBITDA margin declined to 23.8% due to our continuous expansion of IDC capacity. During the quarter, we added over 3,300 cabinets to our locations in Shanghai and Jiangsu provinces, which brought our total cabinet capacity to 39,646 by quarter-end. This strong performance was the product of our effective execution during the crisis, which enabled us to maintain our construction and cabinets delivery schedules. In regards to market conditions, China's IDC industry continues to grow at a good pace in the first quarter despite the uncertainty brought about by the outbreak of COVID-19. While the pandemic has caused a momentary pause in construction, social distancing policies around the country have begun loosening in the second quarter, and the multiple IDC services remain strong. Furthermore, our data centers are increasingly recognized as an important component of China's digital transformation; the government has begun to take a more positive extend towards the environment. We expect that the ongoing movement towards corporate digitalization, as well as deployments of innovative IDC solutions, will continue to help drive industry expansion over the long term. For our retail IDC services, which include connectivity and other value-added services, customer demand was remarkably resilient during the quarter as various industries shifted to work-from-home arrangements during the quarantine period. However, we also saw a lower number of orders across certain verticals, namely online education, online gaming and entertainment, and software-as-a-service. Meanwhile, due to the lockdown measures and social distancing policies, certain verticals experienced a slower quarter while the demand and the move-ins from other verticals, although relatively removed from the pandemic impacts, were delayed as a result of holiday extensions and remote work measures. As of now, we are monitoring the situation attentively and we remain in close contact with our business partners and customers as the pandemic developments become more positive in the second quarter. We expect that the demand for innovative IDC solutions will maintain its healthy growth trajectory. On a wholesale front, we continue to enhance our relationships with large scale informatics while proactively engaging with our partners during the pandemic to fortify our market leadership. These clients are affected by national coverage of our pipeline resources, the quality of our hyperscale IDC services, and our ability to augment their operating efficiencies. In May 2020, we signed two annual deals with a leading Chinese internet company to provide colocation facilities in both the northern and eastern parts of China based on our existing resources. Going forward, we plan to complete construction in phases during 2020 and 2021. In summary, we remain committed to generating value for both clients and shareholders. The essential nature of our services, commitment to the protection of employee safety, and the ability to maintain operations when part of our staff works from home have allowed us to prosper in the face of the global pandemic. Based on the stability under the growth of industrial demand as well as recovery in the post-pandemic periods, we remain confident in our prospects going forward. Now, I would like to hand the call over to Sharon Liu, CFO of our company, to give you more details on our financial results.

Sharon Liu, CFO

Thank you, Alvin, and hello, everyone. Before we start our detailed financial discussion, please note that we will present non-GAAP measures today. Our non-GAAP results exclude certain non-cash expenses that are not part of our core operations. The details of these expenses may be found in the reconciliation tables included in our press release. Please note that all of the financial numbers we are presenting today are in RMB terms and that percentage changes are on a year-over-year basis unless otherwise stated. In an uncertain macro environment, we concluded the first quarter with strong financial results, improved our operating efficiency, and kept our construction and cabinet delivery schedules on track. Notably, in the first quarter, other revenue reached the high-end of our previous guidance range while our adjusted EBITDA was around the mid-point of our previous range. Revenue in the first quarter increased by 25.1% to RMB 1.09 billion from RMB 871.9 million in the same period of 2019; such growth was primarily due to the industry's healthy trajectory, which is being driven by the ongoing trend of corporate digitalization across China. It was also partially due to an increase in IDC demand from retail customers resulting from certain industry tailwinds that emerged during the pandemic. Retail IDC ARPU per cabinet in the first quarter decreased slightly to 8,747 from 8,788 in the same period of 2019. We net added 3,355 cabinets during the first quarter of 2020. As of March 31, 2020, we operated and managed 39,646 cabinets, and the compound utilization rate in the first quarter was 60.4% compared to 65.6% in the first quarter of 2019, which was mainly due to our continued delivery of additional cabinets in the period. More specifically, our utilization rate for those mature IDCs delivered prior to 2019 improved to 72.3% in the first quarter of 2020 compared to 71.8% in the first quarter of 2019. At the same time, the utilization rate for those newly built and ramp-up IDCs delivered since 2019 improved to 12.3% compared to 8.6% in the first quarter of 2019. Adjusted cash gross profit in the first quarter, which excludes depreciation, amortization, and share-based compensation expenses, was RMB 417.1 million compared to RMB 406.7 million in the same period of 2019. Adjusted cash gross margin was 38.2% compared to 46.6% in the same period of 2019. The decline in margin on a yearly basis was due to the delivery of additional IDC capacity. Adjusted operating expenses in the first quarter, which exclude share-based compensation expenses and impairment of receivables from equity invested, increased to RMB 177.8 million from RMB 171.3 million in the first period of 2019. As a percentage of net revenues, adjusted operating expenses decreased to 16.3% from 19.6% in the same period of 2019. Adjusted EBITDA in the first quarter grew by 2.3% to RMB 259.4 million from RMB 253.5 million in the same period of 2019. Adjusted EBITDA margins decreased to 23.8% from 29.1% in the same period of 2019 due to the delivery of additional capacity. Net loss attributable to ordinary shares in the first quarter was RMB 138.8 million. Basic and diluted losses were RMB 0.18 per ordinary share and RMB 1.08 per ADS, respectively; each ADS represents six ordinary shares. Moving on to our balance sheet and liquidity; at the end of this first quarter, our debt to asset ratio was 66.8%, and our debt to adjusted EBITDA ratio was 4.2. Net cash generated from operating activity was RMB 58.7 million in the first quarter. As of March 31, 2020, we recorded a cash position of RMB 3.49 billion. Going forward, we plan to maintain a healthy balance sheet as a means of maximizing our ability to capture potential growth opportunities and expand our services in key markets. In order to support the company's organic growth and meet its delivery target of 15,000 cabinets, we are planning for CapEx to be between RMB 2.4 billion and RMB 2.8 billion in 2020, which is in line with our three-year growth plan. Looking forward, we expect net revenue for the second quarter of 2020 to be in the range of RMB 1.14 billion to RMB 1.16 billion and adjusted EBITDA to be in the range of RMB 290 million to RMB 310 million. For the full year of 2020, we now expect net revenue to be in the range of RMB 4.6 billion to RMB 4.8 billion and adjusted EBITDA to be in the range of RMB 1.25 billion to RMB 1.35 billion. This forecast reflects our current and preliminary views on the market and our operational conditions, which are subject to change and do not factor in any of the potential impact that could be caused by the COVID-19 epidemic in the future. This concludes our prepared remarks for today. Operator, we are now ready to take questions.

Operator, Operator

Thank you very much. Ladies and gentlemen, we'll now begin the question-and-answer session. [Operator Instructions] Our first telephone question is from Edison Lee from Jeffries, Hong Kong. Please ask your question, Edison.

Edison Lee, Analyst

Hi, good morning, Alvin and Sharon. Thank you very much for taking my questions. So first of all, congratulations on a very strong revenue growth in the first quarter. I have two questions. Number one is, I would like to know because one of your peers actually told investors that power costs were actually a little bit lower than expected in the first quarter owing to some government support policy. So, I would like to see whether VNET also saw something like that? And would you expect some work on policy on power costs in the rest of the year can emerge to help lower the cost for you guys? So that's question number one. Question number two is that I would like to clarify regarding your capacity growth in the first quarter, the 3,300 cabinets; whether it includes any wholesale in that number? And if it does, how much is that? Thank you.

Sharon Liu, CFO

Thank you, Edison. I will take your question on the capacity, as well as the power cost. Actually, our power costs represent around 15% to 18% of our total revenue in our IDC business. We see that power cost was stable during Q1. Of course, for government policies; as the data center matures, we can apply for a reduction of the power capacity commitment. That will help us to reduce the power costs, but the amount is not so significant. Regarding your questions related to our capacity delivered in Q1, actually we have delivered two data centers. One is the wholesale data center in Jiangsu campus, which is around 1,000 high power density cabinets. So, the company will start to recognize wholesale revenue and EBITDA from Q2. Thank you.

Alvin Wang, CEO and President

This is Alvin. I will add a few words regarding your first question. Actually, we do see some favorable policy from the government regarding optimizing our power costs. But that policy will be temporary; it will adjust for a few months and will apply to some of our data centers across our network. So, the impact is positive, but it will be temporary and will have a marginal impact. Thank you.

Edison Lee, Analyst

If I can ask a follow-up on the power cost. How much of your power arrangement is actually based on direct power purchase?

Sharon Liu, CFO

Hi, welcome. Almost all the power is purchased from the government.

Alvin Wang, CEO and President

The state rate from the north and from the south applies.

Edison Lee, Analyst

Okay, that's fine. Thank you very much.

Alvin Wang, CEO and President

Okay, thank you.

Operator, Operator

Next telephone question is from Yang Liu from Morgan Stanley. Please ask your question.

Yang Liu, Analyst

Thank you for the opportunity to ask questions. I have two questions. The first one: management mentioned that you signed two MOUs with an internet company. Could you please share more detail on that; on size or data public cloud, or is it a customer or - yes, what was this vertical, particularly? Is it a wholesale or retail customer? The second one is - could management share your thoughts on the public rates policy issued by the CSRC and NDRC? And what is VNET's plan to leverage that kind of rates policy in the future? Thank you.

Alvin Wang, CEO and President

Okay, thank you Liu Yang for your questions. I will address your first question. As you mentioned, we already signed two MOUs with a leading Chinese internet player who is our existing customer. These two projects are wholesale projects, and we expect the first project to deliver within this year, while the second will deliver in different phases in the following years. Actually, these two projects mark another milestone for us to enhance our cooperation with leading customers, especially on the wholesale side. Additionally, if we combine all the MOUs together with wholesale customers, we have accumulated 19 megawatts of contracts already. Thank you.

Sharon Liu, CFO

Hi, Yang. Regarding your question on public rates, we noticed that on April 13, NDRC and CSRC jointly announced the pilot program on the infrastructure-related public rates. As the Chinese government has included data centers in their new infrastructure scope, mature data center assets generating stable cash flows are the suitable assets for these rates. According to resources we talked to, the issuer should have ownership of the IDC land and property, and the government likes diversifying the customer base in the data center. For our case, we have qualified data centers for public rates, and we believe this is a viable alternative funding channel for other material data centers. We will continue to focus on the progress because the document announced is only a consultation version; we'll wait for the final version and clearer policy. Thank you.

Yang Liu, Analyst

Thank you.

Operator, Operator

Our next telephone question is from Tina Hal from Goldman Sachs. Please ask your question, Tina.

Tina Hal, Analyst

Hi, thank you very much management for your time. I have two questions. The first one is that, have you seen any supportive policies coming out from the government on data centers as the new infrastructure area? Has there been any new capacities coming into the market either in Tier 1 places or the Tier 1 adjacent markets such as Jiangsu? And related to that, have you seen the competition ramp up to some extent? And is it getting easier or more difficult to acquire land and electricity resources? So, that's number one. And in terms of the second question, also under the MOU that you signed recently with a wholesale customer; could you share more details on what kind of size - and then, specifically, which quarter of the year can you see the MOUs starting to generate revenues? Thank you.

Alvin Wang, CEO and President

Thank you, Tina, for your questions. Regarding your first question, there is very strong support from the government regarding data centers in China. We see that local authorities from different provinces have issued policies to support or encourage more investments in data centers and new infrastructure for the country. I expect that, including ourselves, we can gain more access to land and property and also power supply for high-tier data centers across different locations. At the same time, I will say that we see this is a very competitive market landscape, requiring strong customer relationships, engineering, technology, capital, and of course, cost control. So, we do see that we have positioned ourselves well in the coming years to acquire more resources to serve our customers with their increasing demand. Regarding your second question, as I mentioned before, we have signed with our existing customers and released two wholesale projects, both involving leading customers. One is in Beijing, which we expect to deliver in early Q3 this year, and the second, an even bigger one, will be in the central part of China, with delivery taking place in the second quarter of next year, and it will involve expansion in subsequent phases.

Operator, Operator

[Operator Instructions] Our next telephone question is from Jen-Yang Chen from CICC. Please ask your question.

Jen-Yang Chen, Analyst

Hi, management. Thank you for taking my question. I have two questions. The first one is about our future expansion plans. We noticed that the Shanghai government has announced to increase another 16,000 rep quota. Would we have any adjustments accordingly on our agency portfolio expansion? And how do we expect any other supporting policies in the future? My second question is about our customers from cloud computing. We noted that cloud computing has very strong demands on the IDC industry. For example, Alibaba has announced a RMB 200 billion investment. How do we adjust our future strategies accordingly to meet the hyper-scale customer demands? Thank you.

Alvin Wang, CEO and President

Jen-Yang, thank you for your questions. Regarding your first question, I appreciate your noting the supporting policy from different local governments, especially Shanghai, which has already made clear announcements. This gives us a way to prioritize Shanghai as one of our top markets, and we do have big projects there in the pipeline to apply for new power quotas in the next batch of approvals. We expect the approval process to be completed in the coming quarters, and we are confident that we can gain strong support from the local authorities based on our capacity and strong track record in Shanghai. Moreover, we will also expand our capacity not only in Shanghai but also in several cities around it. We have a Jiangsu campus and we expect further expansion in the surrounding area as well. Regarding your second question about cloud computing, we see strong demand from cloud customers already in the first quarter, and we have been actively engaging with leading players, including Alibaba, Tencent, Huawei, and JD. We anticipate that the public cloud segment will be a major growth driver for our business in the coming years. Thank you.

Unidentified Analyst, Analyst

Thank you.

Operator, Operator

Our next telephone question is from Jon Atkin from RBC. Please ask your question, Jon.

Jon Atkin, Analyst

Thank you, and good morning. I wanted to ask a question about the evolution of cloud demand, public cloud, and any trends that you can talk about regarding enterprise migration from co-location to public cloud or hybrid cloud deployments. Is there anything that you're noticing in your business or more broadly with respect to cloud migration or hybrid cloud adoption? Thank you.

Alvin Wang, CEO and President

Thank you, Jon, for your question; it's a very broad question. We are seeing strong business demands from public cloud customers. Many of them have huge plans, meaning that in the coming years, public clouds will have significant demand for IDC custom players, including us. At the same time, we also see some of our own IDC customers strongly demand hybrid clouds, indicating that they intend to deploy capabilities not just on public clouds, but also on dedicated hosting as well. Based on our cooperation with leading public cloud players, we can provide cutting-edge, competitive hybrid cloud solutions to our customers, which we consider a major competitive advantage. Thank you.

Jon Atkin, Analyst

Thank you.

Operator, Operator

[Operator Instructions] There are no further questions at this time. I'd like to hand the call back to the speakers for closing remarks. Please go ahead.

Rene Jiang, Investor Relations Director

Thank you again for joining us today. If you have any further questions, please feel free to contact the company's Investor Relations team. Thank you.

Operator, Operator

Ladies and gentlemen, that does conclude the call for today. You may all disconnect. Have a great day. Bye.