VNET Group, Inc.

Hello, ladies and gentlemen. Thank you for standing by for the third quarter 2022 earnings conference call for VNet Group, Inc. At this time, all participants are in a listen-only mode. After the management's prepared remarks, there will be a question and answer session. Participants from our management include Mr. Jeff Dong, Chief Executive Officer, Mr. Tim Chen, Chief Financial Officer and Xin Yang Liu, Investor Relations Director of the company. Please note that today's conference call is being recorded. I will now turn the call over to the first speaker today, Ms. Xin Yang Liu.

Please go ahead.

Thank you, operator. Hello, everyone, and welcome to our third quarter 2022 earnings conference call. Our earnings release was distributed earlier today. and you can find a copy on our website as well as our newswire services. Please note that the discussion today will contain forward-looking statements made under the safe harbor provisions of the US 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. VNAT does not undertake any obligation to update any forward-looking statements except as required under applicable law. Please also note that VNAT's earnings trust release and this conference call include the disclosure of unaudited GAAP financial matters as well as unaudited non-GAAP financial matters. VNAT's earnings trust release contains a reconciliation of the unaudited net gap matters to the unaudited gap 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, Qingyuan. Good morning and good evening, everyone. This is Jeff. It's a great pleasure to meet and speak with all of you today. I'm deeply honored to take on the role of CEO and excited to explore the great opportunities and prospects ahead for VNet. I look forward to leveraging my cross-industry expertise and working closely with our talented team to drive the company's dual core growth strategy and cement our commitment to delivering sustainable long-term value to our shareholders. I'd like to start with an overview of our third quarter performance. Against the backdrop of mounting macroeconomic headwinds, we remain focused on fulfilling market demands for high-quality and reliable ITC services. By the end of the third quarter, we had grown total capital needs under management to 82,660 from approximately 65,300 one year ago. At the same time, capital needs utilized by customers increased sequentially by 1,027 to approximately 45,530 compared to approximately 38,301 years ago. As a result, overall utilization rate remains flat at 55.1% as compared with the end of June. In addition, our retail MRR per company ramped up to 9,287 RMB in the third quarter. compared with 9,186 RMB in the previous quarter. Our third quarter financial results reflect healthy progress in our wholesale and retail business, as well as our effective execution of our dual-core strategy. Our net revenues for the third quarter increased by 16.3% year over year to 1.814 billion RMB and adjusted EBITDA-rich 455 million RMB. Today's world is preparing for digital as a new norm. For business to attempt and thrive in this new era, digital transformation is paramount. As we witnessed as the 20th National Congress of the CPC, the central government support this transformation as part of China's high-quality growth trajectory. Policy guidelines favoring technological innovation and digital development across the widest spectrum of industries are in place. We are excited to see the digital infrastructure sector at the forefront of this broad-based digitalization effort and believe that it will further fill market demand for data center services. As a leading player in IDC space, we are ideally positioned to capture this burgeoning demand and unleash new growth potential going forward. Despite a challenging and volatile near-term macro environment, we see long-term demand remains strong, with fundamentals surrounding cloud and digital transformation still intact. In response to the short-term headwinds, we plan to adopt a more prudent approach to our company delivery for the fourth quarter. Therefore, we are further revising our 2022 full-year company delivery plan to the range of 8,000 to 9,000. from the previous range of 9,400 to 12,400. The current outlook has factored in macro softness, slower moving, and the COVID-related restrictions. Now let's take a closer look at our progress across our business line during the third quarter. On the wholesale business front, we continue to gain sales momentum. In the third quarter, we send a new contract of approximately 15 megawatt with a leading cloud service provider in China to build its network infrastructure in the Yangtze River Delta region. Moreover, we recently once again extended our wholesale data center services contract with one of our largest existing customers, a leading social platform in China. This new order will generate a capacity of approximately 33 MW. Since the launch of our wholesale business in 2019, we have established a strong presence in this market segment, accumulating total contracted capacity in the service or under MOU of 283 megawatt by the end of the third quarter. Our in-depth industry know-how, methodical resource management, and sophisticated engineering capabilities are key to our success in this sector. On the retail business front, we are pleased to have delivered a growth amid a challenging macro environment highlighted by an expanding customer base and exciting progress in value-added service offerings. In the third quarter, a suite of existing customers in automobile, financial services, online gaming, local services, and many other sectors expanded their orders with us. At the same time, we also attracted more new customers among financial institutes, the healthcare service providers, and local service platforms. Furthermore, Our value-added services continue to attract new prospects to our retail business. In the third quarter, we won several prestigious customers for our interconnectivity services, including a leading consumer electronics tech brand, a leading insurer in China, and a well-known restaurant chain operator in China. In particular, for this restaurant chain operator, we began to offer our in-house developed interconnectivity solutions built on our innovative SD-WAN technology. Upon implementation, this solution will successfully provide deployment of secure, flexible, and reliable connectivity across a customer's national network with more than 2,000 stores. We view this project as a milestone in the go-to market of our state-of-the-art SD-WAN technology, as well as a good starting point to roll out the solution into different verticals. Turning to our Blue Cloud business, we have continued to make progress on our cloud lending in China business. In the third quarter, we helped a leading international IoT automation company to manage its cloud-based products, offerings accessible to customers in China, and are providing operations and maintenance services accordingly. This project illustrates our remarkable value proposition in helping international technology companies find a more efficient and effective way to enter and expand into the China market. In addition, this quarter we extended a closed solution to emerging Chinese smart EV enterprise by developing an integrated and efficient supply chain management system, which is seamlessly tailored to the customer's auto parts procurement process and deeply integrated with other module-based solutions in its digital infrastructure. Going forward, we aim to strengthen our presence in the automotive ecosystem and explore more industry-specific cloud business opportunities across a wide variety of verticals by leveraging our unique strengths in ITC technology and cloud services. Before I ramp up my remarks today, I'd like to take a moment to celebrate our valuable partnership with Changzhou Hightech Jinglong Holding Group a subsidiary of the CEO Changzhou Hi-Tech Group, to form a joint venture with a total investment of 2 billion RMB. The capital contribution from Vinai will be up to 700 million RMB, drawing on both company's resources and expertise. This new joint venture will pursue new opportunities to acquire, develop, and operate IDC projects across the nation. The JVC initial pipeline of the potential acquisition targets includes a number of high-quality data center assets located in multiple megacity clusters in China, such as the Greater Beijing Area and the Great Bay Area. This partnership represents an important step towards extending our business horizon and strengthening our presence in the digital infrastructure sector. In summary, we see strong long-term demand and bright future for ITC services in China despite short-term macro turbulence. With government support, our effective and flexible dual core growth strategy and competitive service offerings, we are well equipped to navigate near-term challenges and capitalize on future demand prospects. We will continue to execute prudently yet decisively, statistically positioning the company to capture rising opportunities as more industries forge ahead with their digital transformation, creating long-term value for our shareholders along the way. Thank you, everyone. With that, I will now turn the call over to our CFO team to discuss our financial performance for the quarter and our business outlook.

Thank you very much, 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 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, including in our earnings press release. Please also note that unless otherwise stated, all the financials we present today are for the third quarter of 2022 in RMB terms. We're pleased to report another quarter of results, which reflects the effectiveness and agility of our dual core growth strategy in a challenging macro environment. We remain confident in our distinctive growth strategy, outstanding value proposition, and a powerful suite of service offerings which empower us to capitalize on long-term prospects of the data center industry in China. Next, 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, our net revenue increased by 16.3% to $1.81 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 business and VPN business. Gross profit. was 316.6 million in the third quarter of 2022, representing a decrease of 15.6% from the same period of 2021. Gross margin was 17.5% in the third quarter of 2022, compared to 24% in the same period of 2021. Adjusted cash gross profit, which excludes depreciation, amortization, and share-based compensation expenses was $707.7 million in the third quarter of 2022, an increase of 4.9% from the same period of 2021. Adjusted cash gross margin in the third quarter of 2022 was 39.0% compared to 43.2% in the same period of 2021. Adjusted operating expenses. which exclude share-based compensation expenses and compensation for post-combination employment in an acquisition were $275.1 million in the third quarter of 2022 compared to $244.0 million in the same period of 2021. As a percentage of net revenues, adjusted operating expenses in the third quarter of 2022 were 15.2% compared to 15.6% in the same period of 2021. Adjusted EBITDA in the third quarter of 2022 was $455.3 million, representing an increase of 1.1% from the same period of 2021. Adjusted EBITDA in the third quarter of 2022 excluded share-based compensation expenses of $35.2 million. Adjusted EBITDA margin in the third quarter of 2022 was 25.1% as compared to 28.9% in the same period of 2021. Our net loss attributable to ordinary shareholders in the third quarter of 2022 was $425.2 million compared to a net profit of $156.2 million in the same period of 2021. Basic and diluted loss were both 0.48 per ordinary share and both 2.88 per ADS. Each ADS represents six Class A ordinary shares. Turning to our balance sheet, as of September 30, 2022, the aggregate amount of the company's cash, cash equivalents, and restricted cash was $3.76 billion. Meanwhile, net cash generated from operating activities in the third quarter of 2022 was $607.4 million compared to $134.7 million in the same period of 2021. Our CapEx in the third quarter of 2022 was $580.5 million. Moving to our financial outlook, We are maintaining our outlook for the full year of 2022 with net revenues expected to be in the range of $7,250 million to $7,550 million and adjusted EBITDA expected to be in the range of $1,800 million to $1,950 million. This concludes our prepared remarks for today. Operator, we are now ready to take questions. Thank you. Thank you.

We will now begin the question and answer session. To ask a question, please press star 1-1 on your telephone. Once again, that's star 1-1. Please stand by.

First question.

Our first question will come from Yang Liu from Morgan Stanley. Your line is open. Yang, your line is open.

Hello, can you hear me? I have one question regarding the future CapEx plan. Given the company has already decided to set up a JV with partner, how should we think about the future CapEx split? or the stakes in the JV for the future expansion. I just have a brief question. Thank you.

Okay. In terms of the CAPEX plans, I'll leave the question to the team. But to address the cooperation with Changzhou, I would highlight From my discussion, V-Net will take 35% of the equity interest in the JV structure with Changzhou, which is kind of the strategic partnership between V-Net and the Changzhou high-tech holding group, a subsidiary of a state-owned group. to form a joint venture with us as of the 2 billion RMB. I mean, to give us data and join on both companies' resources and expertise. This new joint venture will pursue new opportunities in the future to acquire, develop and operate certain projects across the nation. And I mean, for VNAT, the GVC initial pipeline includes a number of the high-quality assets located in the greater Beijing area and the greater Bay Area, especially for the Bay Area, which is kind of the strategic exposure to us since we have less exposure there. This partnership also represents an important breakthrough in expanding our business horizon, for example, our future fund management. and also strengthening our presence in the digital infrastructure sectors.

And can you hear me?

Yes, I can.

Yeah, okay. So basically for the second part of the question, I think you were asking a little bit in terms of the CapEx and impacted sort of CapEx split. I think the company is looking at its overall CapEx spend Obviously, the markets are challenging at the moment on the offshore side, but I would stress that overall, VNet continues to enjoy very, very strong support from the local onshore renminbi banks in terms of project financing and other forms of financing available to us. But we are looking at the overall CapEx. or joint ventures like the one that Jeff just mentioned, I think are an important way for us to continue to be able to secure the resources necessary for our customers while at the same time perhaps moderating the cash spent on our side. So it really is an attempt to find ultimately The split between kind of these types of ventures and VNet will depend on the target projects. So Jeff's talked about some of the areas that are focused with Changzhou. And so for those types of projects, obviously then we would have a smaller share or smaller split. But the overall scale itself is also capped. So I'd say keep watch over the space. But at the moment, it is a way for us to diversify our funding sources a bit. Thank you.

May I follow up? The company will not put all the new pipeline in the JV, right? It's just a selective project in the JV?

That's correct. That's correct. There are targeted projects that will be put in, so not the entire pipeline, no.

Is there any... overall strategy or rule or what type of project will be put in the JV and what will be done by VNet itself or partner with other potential funding partner or other players. Thank you.

I'll tackle this as well. So Jeff just now mentioned sort of Greater Beijing Area, Greater Bay Area. So those are two areas that we're looking at specific projects with Hangzhou on the JV. Obviously, that could expand, but there is a limited pool of capital there as well. So that's the initial focus, and there are already targeted projects that we're looking at with them. So when we have more details, we'll be sure to disclose it to the market.

Thank you.

Most welcome. Thank you. One moment for our next question. Our next question comes from the line of Edison Lee from Jefferies. Your line is open. Edison Lee from Jefferies, your line is open.

Hi. Thank you very much for taking my question. My first question would be very much talking to Jeff. and I want to congratulate Jeff on becoming the CEO, but Jeff, can you share with us your near term objectives in this position and maybe also your longer term vision for the company? And I think it's important for investors to also find out what your KPIs are and because there's a profit decision, deal going on right now so I think investors definitely would like to find out in fact where the company is heading right under your leadership so that's question number one question number two is about the Changzhou JV I understand that Vina is going to manage all the projects that will be acquired by this Changzhou JV so I want to know operationally what are those IDCs that will be acquired by the Changzhou JV will actually be integrated with VNet and how does that work? Thank you.

Okay, thank you. First question, I would like to see my goal actually for the short term and try to try to, I mean, there's a couple of things. The first thing is in terms of the strategy, I will continue to strengthen our wholesale and retail dual core growth strategy. And second goal is to try to improve our operation, optimize the overall operations and diversify our customer base. We will have some new customers such as financial institutions and some new economy like the EV sectors. Another thing is we've done some restructure from our middle office, try to improve our efficiency as well. For the long term, we will do some cost control and acquire some quality EBITDA increased, et cetera, as you mentioned. That's to address the first question. Regarding my second question for Changzhou, I think most of the people are interested in this part. I would say Changzhou cooperation is more like we team up together to identify some certain assets and which is kind of the debt restructure on the target. So going forward, we'll we will try to leverage the Changzhou platform and to expand our AUM and our exposures going forward, which is a key to strategically position ourselves on this prospect. So that's my question.

Thank you, Jeff. Can I follow up with another question, which is, Will VNet be selling your existing assets into this drone venture?

Edison, I don't think so either.

Yeah, these are new projects, Edison. So we would not, this is not an instrument where we would be selling our existing pipeline into this entity. So there are new projects being identified and targeted. Jeff talked about sort of debt restructuring. These are also projects where perhaps there is an opportunity given the current owners of some of these projects. And so we're teaming up with someone with the financial firepower to be able to take advantage of these opportunities.

Okay, so let me clarify that. So it seems that the Challenging Job Venture will focus on brownfield projects. And so that's why VNet will continue to focus on greenfield projects. So would that be an accurate thinking?

The current targets, yes, would be potentially brownfield or otherwise, yes. So less greenfield projects.

Okay. Thank you.

But, yeah, we won't be selling our pipeline into that entity itself.

Okay. Yeah, thank you. That's it for me.

Okay. Thanks, Nelson.

One moment for the next question. Our next question is from from UBS.

Hi, thank you for the opportunity to ask the question. So I have one question. So I noticed that we have revised down the cabinet delivery plan. So what's our latest campus budget for this year and next year? And also, as Justice mentioned, cost control is one of the long-term targets. So just wondering if there's any timeline target for VNet to achieve, say, positive free cash flow or self-financing. Thank you.

Hi, sir. Can you hear me?

Yes, we can.

Yes.

Okay, good. I'll take this one. So your first question was on cabinet delivery. And for that, we are, as we mentioned, revising our cabinet delivery into the range of $8,000 to $9,000. And basically, the outlook for the sort of rest of this year into next year, we've already factored in the overall macro softness that we've seen, also the slower move-in. And then there are some construction delays related to COVID-related restrictions, but those are, I would say, less of a factor, but still a factor in terms of shifting perhaps this year into next. In terms of our outlook in terms of 2023, we'll give some more color in fourth quarter, but we're expecting that next year's delivery will be similar to this year, perhaps a little bit better. What was your second question, Seth?

So, as cost control is one of the long-term targets, so just wondering if there's any timeline target for BNET to achieve self-financing?

Okay.

Or like positive for cash flow? Yeah.

So, I think overall, if you look at our financing plans right now, there's a couple of things that we're focused on. One is on the CapEx side and obviously sort of cash out. I would say that we're increasingly selective on our CapEx and prudent CapEx spend. We do also still have very strong support from the domestic banks onshore financing and then alternative financing in terms of the Changzhou Corporation as well as exploring onshore reed structures. And then last but not least, when you're sort of looking at our overall ramp up, you continue to see the billable cabinets increasing. I would say that just given all these things put together, probably targeting 2024, I think next year still will be quite challenging just given the fact that we were still targeting something in the range of three and a half to four billion of capex. But again, some of it we can moderate with these corporations.

Got it. Thank you.

Most welcome.

One moment for our next question. Our next question comes from Ethan Zhang from Nomura. Your line is open.

Ethan Zhang from Nomura. Your line is open.

Oh, sorry.

Thanks. My question is, I note that our first quarter EBITDA margin was down like 3 percentage points compared to 2Q or 3Q of last year. Just wonder, could management give us some breakdown or quantitative impact of different negative factors that affect our EBITDA margin? And what is the outlook for the EBITDA margin for next year? Thank you.

Hi Ethan, it's Tim here.

In terms of overall EBITDA margin, actually the company has been working quite hard on cost controls because we have seen during the course of this year, obviously costs like utilities and so forth going up, but we've managed to moderate that with some cost controls and also deferral of classes for third quarter. In terms of the next year and expectations, I think that we expect that the margin compression will also then flatten out, but it will depend on the overall continued ramp-up of the business and that there will be no further changes to our underlying cost of sales. But we'll have some more details in fourth quarter in terms of our views as we end this year. Thank you. Got it.

Got it, got it. Thank you.

Thank you. One moment for our next question. Our next question will come from the line of Alex Wang from Daiwa. Your line is open.

Yeah, sorry, can you hear me?

Yeah, very clear.

Okay, yeah, it's Gohan from Daiwa. So, first two questions. So first is, Do you guys enjoy more about the estimated CAPEX for all our existing unfinished projects within our pipeline? And the second question is, could you share more color on debt repayment issue and the pressure from a potential lingering debt? Thanks.

Sure. Let me take your second question first. In terms of repayments, we have a small outstanding convertible note that's coming up next year, first half, around 70 million US dollars. And then our next maturity bump will be our 600 million in CB. So that's something that we have already started planning for and we'll be tackling during the course of 2023. In terms of your second question, look, You're talking about CapEx on our outstanding MOU projects, or what do you mean by – we have CapEx then this year, obviously, for projects that we're delivering in 2023, but we also then have the continued development of new projects as well. So I just wanted to clarify your question.

Yeah, just excluding the partnership with Changzhou. So what's the estimated cap for our existing unfinished projects within our own pipeline in the next three years?

Probably won't be able to give you the next three year guidance here. We have actually more than one of these Changzhou types of projects under discussion. So what I can tell you is that what we're looking at for Next year is probably a similar capex level as this year, and it includes the remaining deliveries for this year, for deliveries in 2023, and obviously preparations next year for deliveries in 2024 in terms of the power infrastructure and so forth. We'll probably come to you offline and have some discussion on the general parameters for the coming three years. But obviously, as we continue to get new MOUs each quarter, that number will change and shift. And so we'll have to rerun those numbers as well because we've just had a couple of new MOU wins. Thank you.

Okay, thank you.

Thank you. That's all the time we have for Q&A today, ladies and gentlemen. That concludes our conference for today. Thank you for participating. You may now disconnect. Everyone have a great day.