VNET Group, Inc.

Hello ladies and gentlemen, thank you for standing by for first quarter 2023 earnings conference call for VNet Group Inc. At this time, all participants are in listen-only mode. After management's prepared remarks, there will be question and answer session. Participants from our management include Mr. Jeff Doan, Chief Executive Officer, Mr. Tim Chen, Chief Financial Officer, and Missing Yuan Liu, investor relations director of the company. Please note that today's conference call is being recorded. I'd now like to turn the call over to first speaker today, Missing Yuan Liu. Please go ahead.

Thank you, operator. Hello, everyone, and welcome to our first 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 the discussion today will contain forward-looking statements made under the CPAPA 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 maturely 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. BNAT does not undertake any obligations to update any forward-looking statements except as required under applicable laws. Please also note that BNAT's earnings prejudice and this conference call include the disclosure of unaudited GAAP financial matters as well as unaudited non-GAAP financial matters. BNAT's earnings prejudice contains a reconsideration 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.vinet.com. I will now turn the call over to our CEO, Jeff.

Thank you, Hing-Yuan. Good morning and good evening, everyone. Thank you for joining our call today. I will start with the overview of our first quarter results. I will turn the call over to Tim, our CFO, who will discuss our financial results and outlook in more detail. We got off to a great start in 2023 with a solid first quarter performance, thanks to our effective dual core growth strategy and competitive service offerings. In the first quarter, we sequentially ended 1,300 utilized cabinets, growing our overall utilization rate to 56%. 0.5% from 55% last quarter. Total companies under management reached 87,310 by the end of the first quarter, compared with approximately 78,960 one year ago. Notably, our retail MRR per company reached a record high of RMB 9,486 during this quarter, up from RMB 9,371 in the previous quarter. First quarter revenue of RMB 1.81 billion represent an increase of 9.7% year-over-year and just EBITDA grow about 10% year-over-year to reach RMB 556.2 million, demonstrating our ability to drive stable growth and make China steady post-pandemic recovery. Before I talk more about our business results, I want to share some color on the broader bankroll climate. Official statistics show China's GDP growth 4.5% year-over-year for the first quarter, exhibiting a clear post-pandemic recovery path. With the digital economy posed to become China's key growth driver in the coming years, China's government is diligently advancing its digital China vision. Its strategic efforts include taking forward-looking steps in building digital infrastructure, fostering more innovation and value creation in platform economy, and accelerating digital transformation across a broader class of economy and the general population, according to the NDRC. Given this context, advanced infrastructure facilities such as 5G connectivity and data centers will serve as strategic cornerstones for the development of the digital economy, fulfilling growing demand from a broad spectrum of industries, including internet players as well as traditional industries. As a leading player in China's IDC space, we are well positioned to provide ever-improving services to customers and seize opportunities arising from the favorable policy landscape and digital economy boom. Now let's take a closer look at our first quarter business updates. Execution of our dual core strategy continues to prove strongly effective in both the wholesale and the retail ITC markets. Our wholesale service offerings continue to gain traction among leading internet players during the quarter. As we mentioned during the last earning call, in the first quarter we want to bid for a new customer, one of China's internet giants, to deploy ITC services to support its business expansion through our ITC assets. located in the Yangtze River Delta region. The overall project will total more than 100 megawatt and be delivered in multiple phases. The project is now progressing smoothly and the initial phase of the companies will be delivered by the end of this year as scheduled. This project once again exemplifies our compelling value proposition and the service capabilities for wholesale customers. Moving on to our retail business, in today's business operating environment, companies of all sizes and sectors are pursuing digital transformation with increasing urgency. Our high-quality, scalable retail ITC service offerings are attracting more and more enterprises demanding fast, reliable, and secure digital access to facilitate their digital transformation agendas. In the first quarter, growing demand from cloud services, media, and traditional sectors drove an expansion in our number of new customers. At the same time, we continue to win extended orders from existing customers across a variety of industries, including local services, IT services, online gaming, and financial services. Our comprehensive service offerings and customized solutions creates an excellent service experience for customers, solidifying our customer loyalty and boosting our overall competitiveness. Next, I want to share an update on the Blue Cloud business. In April, Microsoft and our Blue Cloud jointly launched Microsoft Teams, one of Microsoft 365's core modules for the Chinese market. Together with Office 365, Microsoft Teams will be operated under Microsoft 365 by our Blue Cloud in China, bringing more robust and efficient functionality supported by Blue Cloud's secure and reliable cloud services. As China's digital transformation accelerates, we'll leverage Blue Cloud's cloud operation expertise and decade-long strategic partnership with Microsoft to further unlock its unique value proposition. Last but not least, I'd like to provide an update on our ESG performance, which is an important part of our growth and long-term value creation philosophy. Last month, we released our third annual ESG report detailing our 2022 ESG initiatives and outcomes, including third-party verification of our carbon inventory results. We also highlight achievements such as our average annual PoE of 1.37, a green power purchase agreement with a supply guarantee of approximately 500 million kilowatt hours over the next five years, and an increase in our percentage of female employees in management positions to 29%. Going forward, we will continue to deepen our ESG engagement and embrace our responsibility to deliver sustainable value to our shareholders. In summary, our solid first quarter performance underscores our core strengths and execution capabilities. With China's post-pandemic economic recovery well underway, alongside support from policies designed to boost the digital economy, we are optimistic about the domestic IDC service industry's growth prospects for the rest of the year. We'll remain committed to our effective dual core growth strategy, focusing on our core business by providing our retail and wholesale customers with reliable and customizable services while fulfilling incremental digital demand to facilitate digital transformation across verticals. Thank you, everyone. I will now turn the call to Tim 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 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 first quarter of 2023 and in RMB terms. Let me walk you through the first quarter financial results. Unless otherwise specified, the growth rates of the reviewing are all on a year-over-year basis. We delivered solid results in the first quarter amidst a steady post-pandemic recovery in China. In the first quarter, our net revenues increased by 9.7% to $1.81 billion from the same period last year, mainly driven by the continued growth of our IDC business as well as our cloud and VPN services. Gross profit was $352.4 million in the first quarter of 2023, representing a decrease of 0.9% from the same period of 2022. Gross margin was 19.5% in the first quarter of 2023 compared to 21.6% in the same period of 2022. Adjusted cash gross profit, which excludes depreciation, amortization, and share-based compensation expenses, was $754.3 million in the first quarter of 2023, an increase of 10.1% from the same period of 2022. Adjusted cash gross margin in the first quarter of 2023 was 41.8% compared to 41.6% in the same period of 2022. Adjusted operating expenses, which exclude share-based compensation expenses and compensation for post-combination employment in an acquisition, were $228.8 million in the first quarter of 2023 compared to $200.8 million in the same period of 2022. As a percentage of net revenues, adjusted operating expenses in the first quarter of 2023 were 12.7%, compared to 12.2% in the same period of 2022. Adjusted EBITDA in the first quarter of 2023 was $556.2 million, representing an increase of 9.9% from the same period of 2022. Adjusted EBITDA in the first quarter of 2023 excluded share based compensation expenses of $8.3 million. Adjusted EBITDA margin was 30.8% in both the first quarter of 2023 and 2022. Our net income attributable to ordinary shareholders in the first quarter of 2023 was $82.3 million. compared to a net income of $90.7 million in the same period of 2022. Basic and diluted earnings were $0.09 and $0.07 per ordinary share respectively, and $0.54 and $0.42 per ADS respectively. Each ADS represents six Class A ordinary shares. Turning to our balance sheet, as of March 31, 2023, the aggregate amount of the company's cash, cash equivalents, and restricted cash was $3.24 billion. Meanwhile, net cash generated from operating activities in the first quarter of 2023 was $455 million compared to $482.6 million in the same period of 2022. Our capex in the first quarter of 2023 was $611 million. Next, moving to our outlook. For the full year of 2023, our outlook remains unchanged, with net revenues expected to be in the range of $7,600 million to $7,900 million, representing a year-over-year increase of 7.6% to 11.8%, and adjusted EBITDA to be in the range of $2,025 million to $2,125 million, representing a year-over-year increase of 8.1% to 13.5%. Looking forward, we will continue to explore new opportunities arising from the robust digital demand and to further strengthen our presence as a leading IDC player. As always, we are dedicated to delivering sustainable value to all of our stakeholders in the long run. This concludes our prepared remarks for today. Operator, we are now ready to take questions.

Thank you. We will now begin the question and answer session. To ask a question, please press star 11 on your telephone. To withdraw your question, please press star 11 again. Our first question comes from the line of Yang Liu from Morgan Stanley. Please ask your question, Yang.

Thanks for the opportunity. I have three questions here. The first one is about the demand and the move-in. We see steady improvement of the utilization rate in first quarter. Does management believe that overall customer moving will continue to improve further in third quarter? And we have this question because of the overall macro data trending down a little bit in April. So that's why I think there's some concern on the overall demand side. can management share with us the latest observation in the operation? The second question is that we observed a few public cloud vendors are cutting their price or unit price recently in the market and what is the management view in terms of this kind of price action transferring to data center no matter from the volume demand perspective or from the pricing pressure or whatever, this kind of commercial negotiation perspective. That's the second question. The third question is, we are glad to see that the company introduced Microsoft Teams in China. And what makes the market more excited is that Microsoft's launch of Office Co-Pilot. Does VNet have any plan to introduce the new generation of AI product to China. Thank you.

Hi, Yang. It's Jeff. Let me give you some colors on three questions you just asked. The first one is about the demands. We are glad, as we keep repeating, actually from the macro side, such as China reopening favorable regulatory environments, like supporting the development of the platform economy and digital economy. We have seen kind of the trend, it's been recovered from the market, but to be honest, given the facts to the real market, we need to be more patient for the market to warm up. to wait to be fully recovered from the market. And as we mentioned, we have already obtained a large, very large order actually from the market as well, which is a signal. I can see we have the ability and the market has already been recovered, especially from some of the customers, like the show video players. instead of the other cloud service players. And second question, regarding the cloud service players, you just mentioned price cut. There are some observations we can share with you. The first, I would say, we don't have any direct competition with the cloud service players. regarding our price cost as we have a different customer base. The second is the companies we are in several sectors like financial services will only be able to use IDC instead of a public cloud to meet the compliance requirements. I'll take example, we recently signed contracts with Morgan Stanley, which is an example they only can do with IDC instead of a cloud. And in terms of pricing, all the pricing we have signed has already been determined in the contract as well. So we don't see any immediate or direct feedback actually from their price cut.

Actually my question here is that do you think their price cut will generate more business volume to overall public cloud and then transfer to IDC suppliers.

Yeah, yeah, yes. We think that that will be probably true. We agree with that.

Thank you.

All right, thank you.

Sorry, how about the third?

Yes, in terms of Microsoft, I would say the Blue Call and the Microsoft, we recently launched in China, and we would expect the enterprise will build an integrated modern office management system. and intelligent and scalable collaboration platform to help those customers operate efficiently. That's what we're looking for. And in terms of what we have got from teams, we will see what we can do in terms of the income and also The further additional products add on from teams going forward, we will keep the monitoring and see what we can, after we launch, we will see what we can give to the market immediately.

Thank you.

Thank you. Our next question comes from the line of Edison Lee from Jefferies. Please ask your question, Edison.

Okay. Hi. Morning, management. I got three questions. The first one is in the first quarter, you added 1,400 utilized cabinets. Can you share with us the split between retail and wholesale and what sort of demand you are seeing from retail versus wholesale so far and number two is the um number two is the non-idc business can you actually share some color on the growth of the microsoft business and the vpn business so far and what is your outlook in the rest of the year and number three is on your cb uh that will be putable next year Can you discuss whether you have a plan or what are you thinking of in terms of the refinancing of that CD? Thank you.

Thank you, Edison. Let me take a crack at this and then I'll have Jeff add additional comments from his side as well. In terms of the additional billable cabinets, I would say that the majority of those additional cabinets are coming from the wholesale business. But that is also not a surprise given the fact that those customers do ramp up in larger volume in terms of cabinets as compared to our smaller scaled enterprise customers. So again, it's driven largely by the wholesale customers. Jeff earlier on talked about, and we've mentioned for the last few quarters already, a bifurcation in the wholesale customer as well between the cloud service provider customers versus the large internet companies. And I think that, again, you've seen, I would say, more ramp up and a faster ramp up with regards to large internet companies. So that would be comprising the wholesale side of that split. For the non-IDC business outlook, there is a continued growth In that business, obviously, you've seen that Microsoft has launched or landed new products, and so we do expect that that will continue to grow. And as that business grows, then obviously our Blue Cloud-related business will grow as well in a similar fashion. Last but not least, very much aware of the market's questions around the upcoming CB for next year, the $600 million. CB, we have already received the requisite NDRC approvals and we actually have a number of both onshore RIM and B as well as offshore US dollar alternatives and solutions in progress. As soon as we have further details, we will then announce them to the market. Jeff, I don't know if you wanted to add anything else with regards to the retail wholesale growth or the non-IDC business outlook.

Yes, I think the team has already covered most of the part. I just want to add, you know, in terms of the new, you know, added billable capities was contributed mainly from the wholesale business as well. In terms of the revenue percentage, we covered like 30% from the wholesale. and 70% more from the retail. In terms of the capacity and the billable cabinets, AUM is about 40% from the wholesale and 60% from the retail. And for the Microsoft and Teams related to the chat GPT, I would say it's really very positive signals to us, and we will see, you know, We will see more domestic LLMs, which are required to provide computing power for training. Demands from those models will boost for data centers, especially in the low-tier areas, as latency is now a major concern going forward. probably one of the positive things going forward. And also the higher level of the inter-data center communication, what we call cross-connection, which is one of the unique advantages with enterprise utilizing interconnections to reduce latency as AI is continuously trained on the new data sets for improved accuracy and response with those information. we would think about this probably be the next direction for the data centers as well. So that's some comments I can share with you on the Microsoft Teams.

Thank you, Jeff. Is it possible to talk about the growth rate of the non-IDC business in the first quarter? Non-IDC. Sorry, can you hear my question?

Sorry, you're saying the growth rate of the non-IDC businesses?

Yeah, in the first quarter.

We don't give that segment breakdown, but I would say that the growth rate probably would be somewhere in the high single digit. I see.

And do you expect that to be similar in the rest of the year?

Difficult to say at this moment, because again, if you're looking at the non-IDC business, you're looking at the VPN business, but also the Microsoft side. And I think that that is, the Microsoft side, we do have less visibility. I mean, you have visibility around the growth of the underlying business, but only as it is shown to us. So again, we don't have that end connection to the end customer, right, in terms of Microsoft's final business. So hard to say at this moment, but I would say, If you look at the overall trend, first quarter, it's still early and trend is still coming out of COVID. I think after another quarter or so, we probably will have a much better gauge if this is going to accelerate or flatten at the same levels or decelerate in terms of the growth. So we'll have a better idea probably next quarter.

Okay, thank you.

All right, thank you. Our next question comes from the line of Eden Zhang from Nomura. Please ask your question, Eden.

Okay. Good morning, management. I have one question. So I note that your retail IDC MRR has been continuously increased since second quarter of last year and already reached around 9.5 thousand RMB. just wonder what's the driver behind the sequential improvement in our retail MRR and also could management give us more colors on our wholesale IDC MRR and what's your expectation on the future trend for our pricing? Thank you.

Let me take the first one and then I'll see if Jeff has some color on the second. In terms of retail MRR, I mean, we've always talked about the fact that we expected the MRR to be north of 9,300 or so. And I think if you look at historical data, it's been up and down certain quarters. I think in this quarter in particular, I would say there would be two key factors. The first is that there are additional value-added services being added by existing customer cabinets. So as an example, you have an increase in O&M services from customers. So that effectively does not increase the total number of underlying cabinets you're dividing by, but rather increasing the top, the revenue side. So obviously the MRR for the overall retail cabinets will go up. Secondly is that the new cabinets that we are adding are higher MRR cabinets. Again, there is a demand. for the co-location and value-added services from our customers. And so that is another trend. I would say less than the first one. The first one is a bigger driver for this quarter is really customers adding to already their suite of services that are being offered by VNet and therefore increasing the overall MRR for the segment as a whole. For, I guess, pricing on the wholesale side and kind of where we see it going. Maybe I'll pass that to Jeff to provide some comments there.

In terms of MR on the wholesale side, I would answer from two aspects. One is from the market supply side. As you know, a lot of the smaller players have been capital staffed recently, especially since last year. Actually, it has helped to slow down the supply side as well. And the larger players, like us, with some of our other peers, we have also scaled back for the market to make sure we match the supply side, which is one thing we would see from the supply-demand side. And also in terms of pricing of the order, we do see especially for the MRR on the wholesale side, it's turned down a little bit, but especially from our analysis, we can see, especially since starting from 2023, we see some of the recovery signals actually It's come up from early of the year. You know, there were a few smaller players in the market, especially some established big players like us have been more cautious about the cash spending. That being said, we don't bother to go after class deals at any cost. which is to some extent the pricing will be stable up and down in a certain level. And going forward from our side, we would do better cost control and also to improve our efficiency to compromise any up and down from the market side.

Thank you. Right, thank you. Our next question comes from the line of Justin Huang from UBS. Please go ahead, Justin.

Hi, thank you for taking my question. I have two questions. The first one is always happy to meet you. So I'm wondering if you have seen any growing customer demand or accelerate removing some recent AI deployment in China? And the second question is on EBITDA margins. So I noticed your Q1 EBITDA margin remains stable year on year. So I'm wondering what's the reason behind, and maybe you could mention, please give us some color on the EBITDA margin going forward. Thank you.

Hello?

Hi, Jasmine. Yeah, sorry, can you hear me? Yeah. Yeah, yeah. So your question on the ChatGPT is whether or not you've seen increased, we've seen increased customer demand? Yeah. Yeah, I mean, I would say it's probably still early stage in terms of the direct impact you know there are customers that have announced obviously to the market that they're developing relevant products and services linked to the AIGC having said that I would say that you know it has not yet turned into very tangible you know new tenders and so forth around that product so I would still say it's quite early stage Secondly, in terms of the EBITDA margins for first quarter, actually, as we mentioned in our earnings release as well, it did also exceed our own internal forecasts and expectations, and there are a couple of key drivers. One is there are, and there's a seasonality aspect as well, in the first quarter, there are certain non-recurring revenues that come in or benefits from that that impact in a positive way the EBITDA and therefore the margins. We also did see some costs that were actually delayed from first quarter into second quarter and so what you'll probably see is slightly higher than expected margin in the first quarter as compared to if you look at your modeling lower than what we expected for the second quarter, and that's purely just a timing issue. Third, which is relevant still, is we've been going through quite a challenging time in our industry, and so we have very much focused on cost controls. And so on our utility side and cost management side, we've been continually rolling out new measures and I still that's a positive again to the the margin so yes you know I'd say in terms of your overall question it is in line with last year but but I think there are a number of factors and again higher than what we had expected does that help to answer the question Jasmine yeah thank you you're most welcome

Let me give you some colors on AI demand, as you mentioned. We do see the trend from AI-based customers as well, but it's mainly from our retail side. Let's take an example. We got some feedback from Beijing government agencies, especially around the Beijing area. Those customers with AI-related computing needs is very strong, but it's mainly from retail side. We are keeping the dialogue with some of the customers with AI-based in nature, but we haven't seen much demands actually from the wholesale side.

Okay, thank you. All right, thank you very much for all your questions. And with that, ladies and gentlemen, we conclude our conference for today. Thank you.