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Q1 2023 Earnings Conference Call
spk06: 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 Dong, Chief Executive Officer, Mr. Ting Chen, Chief Financial Officer, and Ms. Xin Yuan Liu, Investor Relations Director of the company. Please note that today's conference call is being recorded. I would now like to turn the call over to first speaker today, Ms. Xin Yuan Liu. Please go ahead.
spk00: 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 SIPP hyper-provision 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 obligations to update any forward-looking statements except as required under applicable laws. Please also note that VNET's earnings press release and this conference call include the disclosure of unaudited gap financial measures as well as unaudited non-gap financial measures. VNET's earnings press release contains a reconsideration of the unaudited non-gap measures to the audited gap measures. 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 .VNET.com. I will now turn the call over to our CEO Jeff.
spk02: Thank you, Qingyuan. Good morning and good evening, everyone. Thank you for joining our call today. I will start with the overview of our first quarter results. As of now, 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 discretionally ended 1,300 utilized cabinets, growing our overall utilization rate to .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 cabinet 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 represents an increase of .7% year over year, and just EBITDA grew about 10% year over year to reach RMB 556.2 million, demonstrating our ability to drive stable growth and make China's 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 .5% year over year for the first quarter, Existing 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, including taking forward-looking steps in building digital infrastructure, fostering more innovation and value creation in the platform economy, and accelerating digital transformation across the broader swath of the 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 ITC 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 retail ITC markets. Our wholesale offerings continue to gain traction among leading internet players during the quarter. As we mentioned during the last earnings 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 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 enterprise 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 create 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'll continue to deepen our ESG engagement and embrace our responsibility to deliver a 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 pull from policies designed to boost the digital economy. We are optimistic about the domestic IT 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 cross-verticals. Thank you, everyone. I will now turn the call to Tim to discuss our financial performance for the quarter and our business outlook.
spk03: 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 RIM and B terms. Now, let me walk you through the first quarter financial results. Unless otherwise specified, the growth rates of the reviewing are all on a -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 .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 .9% from the same period of 2022. Gross margin was .5% in the first quarter of 2023, compared to .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 .1% in the first quarter of 2023. The gross margin of the first quarter was $11.8 million, which was a decrease of .5% from the same period of 2022. Adjusted cash gross margin in the first quarter of 2023 was 41.8%, compared to .6% in the same period of 2022. Adjusted operating expenses, which excludes 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 .2% in the same period of 2022. Adjusted EBITDA in the first quarter of 2023 was $556.2 million, representing an increase of .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 .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 cap ex 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 -over-year increase of .6% to 11.8%. And adjusted EBITDA to be in a range of $2,025 million to $2,125 million, representing a -over-year increase of .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.
spk06: Thank you. We will now begin the question and answer session. To ask a question, please press star 1-1 on your telephone. To withdraw your question, please press star 1-1 again. Our first question comes from the line of Yang Liu from Morgan Stanley. Please ask your question, Yang.
spk01: Thanks for the opportunity. I have three questions here. The first one is about the demand and moving. We see a steady improvement of the utilization rate in the first quarter. Does management believe that overall customer moving will continue to improve further in the third quarter? We have this question because of the overall macro data turning down a little bit in April. 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. 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. What makes the market more excited is that Microsoft launched an office co-pilot. Does VNet have any plan to introduce the new generation of AI products to China? Thank you.
spk02: Hi, I'm Jeff. Let me give you some colors on the 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 the trend being recovered from the market. 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. As we mentioned, we have already obtained a large order from the market, as well as the signal. We can see we have the ability and the market has already been recovered, especially from some of the customers, like the short video players instead of the other cloud service players. And the second question, regarding the cloud service players, you just mentioned the press card. There are some observations we can share with you. First, I would say we don't have any direct competition with cloud service players regarding our press card, 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 public cloud, which means compliance requirements. I will take an example. We recently signed contracts with Morgan Stanley, which is an example they only can do with IDC instead of 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 from their press card.
spk01: Actually, my question here is that do you think their price card will generate more business volume to overall public cloud and then transfer to IDC suppliers?
spk02: Yes, yes, we think that will be probably true. We agree with that.
spk01: Thank you.
spk05: Alright, thank you.
spk07: Sorry, how about the service?
spk02: Yes, in terms of Microsoft, I would say the BlueCore and Microsoft, we recently launched the engine in China. We would expect the enterprise will build an integrated modern office management system. And the intelligent and scalable collaboration platform to help us, 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 added on from Teams going forward. We will see. We will keep the monitoring and see what we can, you know, after we launch, we will see what we can give to the market immediately.
spk01: Thank you.
spk06: Thank you. Our next question comes from the line of Edison Lee from Jefferies. Please ask your question, Edison.
spk08: 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 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. 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 the CB? Thank you.
spk03: 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 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 $500 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 use 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.
spk02: Yes, I think the team has already covered most of the part. I just want to add in terms of the new added billable companies, was the contributed mainly from the wholesale business as well. In terms of the revenue percentage, we cover like 30% from the wholesale and 70% more from the retail. In terms of the capacity and the billable companies, AUM is about 40% from the wholesale and 60% from the retail. And for the Microsoft and Teams related to the CHESS GPT, I would say it's a really very positive signal to us. And we will see more domestic LLMs which are required to provide computing power for training. And I think demand from those models will boost for data centers, especially in the low tier areas as latency is now a major concern going forward. So I think that's 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 interconnect connections to reduce latency as the 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.
spk08: Thank you, Jeff. Is it possible to talk about the growth rate of the non-IDC business in the first quarter? Sorry, can you hear my question? Sorry,
spk03: you're saying the growth rate of the non-IDC businesses?
spk08: Yeah, in the first quarter. Is it possible to show some color on
spk03: that? We don't give that segment breakdown, but I would say that the growth rate probably would be somewhere in the high single digit.
spk08: I see. And do you expect that to be similar in the rest of the year?
spk03: 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 rate 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, you know, first quarter, it's still early and then trying to 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.
spk08: Okay, thank you.
spk05: All right, thank you.
spk06: Next question comes from the line of Eden Zhang from Nomura. Please ask your question, Eden.
spk07: 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. So just wonder what's the driver behind the sequential improvements 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 trends for our pricing? Thank you.
spk03: Okay, 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, you know, up and down at certain quarters. I think in this quarter in particular, I would say there'd 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 know, 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, I would say, 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 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.
spk02: Yeah, in terms of MRR 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 say 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 trend down a little bit. But we, especially from our analysis, we can see, especially since starting from 2023, we see some of the recovery signals actually come up from earlier this year. 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 bandily go after the cash bills 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.
spk07: Thank you.
spk05: All right. Thank you.
spk06: Our next question comes from the line of Justin Huang from UBS. Please go ahead, Jasmine.
spk04: Hi. Thank you for taking my question. I have two questions. The first one is on capital and QE. So I'm wondering if you have any testing, any growing demand or a salary moving from the recent AI deployment in China? And the second question is on EBITDA margins. So I noticed your Q1 EBITDA margin remained stable year on year. So I'm wondering what's the reason behind and maybe could management please give us some color on the EBITDA margin going forward. Thank you.
spk03: Hi, Jasmine. Sorry. Can you hear me?
spk03: Yeah. Yeah. So your question on the chat, you bet is whether or not you've seen increase. We've seen increased customer demand.
spk03: 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 AI GC. 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, you know, for first quarter, actually, it as we mentioned in our earnings release as well, it did also exceed our own internal forecast and expectations. And there are a couple of key drivers. One is there are and this is there's a seasonality aspect as well. In the first quarter, there are a 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, you know, 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 so that's a positive, again, to the margin. So, yes, I'd say in terms of your overall question, it is in line with last year. 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?
spk04: Yeah, thank you.
spk03: You're most welcome.
spk02: Let me give you some colors on the 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 recently got some feedback from Beijing government agencies, especially around the Beijing area. Those customers with AI-related computing needs are very strong. But it's mainly from the retail side. We are keeping the dialogue with some of the customers with AI-based in nature. But we haven't seen much demand actually from the wholesale side.
spk04: Okay, thank you.
spk06: All right, thank you very much for your questions. And with that, ladies and gentlemen, we conclude our conference for today. Thank you.