Hello, ladies and gentlemen, thank you for standing by for the GDS Holdings Limited's Second Quarter 2023 Earnings Conference Call. At this time, all participants are in listen-only mode. After management's prepared remarks, there will be a question-and-answer session. Today's conference call is being recorded. I would now like to turn the call over to your host, Ms. Laura Chen, Head of Investor Relations for the company. Please go ahead. Laura.

Hello, everyone. Welcome to the second quarter 2023 earnings conference call of GDS Holdings Limited. The company's results were issued via newswire services earlier today and are posted online. A summary presentation, which we will refer to during this conference call, can be viewed and downloaded from our IR website at investors.gds-services.com. Leading today's call is Mr. William Huang, GDS's Founder, Chairman and CEO, who will provide an overview of our business strategy and performance. Mr. Dan Newman, GDS's CFO, will then review the financial and operating results. Ms. Jamie Khoo, our COO, is also available to answer questions. Before we continue, please note that today's discussion will contain forward-looking statements made under the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, the company's results may be materially different from the views expressed today. Further information regarding these and other risks and uncertainties is included in the company's prospectus as filed with the U.S. SEC. The company does not assume any obligation to update any forward-looking statements, except as required under applicable law. Please also note that GDS' earnings press release and this conference call include discussions of unaudited GAAP financial information, as well as unaudited non-GAAP financial measures. GDS press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited most directly comparable GAAP measures. I'll now turn the call over to GDS Founder, Chairman and CEO, Mr. William Huang. Please go ahead, William.

Thank you. Hello, everyone. This is William. Thank you for joining us on today's call. During the second quarter, we continued to focus on our - strategic business objectives. In China, we are selectively targeting new business to give us a shorter book-to-bill cycle. We are prioritizing delivery of the backlog to grow revenue with less CapEx. We are increasing utilization rates to drive up return on invested capital. We are only initiating new projects based on firmly committed orders, and we are monetizing assets to achieve positive free cash flow as soon as possible. For international, we are developing a second growth engine. We are winning new business from reference China and global customers. We are leveraging our competitive advantages in cost and speed of execution. We are financing expansion without relying on GDS balance sheet, and we will benchmark valuation creation through external funding loans. By pursuing these objectives, we will strengthen our financial position and unlock value for GDS shareholders. As we review our performance quarter-by-quarter, we will measure our progress against these targets. Turning to the Slide 5. In the first half of 2023, our growth additional area committed was around 28,000 square meters, 55% from China and 45% international. In China, new business volumes are down as customers need more time to ramp up. This gives us breathing space to focus on our other priorities, while our market leadership position remains as strong as ever. In Southeast Asia, demand is very strong. We have won great new business, which lifts us our growth. For the second half of 2023, we expect gross new booking at similar level to the first half. Looking further ahead, there is no doubt that demand will rebound in China. Data center supply in Tier 1 markets has been restricted for…

Thank you, William. Starting on Slide 18. In conjunction with our strategic business objectives, we've adopted the following key financial targets. For the China segment, we aim to grow adjusted EBITDA at a mid-teens percentage CAGR. We are reducing organic CapEx to an annual level of RMB2 billion to RMB3 billion from next year onwards. We will be free cash flow positive within three years or sooner with the benefits of asset monetization. And we will bring down net debt to adjusted EBITDA to below 5 times. For the International segment, we will be EBITDA positive next year. Based on our current business plan, International will generate over 15% of consolidated adjusted EBITDA after three years. We are taking a low-risk approach only investing with the backing of firm customer orders and achieving similar returns to China. We will raise equity capital directly at the International level and project finance on a non-recourse basis. Turning to Slide 19. In 2Q '23, we grew revenue by 2.6% quarter-on-quarter and adjusted EBITDA by 9.3% quarter-on-quarter. During 2Q '23, we recognized one-time service revenue of RMB70.7 million arising from early termination of 3,000 square meters from the backlog and cash reimbursement of RMB22.1 million from our depository bank. Excluding these two items, revenue was flat and adjusted EBITDA was up 1.1% quarter-on-quarter. Turning to Slide 20. During 1H '23, we achieved net additional area utilized of 12,000 square meters. While gross add was sustained at historic levels, net add was impacted by a single customer redeploying between our data centers, as previously disclosed. This redeployment will continue into the second half of 2023. However, with contribution from International, we expect net additional area utilized to step up significantly. Monthly service revenue per square meter was RMB2,170 in 2Q '23. Excluding the one-time service…

[Operator Instructions] We are now going to proceed with our first question. And the questions come from the line of Yang Liu from Morgan Stanley. Please ask your question.

Thanks for the opportunity to ask a question. I have a question related with the international business. Previously, I think you talked a lot in terms of the strategy going - the surrounding area of Singapore. And now you have a power quota or the permit to build a data center inside of Singapore. So what could be the updated strategy for the whole Southeast Asia development plan? Especially what will be the business model for the Singapore data center? And of course, whether you have a plan to spin off the whole international business.

Okay. Thank you, Yang Liu. I think the strategy for Southeast Asia from day 1, we already firm very, very clear view to build a data center in three major places. One is Singapore. One is Johor. One is Batam Island. This is, in our view, is a perfect structure for serve the current requirement even for the future requirement. Because Singapore - as everybody knows, Singapore is a network half and a lot of our customers who want to deploy the data center in this region try to get their network in Singapore network - pop whatever called. But these three, we have also plan to link this three data center area together - as to serve to our customer as a platform. So I think the business will give us a lot of advantage in the future compared with other competitors. We are the first one who own these three - own the data center in three areas. So this is perfect for our future, let's say, marketing, right? So this is our - major focus, is our core asset to get back in the next five years. But on other hand, we're also looking for very proactive to looking for some opportunity in Jakarta, Kao, and also other countries opportunity. But again, I say, this is, we call the SIJORI area will be our focus in the next five years. And we believe the demand is getting more stronger and stronger. So the future visibility is very, very high. The second question is the spin-off. I think definitely, Dan already - last quarter, we already introduced it. We will focus on - we will spread the business to look at our business. One is China portion, one is international. The two market actually is in different situations. In China, everybody - demand in the last two years is a slowdown, but we should echo this situation. So, we firm our new strategy to try to push China business moving towards the cash flow positive and strengthen our financial capability. This is our - we already introduced to the market in - that's our business plan in next three years. But on the other hand, since the AI coming in a very big way, so I think we have to - we can leverage our 20 years' experience and capability to catch up - well catch up this opportunity. So in international business, we will aim to grow more fast than in China business. So we needed more capital, but we don't want to use more our Holding capital to get back the business. So in the next few months, we already started working on that to raise external funds to support our international business. We got a lot of the interest from the different private equity, so far, yes.

Yes. Thank you.

We are now going to proceed with our next question. And the questions come from line of Jonathan Atkin from RBC. Please ask your question.

Thank you. So I have a financial question, and that is just anything to call out in terms of one-time impacts through the rest of the year you had kind of the early termination that we talked about in the script. But anything else that, yes, maybe you could elaborate on between now and year-end, that would affect 3Q, 4Q, or even next year? And then secondly, related to your Southeast Asia footprint. I wonder if you could maybe provide us an update on the demand trends that you're seeing in Hong Kong. And then in Johor, are you seeing continued potential for upsizing of your footprint based on the existing customer relationship? Or could the demand there potentially diversify? Thank you.

Thank you, Jon. I'll start with the financial questions. We don't expect more one-time items like the experience in the second quarter in the second half of this year or beyond, so far as we can foresee. If these one-time items are material, we will disclose them to try to establish a normalized number, so that we can continue to track the quarter-on-quarter trend as we have done ever since we went public 2016. William, do you like to talk about demand in Hong Kong and the next wave in Johor?

Yes. I think the demand in Hong Kong is still maintained the normal, right? I think the - every year's growth is around 70 megawatts. This demand is from the different region, like from China, also from U.S., from the other domestic customer as well. So this is nothing changed so far. So we are still on track. The market demand supply also no significant change. So still in terms of supply, also very balanced. So I think the Hong Kong market is to stay on the very stable growth period. In Johor, if we talk about Johor, what we see is that, Johor now is more hot for all the data center player, also for all the customers. What we can see is a lot of the international player - international cloud player, also Internet giants, they all show more high increased level into Johor. So this has changed a lot, very encouraging us. So our target is definitely not just to follow up our customer - existing customer. We're definitely very interested to get some new customer name from the different region to diversify our portfolio as - just like what we did in China, diversification is very important for us, and we are good at that.

And then lastly, on Singapore, given the tightness of supply and the fact that you were one of only a small number of companies to get the permission to proceed with new data center development, do you think that you're inclined to do more of a kind of a wholesale hyper scale approach with a smaller number of tenants in order to stabilize the asset quickly once it's developed? Or would you pursue more of a kind of a retail-oriented approach? Do you have any thoughts on that?

Yes. So far, we are - I think there's two type of customers that we are interested. One is, who will deploy their IT in three region. That including Batam, Singapore, and Johor. This is our first priority to support - which remain support our strategy, right, which I think we already showed this plan to some of our customers, they are very interested. So the second - priority, definitely in Singapore is a financial center, which is our - we are very familiar with the financial institutions demand and a requirement. So we also aim to sell some to retail customers for example, like the financial institution, right, we can get a more high margin and a very stable commitment, that's our go-to-market strategy.

Thank you.

We are now going to proceed with our next question. And the questions come from the line of Frank Louthan from Raymond James. Please ask your question.

Great. Thank you. So looking out to your guidance, kind of what does it take to hit the higher end of the range of your guidance? What sort of assumptions are built in there? And if you can kind of break that out between the impact from China and also from the out-of-region business as well? Thanks.

Thank you, Frank. Our track record with guidance has been fairly good. Normally, the full year outcome is not deviated far from the midpoint of our guidance range in prior years. It's a recurring revenue business. And the move-in rate is what dictates most of the growth year-on-year. So, as we're already halfway through the year, I think the part that we're on within that guidance is already quite well set. Having said that, in the second half this year, particularly in the fourth quarter, we're going to have our Johor data centers come into service and also in China, some of the data centers, which are the destination for the customer who is redeploying between our data centers. And the move-in rate for those contracts is quite fast. In one case, a few months and in another case, perhaps one year. So even if we assume that the run rate in China remains as it has been, at least, the gross additional area utilized has been quite consistent, I think, for about the past 10 quarters. So even if we assume that, that remains at the current run rate, and there is no recovery, because we can't predict that yet. Our growth will pick up, because of the additional contribution from these contracts, particularly, Johor. So that will happen too late this year to make much difference to our financial results this year. But clearly, it will contribute to higher year-on-year growth next year. So, we look forward to that and obviously, we'll reflect that in our guidance for next year when we come out with that.

Okay, great. Thank you very much.

We are now going to proceed with our next question. And the questions come from the line of Sara Wang from UBS. Please ask your question.

Hi. Thank you for the opportunity to ask questions. So I have two questions. The first one is on the potential target of Southeast Asia business. So, I see that we are now targeting the overseas business to contribute more than 15% of EBITDA within three years. And then I recall December was around 10% during last earnings release. So just wondering if there's any [technical difficulty]

What's your question?

No, we lost the - did we lose the connection or she dropped?

Can you say is this only [indiscernible] visibility. Can you hear me?

Yes, we can now.

Now can you repeat your question? We just missed, sorry.

Yes, sure. So I see the target for the oversea business to contribute 15% of EBITDA within three years. And then I recall the number was around 10% during our last earnings call. So I'm just wondering, is this just a simple update because of better visibility? Or actually, we are being more optimistic? And then, what's the like key points for us to be more optimistic? This is my first question.

Yes. Thank you. Your observation is correct. We did revise up that number moving from 10% to 15% is significant, but in absolute terms, we're not talking about hundreds of millions of dollars between tens of millions of dollars higher forecast. And you would have noticed that in the second quarter, we did upsize an existing order in Johor. So that was part of the reason for we're doing that. Frankly, I also noticed that some analysts and leading analysts begin to put more focus on international business and try to quantify how significant it can be within the context of GDS Holdings as a whole. So, we're responding to that. We try to provide some more disclosure.

Got it. Thank you. And then my second question is about William. So during the last earnings call, I think William has shared his intention to increase the shareholding in GDS. I'm just wondering if there's any update on this. Thank you.

Yes. I already bought the 50%, which I committed, right? So I still will continue to execute that.

Got it. Thank you.

We are now going to proceed with our next question. And the questions come from the line of Timothy Zhao from Goldman Sachs. Please ask your question.

Sure. Thank you, management, for taking my question. So my question is regarding the AI demand. I think since the last time that we spoke, I think I remember last quarter, you mentioned that AI driven demand was still in the early stage. Just wondering, given I think we have passed a quarter, three months or maybe longer. Just wondering if management have seen any updates regarding the move-in pace from the generative AI demand from the [indiscernible] in China. And when we think about the CapEx going forward, could management share any color on like what percentage of CapEx will be likely spent on the like high-power density cabinets or transforming the existing cabinets into the power - high power, density wise.

Okay. Yes. In terms of AI demand, I think we are very clear in the international market, now the currently globally, I mean, data center demand mainly driven by the AI type of application, right? So this is a very, very clear chance which already happening in the U.S., in Asia right now. So we are - this is one part. But if we talk about AI demand in China, I think the China, in terms of the model - AI model, it's a little bit behind the U.S. So I think it's still in a very early stage. But of course, in the media, everybody talk of the AI. That's just an indication that everybody try to step in. So I think in terms of how impacted to the data center industry, I think they maybe up to 12 months or 18 months, it will start to impact China data center demand. So in a significant way in my view, yes.

For the second part of your question on CapEx, right, I think if you talk about AI-related CapEx or very high power density capacity, then I think that goes with liquid cooling. So really, it comes down to what percentage of our CapEx or what percentage of the capacity that we're developing will we deploy liquid cooling. As a matter of fact, we have deployed liquid cooling going back more than two years in China. We've done projects both with what's called cold plate cooling and also full immersion cooling. It's been a relatively small part of what we've done so far in China. And for - in the international expansion, we did mentioned that, I think in the international market, maybe we're seeing the flow-through from AI demand come quicker. So, a significant part of what we developed in Johor is using cold plate, liquid cooling, and we developed a prefabricated cold plate liquid cooling module, which we manufactured in China and shipped to Johor. We've talked maybe a bit more generally about the economics and deploying liquid cooling. The overall unit development cost is slightly higher than if we use traditional - more traditional air cooling. But because liquid cooling delivers a lower POE and a higher power density, it also means that there's more IT power capacity available to sell to the customer and to generate revenue. So you have to take into account these different components. And overall, in terms of total cost of ownership or economic returns to us as the data center operator, we think that liquid cooling will create some cost efficiency, where it can be deployed. But so far, we don't think it's going to be a very material change. So I think the last part of your question, talk about - I think you referred to installing in existing data centers. So that's an interesting one, because if you look at all the parts in equipment data center, some of it is used intensively like cooling and some of it is on standby, like power generation. So there's already a replacement cycle for cooling, which typically is every five years. So, that gives us an in-built opportunity as when we change out the cooling plant and equipment, we can always consider to change the technology as well.

Yes, I'll add a little bit. I think in the last two years, our new design data center design is all very high power density. That means we already assessed the trend in China. So our edge of town campus design all can fulfill the future AI demand already - this is all the campus, which we developed in the last two years, whatever in Shanghai, surrounding Shanghai or Beijing or Shenzhen Guangdong, all very high power density and high power capacity. So that means we are well positioned to catch up the AI era.

Great. Thank you for the color. It's very helpful. Thank you.

[Operator Instructions] We are now going to proceed with our next question. And the questions come from the line of Mingxuan Li from CICC. Please ask your question.

Hi, management. Thanks for taking my questions. I have questions about the EBITDA margin. The first one is, why your one-time service revenue has nearly 100 EBITDA margin, because this 70 million revenue portfolio included in EBITDA. And also, excluding the one-time impact, the second quarter EBITDA margin was still better than the first quarter and the same quarter last year. What's the drivers behind this?

Thanks for the question. I couldn't hear so clearly. So let me try to answer based on what I could make out. I think you asked to begin with why that one-time service revenue contributed such a significant improvement in the EBITDA. So the reason for that is, because it's associated with the termination, which means that, there is not a lot of operating cost that goes with that revenue. There is no power consumption and so on, which goes with that revenue. So that revenue has a very high-profit margin on an incremental basis. Excluding that revenue as we did in our disclosures to normalize numbers set a base for the following quarters. I think the EBITDA margin has fluctuated as always, but it's been in a similar range for a number of quarters. So there is more pronounced seasonality now in our business since power tariffs went up and as we've seen some exceptionally hot summers in China, it has resulted in at least a couple of percent, if not more percentage point difference between our EBITDA margins in winter and summer. So that was - that's visible in our number. But overall, if we take a trend over a number of quarters, I think EBITDA margins are going to remain at quite a similar level to where they are today. I think the most significant negative impact has been the increase in power tariffs in China. It's possible that, that will reverse at some point in the future. We don't have any knowledge about that. But with - yes, we're looking at EBITDA margins, which already reflect that impact, and we expect the margin to improve, but only slightly from current levels over the following couple of years.

Thanks. Very clear.

We're now going to proceed with our next question. And the questions come from the line of Michael Elias from TD Cowen. Please ask your question.

Hi, everyone. This is Cooper Belanger on for Michael Elias. Thanks for taking my question. I kind of wanted to follow up on the AI discussion earlier. And given that what we're seeing in the U.S. right now with the incremental AI demand wave and kind of the subsequent shrinking of power supply, I just wanted to hear your thoughts on the upcoming power supply situation and I guess, current, as well as it relates to both Mainland China and International? Thanks.

Okay. I think in the area like Johor, they have - the advantage in Johor is, they have the rich - very rich power capacity. So I think the - in the short term or midterm, the power supply will not be the issue, I think, in the mid-term. In China, I think what we know is in a Tier 1 market, of course, is challenging in the future. But fortunately, for us, as I mentioned in the last two years, we locked up a lot of the big power capacity and built a very high - designed a very high-power density data center. So I think the - what I say - try to say in short term, mid-term in China if the wave coming for everybody is a challenge. But in mid-term, short term, for us is more relaxed for that. But in Johor side, I think there we got to be almost 50% of the power allocation in Johor so far. So, I think we are moving more ahead than any player in Johor area.

Okay, great. Thank you.

As there are no more questions, I would like to turn the call back over to the company for closing comments.

Thank you once again for joining us today. If you have further questions, please feel free to contact GDS Investor Relations through the contact information on our website or the Piacente Group Investor Relations. See you next time. Bye-bye.

This concludes the conference call. You may now disconnect your lines. Thank you.