VNET(VNET) - 2023 Q4 - Annual Report

Part I Explanatory Note This note clarifies VNET's structure as a Cayman Islands holding company operating in China via Variable Interest Entities (VIEs) and outlines the associated legal and regulatory risks - VNET Group, Inc is a Cayman Islands holding company, not an operating company; its primary operations are conducted through subsidiaries and Variable Interest Entities (VIEs) in China[11] - Investors purchase equity in the Cayman holding company, not the operating VIEs, with control derived from contractual arrangements not yet tested in a PRC court[11] - The company was previously identified under the HFCA Act in May 2022, but the PCAOB vacated this determination in December 2022 after gaining inspection access[13] - Recent PRC regulations require a cybersecurity review for foreign listings of platform operators with over 1 million users, but VNET has not been required to undergo such a review as of the report date[16] - Under new CSRC regulations, the company submitted an initial filing on January 3, 2024, related to a US$299 million strategic investment from SDHG-owned entities[15][20] Key Information The company's VIE structure, related financial data, fund transfer limitations, and a comprehensive summary of key risk factors are presented Corporate Structure and Related Risks VNET's reliance on a VIE structure to operate in China is explained, detailing the contractual controls and inherent risks - VNET operates in China through four VIEs due to PRC restrictions on foreign ownership in value-added telecommunications services[24] - Control over the VIEs is maintained through a series of contractual arrangements, including Share Pledge Agreements, Powers of Attorney, and Equity Option Agreements[27][28][29] - The company acknowledges significant risks associated with its VIE structure, including potential non-compliance by PRC authorities and conflicts of interest[35][36] Financial Information Related to VIEs and Parent Condensed financial data for the holding company, subsidiaries, and VIEs is presented, along with details on inter-company cash transfers Condensed Consolidated Statement of Operations Data for FY 2023 (RMB in thousands) | | VNET Group, Inc. | Other Subsidiaries | Primary Beneficiary of VIEs | VIEs and VIEs' Subsidiaries | Consolidated Totals | | :--- | :--- | :--- | :--- | :--- | :--- | | Third-party revenue | — | 1,028,905 | — | 6,384,025 | 7,412,930 | | Gross profit | — | 425,500 | (1,079) | 868,064 | 1,292,485 | | Net (loss) income attributable to VNET Group, Inc. | (2,643,836) | (1,142,564) | 139,753 | (1,021,429) | (2,643,836) | Condensed Consolidated Balance Sheet Data as of Dec 31, 2023 (RMB in thousands) | | VNET Group, Inc. | Other Subsidiaries | Primary Beneficiary of VIEs | VIEs and VIEs' Subsidiaries | Consolidated Totals | | :--- | :--- | :--- | :--- | :--- | :--- | | Total assets | 13,545,223 | 22,773,632 | 998,316 | 17,294,365 | 30,385,903 | | Total liabilities | 7,530,808 | 20,680,221 | 154,228 | 18,026,248 | 23,871,520 | | Total equity | 6,014,415 | 2,093,411 | 844,088 | (731,883) | 6,514,383 | Cash Transfers Through Organization (RMB in thousands) | | 2021 | 2022 | 2023 | | :--- | :--- | :--- | :--- | | Cash received by VNET Group, Inc. | 2,694,169 | 120,488 | 242,571 | | Cash paid by VNET Group, Inc. to subsidiaries | (2,688,968) | (1,941,696) | (273,432) | | Cash paid by subsidiaries to VIEs | (1,337,056) | (3,043,923) | — | - The company faces significant restrictions on transferring capital out of China, as PRC subsidiaries must set aside statutory reserves before paying dividends[46] Risk Factors A comprehensive summary of material risks is outlined across business, corporate structure, China operations, and ADS categories - The report outlines a comprehensive summary of material risks across four main categories: Business and Industry, Corporate Structure, Doing Business in China, and Our ADS[53][56][57][60] Information on the Company An overview of the company's history, business operations, organizational structure, and properties is provided History and Development of the Company Key milestones are detailed, including its founding, Nasdaq listing, strategic partnerships, and recent major investments - VNET commenced operations in 1999, established its Cayman Islands holding company in 2009, and listed on Nasdaq in 2011 under the ticker "VNET"[227] - The company has formed strategic partnerships with Microsoft to operate its cloud offerings in China and with Warburg Pincus to build a digital real estate platform[227] - In December 2023, the company completed a strategic investment of US$299 million from SDHG-owned entities for renewable energy and computing power projects[229] - The board received two non-binding going-private proposals in 2022 and a special committee is evaluating these proposals[229] Business Overview The company's position as a leading carrier-neutral data center provider in China with a "dual-core" strategy is described - VNET is a leading carrier-neutral and cloud-neutral data center service provider in China, operating with a "dual-core" strategy targeting both retail and wholesale customers[232] Data Center and Cabinet Capacity Growth | As of December 31, | 2021 | 2022 | 2023 | | :--- | :--- | :--- | :--- | | Total Data Centers | 104 | 143 | 162 | | - Self-built | 40 | 45 | 50 | | - Partnered | 64 | 98 | 112 | | Total Cabinets | 78,540 | 87,322 | 93,597 | | - Self-built | 74,143 | 82,581 | 89,357 | | - Partnered | 4,397 | 4,741 | 4,240 | - The company's service offerings include Managed Hosting Services, Cloud Services (in partnership with Microsoft), and VPN Services[234] - As of December 31, 2023, VNET served over 7,500 enterprise customers with a low average monthly hosting churn rate of 0.4% for 2023[248] - The company faces competition from state-owned carriers, other carrier-neutral providers, in-house data centers, and cloud service providers[258] Organizational Structure The company's business is conducted through contractual arrangements with its VIEs to comply with PRC foreign ownership laws - VNET conducts its business in China through contractual arrangements with its VIEs to comply with PRC legal restrictions on foreign ownership[333] - In April 2024, the company entered into a series of amended and restated contractual agreements with certain VIEs to replace and supersede prior agreements[334] - The contractual arrangements provide VNET with effective control and economic benefits of the VIEs[335][336][338][340] Property, Plants and Equipment The company's portfolio of leased and owned properties for data centers and offices is detailed - As of December 31, 2023, the company leased approximately 425,903 square meters for its self-built data centers and owned buildings with a total floor area of approximately 387,879 square meters[343] Operating and Financial Review and Prospects A detailed analysis of financial performance is provided, highlighting revenue growth, significant net loss from impairments, and liquidity status Operating Results Financial performance for 2023 shows revenue growth but a significant net loss due to large impairment charges Key Financial Performance (RMB in millions) | Metric | 2021 | 2022 | 2023 | | :--- | :--- | :--- | :--- | | Net Revenues | 6,189.8 | 7,065.2 | 7,412.9 | | Gross Profit | 1,438.0 | 1,358.3 | 1,292.5 | | Gross Margin | 23.2% | 19.2% | 17.4% | | Operating Profit (Loss) | 21.3 | 121.2 | (1,970.9) | | Net Income (Loss) | 515.1 | (762.0) | (2,597.2) | - Net revenues increased by 4.9% in 2023 to RMB 7,412.9 million, driven by a growing number of utilized cabinets and increased demand for cloud services[377] - The company incurred a significant net loss of RMB 2,597.2 million in 2023, primarily due to a one-time impairment of goodwill and long-lived assets[381] Key Operating Metrics | Metric | 2021 | 2022 | 2023 | | :--- | :--- | :--- | :--- | | Cabinets Under Management (End of Period) | 78,540 | 87,322 | 93,597 | | Cabinet Utilization Rate (End of Period) | 53.1% | 55.0% | 59.0% | | Avg. Monthly Recurring Revenue per Cabinet (Retail) | RMB 9,190 | RMB 9,270 | RMB 9,497 | | Avg. Monthly Churn Rate (Managed Hosting) | 0.2% | 0.2% | 0.4% | Liquidity and Capital Resources The company's liquidity position, cash flows, debt structure, and available credit facilities are detailed - As of December 31, 2023, the company had cash of RMB 5,099.0 million but also an accumulated deficit and net current liabilities, raising going concern doubts[384] Cash Flow Summary (RMB in millions) | Cash Flow | 2021 | 2022 | 2023 | | :--- | :--- | :--- | :--- | | Net cash from operating activities | 1,387.9 | 2,440.2 | 2,063.5 | | Net cash used in investing activities | (3,772.6) | (3,559.3) | (3,905.1) | | Net cash from financing activities | 967.6 | 2,298.1 | 3,941.1 | - As of December 31, 2023, total outstanding debt was RMB 5,866.8 million, with unused credit lines of RMB 2,811.1 million[386][399] - In 2023 and early 2024, the company repurchased all remaining 2025 and 2026 Convertible Notes[387][388] Research and Development R&D expenses and the company's intellectual property portfolio, including patents and software copyrights, are presented R&D Expenses (RMB in millions) | Year | R&D Expense | | :--- | :--- | | 2021 | 188.5 | | 2022 | 306.8 | | 2023 | 322.2 | - As of December 31, 2023, the company's R&D efforts have resulted in 170 patents, 105 patent applications, and 335 software copyright registrations in China[404] Critical Accounting Estimates Key accounting estimates are discussed, including significant impairment charges for goodwill and long-lived assets - The company recognized a full goodwill impairment of RMB 1,364.2 million for FY 2023 due to adverse macroeconomic conditions and a sustained decrease in share price[408] - An impairment loss of RMB 506.7 million was recorded for long-lived assets for FY 2023 due to weaker-than-expected operations[409] - The company revised the estimated useful lives of certain data center assets, which is expected to reduce depreciation expense by approximately RMB 395 million in 2024[374] Directors, Senior Management and Employees Details on leadership, compensation, board structure, and workforce are provided Directors and Senior Management Key leadership members, including the Founder, Co-Chairpersons, and CFO, are identified - As of the report date, key leadership includes Sheng Chen (Founder, Co-Chairperson, Interim CEO), Jianbiao Zhu (Co-Chairperson), and Qiyu Wang (CFO)[412][413] Compensation Aggregate compensation for directors and executives is disclosed, along with details of the company's share incentive plan - For the year ended December 31, 2023, the aggregate compensation paid to directors and executive officers was RMB 14.2 million (US$2.0 million)[421] - The company maintains the 2020 Share Incentive Plan, which was amended in January 2024 to increase the maximum number of authorized shares[421] Board Practices The composition and responsibilities of the Board of Directors and its three main committees are outlined - The Board of Directors consists of seven members and has three committees: an Audit Committee, a Compensation Committee, and a Nominating and Corporate Governance Committee[425][428] - The Audit Committee is chaired by Sean Shao and includes two other independent directors, overseeing financial reporting integrity and compliance[429] Employees A breakdown of the company's workforce by functional area as of year-end 2023 is presented Employees by Function as of December 31, 2023 | Functional Area | Number of Employees | % of Total | | :--- | :--- | :--- | | Operations | 1,480 | 49% | | Sales, marketing and customer support | 383 | 13% | | Research and development | 528 | 17% | | General and administrative | 647 | 21% | | Total | 3,038 | 100% | Major Shareholders and Related Party Transactions The company's principal shareholders are identified and significant transactions with related parties are detailed Major Shareholders Principal shareholders and the company's multi-class share structure are detailed Principal Shareholders as of February 29, 2024 | Shareholder | % of Beneficial Ownership | % of Voting Power | | :--- | :--- | :--- | | Shandong Hi-Speed Holdings Group Limited | 41.2% | 35.0% | | Sheng Chen (Founder) | 4.1% | 17.3% | | FIL Limited | 5.2% | 4.4% | - The company has a multi-class share structure with Class A (1 vote/share), Class B (10 votes/share), and Class C (1 vote/share with veto rights) shares outstanding[437] Related Party Transactions Key transactions with related parties during 2023, including loans and service purchases, are disclosed - In 2023, the company engaged in several related party transactions, including providing a loan of RMB 80.3 million and obtaining a loan of RMB 350.0 million[445] Financial Information Significant legal proceedings, including arbitration and a class action lawsuit, are discussed alongside the company's dividend policy Legal Proceedings and Dividend Policy The company's involvement in ongoing legal disputes and its intention to retain earnings for business expansion are outlined - The company is involved in arbitration related to the 2021 acquisition of BJ TenxCloud, with seller claimants seeking approximately RMB 180.1 million[449] - A putative securities class action lawsuit was filed against the company in late 2023, alleging materially false or misleading statements[451] - The company does not plan to pay any dividends in the foreseeable future and intends to retain earnings to operate and expand its business[452] Additional Information Details on corporate governance, material contracts, exchange controls, and taxation implications are provided Memorandum and Articles of Association The rights and conversion terms of the company's multi-class share structure are summarized - The company's ordinary shares are divided into Class A (1 vote/share), Class B (10 votes/share), Class C (1 vote/share with specific veto rights), and authorized but unissued Class D (500 votes/share)[460][462][464] - Class B, C, and D shares are convertible into Class A shares on a 1:1 basis, with automatic conversion triggers upon transfer to non-affiliated parties[460][462] Material Contracts Key investment agreements with entities such as Blackstone and SDHG are outlined - In January 2022, the company entered into an investment agreement with Blackstone for the issuance of US$250 million in 2% convertible notes due 2027[467] - In November 2023, the company entered into an investment agreement with SDHG-owned entities for a US$299 million equity investment[469] Taxation Tax implications in the Cayman Islands and PRC are discussed, along with the PFIC risk for U.S. shareholders - The company is incorporated in the Cayman Islands and is not subject to income tax there; its PRC subsidiaries are subject to a standard 25% Enterprise Income Tax (EIT), with some qualifying for a preferential 15% rate[471][773] - There is a risk that the company could be classified as a PRC resident enterprise, which would subject it to PRC tax on its worldwide income[474] - For U.S. federal income tax purposes, the company believes it was not a Passive Foreign Investment Company (PFIC) for the 2023 taxable year[217][481] Quantitative and Qualitative Disclosures About Market Risk The company's primary market risk exposures, including interest rate, foreign exchange, and inflation risks, are detailed - The company's primary market risk exposure relates to interest rates on its borrowings; a hypothetical 1% decrease in rates would have decreased 2023 interest expense by approximately RMB 67.8 million[486] - Significant foreign exchange risk exists due to substantial U.S. dollar-denominated debt and assets; a hypothetical 10% increase in the USD/RMB exchange rate would have increased the value of these assets by RMB 322.5 million[488] Part II Controls and Procedures Management's evaluation concludes that disclosure controls and internal controls over financial reporting were effective as of year-end 2023 - Management concluded that as of December 31, 2023, the company's disclosure controls and procedures were effective[499] - Based on an assessment using the COSO 2013 framework, management concluded that the company's internal control over financial reporting was effective as of December 31, 2023[500] - The independent registered public accounting firm, KPMG Huazhen LLP, issued an unqualified opinion on the effectiveness of the company's internal control over financial reporting[501][503] Corporate Governance and Other Disclosures Various governance topics are covered, including audit committee experts, accountant fees, home country practices, and cybersecurity risk management Audit Committee Financial Expert The board has identified two members who qualify as audit committee financial experts - The board of directors has determined that Mr. Sean Shao and Mr. Changqing Ye are both audit committee financial experts[506] Principal Accountant Fees and Services Fees paid to the principal accountant for audit and other services in 2022 and 2023 are disclosed Accountant Fees (in US$ thousands) | Fee Type | 2022 | 2023 | | :--- | :--- | :--- | | Audit fees | 2,275 | 1,936 | | Tax fees | 81 | — | | Other fees | 240 | — | Corporate Governance The company's adherence to home country governance practices, which provides exemptions from certain Nasdaq rules, is confirmed - As a foreign private issuer, the company follows certain home country corporate governance practices, exempting it from several Nasdaq requirements[511] Cybersecurity The company's cybersecurity risk management program and governance oversight are described, with no material threats identified in 2023 - The company has an established cybersecurity risk management program, with oversight provided by the audit committee of the board of directors[514] - In 2023, the company did not identify any cybersecurity threats that have materially affected or are reasonably likely to materially affect its business[514] Part III Financial Statements This section contains the company's audited consolidated financial statements for the past three fiscal years, prepared under U.S. GAAP Consolidated Balance Sheet Highlights (RMB in thousands) | As of December 31, | 2022 | 2023 | | :--- | :--- | :--- | | Total Assets | 26,948,405 | 30,385,903 | | Total Liabilities | 19,966,549 | 23,871,520 | | Total Shareholders' Equity | 6,981,856 | 6,514,383 | Consolidated Statement of Operations Highlights (RMB in thousands) | For the Year Ended December 31, | 2021 | 2022 | 2023 | | :--- | :--- | :--- | :--- | | Net Revenues | 6,189,801 | 7,065,232 | 7,412,930 | | Gross Profit | 1,438,030 | 1,358,256 | 1,292,485 | | Operating Profit (Loss) | 21,314 | 121,156 | (1,970,901) | | Net Income (Loss) | 515,101 | (761,994) | (2,597,169) | Consolidated Statement of Cash Flows Highlights (RMB in thousands) | For the Year Ended December 31, | 2021 | 2022 | 2023 | | :--- | :--- | :--- | :--- | | Net cash from operating activities | 1,387,922 | 2,440,214 | 2,063,480 | | Net cash used in investing activities | (3,772,613) | (3,559,252) | (3,905,109) | | Net cash from financing activities | 967,577 | 2,298,080 | 3,941,134 |