Hello, ladies and gentlemen. Thank you for standing by for GDS Holdings Limited Fourth Quarter and Full Year 2016 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'll now 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 fourth quarter and full year 2016 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 Founder, Chairman, and Chief Executive Officer, who will provide an overview of the business. Mr. Daniel Newman, GDS Chief Financial Officer, will then review the financial and operating results and provide our outlook for 2017. 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. Securities and Exchange Commission. 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 audited 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 will now turn the call over to GDS Founder, Chairman, and Chief Executive Officer, William Huang. Please go ahead, William.
Thank you, Laura. Hello, everyone. This is William. Thank you for joining today's call. First, I would like to highlight some year 2016 achievements. 2016 was a great year. It's a year of great achievement for GDS. As you can see on slide three, we grew service revenue by over 50% and adjusted EBITDA by over 60%. We invested significantly to expand our capacity, and our sales growth was phenomenal. We signed our customers for 25,000 sq m of new contracts worth over RMB 120 million in annual recurring revenue. Based on leading market research, our incremental market share grew to over 30%. We delivered nearly 15,000 sq m of area utilized to customers. We added over 23,000 sq m of new capacity into service and ended the year with a very high level of commitment rate. Let's turn it to slide four. Our huge contract backlog has become even bigger.
This gives us high visibility to future growth. At the end of 2016, we had over 23,000 sq m committed, but not yet utilized. It was over RMB 110 million in annual recurring revenue. We are continuing to execute against our plan, delivering our backlog to customers and driving impressive revenue and operating growth quarterly after quarterly. Let's move on to slide five. Before I discuss our results and the strategy, I would like to share our view on the market. As we have stated previously, we believe China represents the biggest data center opportunity in the world, and we believe that GDS is the best positioned in the market. It's well documented that the digital economy in China is booming, and cloud adoption is leading the way. Compared to the U.S., cloud adoption is still in its infancy, but growing fast.
China's internet giants are squarely focusing more and more on cloud. At the same time, the global cloud players are focusing more and more on the China market. All over the world, cloud service providers are driving huge demand for data center capacity. Here in China, we see this trend magnified. Leading cloud service providers in China are driving the majority of the new demand. These guys are looking to also see all of their requirements in Tier 1 market. It's not easy for them to do that. First, cloud service provider here with quite a huge space and power. In China, in the big cities, that's a big challenge. Second, they are deploying their cloud platform in all the Tier 1 city at the same time. You need to be ready everywhere. Third, they want certainty of getting capacity when and where they need it.
Fourth, they want to work with the people who understand them, their requirements, and perform to a very high standard. They want flexibility and the total solution service provider. They want have the high visibility of the resource plan. Here is our golden opportunity. As we have described before, GDS is uniquely positioned in this environment better than anyone else. We have had great success in capturing demand from the cloud. From almost nothing three years ago, cloud service providers now account for 45% of our business. As shown on slide six, we believe that we are the leading supplier to the top three cloud players in China. They are all using multiple GDS data centers. Why do we win with the cloud service provider? We win with these customers by having the right assets in all the right markets, which nobody else has.
These assets are backed up by a secure expansion pipeline and our 15-year solid track record of operation excellence. We believe we have a win-win partnership with the cloud's customers. They are important to us, and we are also important to them. As we get stronger and stronger, this partnership also continues to grow stronger. Our stronger position with the cloud service provider makes us the nature choice for enterprise customers. Our data center offer enterprises co-locating space and a unique access point to multiple cloud. Cloud service provider attract enterprise. As we expand on our ratio, this focus is central to our growth strategy, and it's working. In 2016, we added more than 120 new enterprises logos. In particular, we have had great success with the new kind of financial customer offering, like e-payment, online securities, clearing, and the settlement services.
We believe this type of customer offer a long way for expanded services. Resource supply is critical to keep up our sales momentum. We believe that our ability to source, design, and construct new project tiers are key competitive advantage. As shown on slide seven. At the end of 2016, we had about 25,000 sq m of area under construction, of which 27% was pre-committed. In the current quarter, we are in the process of kicking off a new project in Shenzhen with 10,000 sq m of high-powered space under construction, which is already 50% pre-committed to a major cloud service provider. We are actively seeking to add a new project to our development pipeline. We have promising prospects in all our markets, which we aim to convert in the next few quarters. Let us turn to the slide eight.
We are in a much stronger position now than when we began 2016. We have added capacity, attracted new customers, deepened our existing engagements, and executed according to plan. We've seen across-the-board improvements and now are bigger and stronger than we've ever been. There is huge growth to come from the cloud customer segment, and we want to be the hub for cloud and enterprise development. With our established relationships, we believe that we are in a good position to win this demand in 2017. We aim to deepen our relationships with the major cloud service providers. We are aligning our resource plan to meet their requirements. We are helping them to access our enterprise customer base. At the same, we are leveraging the cloud platform in our data centers to attract and add value to enterprise customers.
As we enter 2017, we will leverage the solid foundation we have laid and continue to deliver resources to fulfill our sales growth. Our key objective for the current year is to beat the level of sales which we achieved in 2016, and we are confident of doing that. Now, I will hand over the call to my colleague, Dan, for the financial review. Thank you.
Thank you, William. Hi, everyone. It's Dan here. In this section, I'll focus on four main areas. Revenue and operating leverage, CapEx, funding, and then the 2017 business outlook. Starting with the 4Q 20 16 P&L analysis on slide 10. We view service revenue, net operating income, and adjusted EBITDA as the key indicators of our financial performance. After stripping out equipment profit, stock-based compensation, and FX gains, all three measures show year-on-year growth of over 50% and quarter-on-quarter growth of over 10%. Let's go into detail on revenue. We have two revenue segments comprising colocation and managed services, which we refer to as service revenue, and equipment sales. Service revenue is recurring in nature, and this is what we consider our core business. Equipment sales arise on a demand basis when customers require us to do some procurement as part of the fulfillment of the service contract. This is non-core.
It may help to strip out equipment sales less cost in order to see more clearly the underlying performance of the service business. The amounts to equipment profit in each period are shown in the note below the table on slide 10. In 4Q 20 16, our service revenue grew by 55% year-on-year and by 12.3% quarter-on-quarter. Next, underlying adjusted net operating income. This measure highlights our performance at the data center level before taking account of depreciation, equipment profit, stock-based compensation, and corporate costs. In 4 Q 2016, our underlying adjusted NOI grew by 58% year-on-year and by 10.2% quarter-on-quarter. SG&A, after deducting stock-based compensation, was $68.6 million in 4Q 20 16, an increase of 32% year-on-year and 9.7% quarter-on-quarter. This increase mainly relates to expanded sales activities and increased corporate costs as we prepared for life as a publicly listed company. Other income mainly comprises foreign currency exchange gains.
The gain in 4 Q 2016 arose from depreciation of the renminbi against the US dollar. Underlying adjusted EBITDA, which is excluding equipment profit and FX gains, was RMB 79.3 million in 4 Q 2016, implying growth of 90% year-on-year and 12.4% quarter-on-quarter. Underlying adjusted EBITDA margin, once again, excluding equipment cost and FX gains, was 26.5% in 4 Q 2016, compared with 21.5% for full Q15 and 26.4% for 3Q16. Turning to the full-year P&L analysis on slide 11. As I stated earlier, all three measures show robust growth. We achieved service revenue of RMB 1 billion in FY16, showing growth of 53%, driven mainly by the near 15,000 sq m increase in area utilized or revenue generating space during the year. Adjusted NOI grew by 48%. If we exclude equipment profit, underlying adjusted NOI grew by 56%. The adjusted NOI margin was 45%, the same as FY15.
At the individual data center level, there was significant operating leverage as utilization ramped up during FY16. However, at the consolidated level, this was offset by the growth drag from over 23,000 sq m new area in service. This is typical with the data center life cycle. Adjusted EBITDA grew by 64%, and underlying adjusted EBITDA grew by 84%. Let's go further into the key growth drivers. As you can see on slide 12, service revenue and area utilized grow in sync. In 4Q16, there was an increase in area utilized of over 2,700 sq m. The churn event, which we discussed in our last earnings call, took effect in early January 2017, so it did not impact these numbers. The monthly service revenue, or MSR per sq m, in 4Q16 was slightly higher than the prior quarter, but this is within the normal range of quarterly fluctuation.
On the right-hand side of slide 13, we show a breakdown of our cost structure for 4Q16. Starting at the data center level, utility cost, which is mainly a variable cost, was 23.2% of service revenue in 4Q16. We do expect to see some upward trend in utility cost as we have more high power density customers moving in. In addition, we have new data centers which take a while to reach optimal power usage efficiency. Other data center level costs are mainly fixed. The adjusted NOI margin, excluding equipment profit, i.e. the adjusted NOI margin for the service business, was 46.7% in 4Q16. This was achieved on capacity with an average 65.6% utilization rate. This capacity was practically sold out. As the backlog is delivered and the utilization rate rises, we should see further operating leverage on fixed costs.
Moving on to the corporate level, our SG&A is dimensioned to current growth levels, so we expect to achieve significant operating leverage on our SG&A costs. As shown on slide 14, we incurred CapEx of RMB 1.1 billion, that's $165 million, in FY16, representing an increase of 57% year-on-year. Our CapEx growth is in line with new business and revenue growth. For the capacity in service at year-end, the cost to complete was RMB 293 million. For capacity under construction at year-end, the cost to date was RMB 269 million, and the cost to complete was RMB 1.1 billion, most of which we expect to incur in the current year. In addition, we will have CapEx related to the new project, Shenzhen 5, which we are taking over, and to other new projects which we expect to initiate during 2017.
Reviewing each of the projects, Shenzhen Four, phase 1 will enter service in 2Q17. It was 19.2% pre-committed at year-end, and there are currently major customer orders in the contracting process. Chengdu One, phase 3 will enter service in mid 2017 and is 100% pre-committed. Beijing Two will enter service in the second half of 2017. There was some delay to this project caused by the government-mandated shutdown of construction in Beijing during a high pollution period. Construction of Beijing Two has restarted. The pre-commitment rate is now 31.4%, including a significant follow-on order from a major U.S. cloud customer which we closed in the current quarter. Shanghai Four is the fourth data center on our main Shanghai campus. The shell and core were built to suit by a property development company. We aim to bring the data center into service by the end of 2017.
All of our major cloud customers are present on this campus, as well as over 100 FSI and large enterprise customers. We already have significant demand in hand for the capacity in Shanghai Four. We regard acquisitions as one strand of our sourcing strategy. As William mentioned, we are in the process of taking over a data center which is currently under construction in Shenzhen. It is a large new building, particularly well suited to use as a data center in a central location with a very substantial amount of secured power capacity. When developed, it will provide us with 10,000 sq m of high-powered net floor area, which is already 50% pre-committed on a long-term basis to a major cloud service provider. The remaining 50% is obviously highly marketable.
The acquisition is subject to satisfactory completion of due diligence, and we aim to close it by the end of the current quarter. It's rare to find a data center of this size and power in such a good location in a Tier 1 market, and it will be a very value-enhancing addition to our portfolio. Turning to slide 15. At year-end 2016, our gross debt was RMB 4.29 billion, and our net debt, including the net proceeds of the IPO, was RMB 2.48 billion. Before discussing our 2017 funding plans, I'd like to provide some explanation of our debt capital structure. Our gross debt can be categorized into RMB 1.1 billion of capital leases, which are almost entirely leasehold interests in properties, where the underlying cash flows will be incurred over periods of up to 20 years.
RMB 1 billion are convertible bonds held by our strategic shareholder, ST Telemedia Global Data Centres, and by Ping An Insurance. The bonds are due in December 2019 if not converted beforehand, and the bondholders have the option to extend the maturity by one year. The balance of RMB 2.1 billion is mainly project term loans, working capital loans, and mezzanine loans. Out of this total, RMB 580 million relates to data centers which are immature, with break-even EBITDA in aggregate. At year-end 2016, our net debt to last quarter annualized adjusted EBITDA was 6.7 x. However, if we exclude the debt related to the immature data centers with break-even EBITDA, the multiple was 5.1 x. If we also exclude the capital lease obligations related to the same immature data centers, the multiple was 3.7x .
In the coming year, our business plan requires us to raise around RMB 2 billion, or nearly $300 million, in new debt facilities, the majority of which we expect to draw by year-end 2017. We have a long track record of successful debt financing, and with our high levels of pre-commitment and long-term contracts with some of the largest companies in China and the world, we are confident of achieving our financing objectives. Turning to slide 16. As mentioned by William, we had a great year for sales. Our total area committed increased to over 61,000 sq m, yielding a backlog of about 23,000 sq m. Out of this total backlog, around 16,200 sq m relates to area under construction, and 6,800 sq m relates to area in service.
The average selling price, or ASP, for the contract backlog was almost the same as the monthly service revenue, or MSR, for the area utilized. On our last earnings call, we told you about a churn event. It took effect in early January 2017. The good news is that we are going to receive a RMB 46 million termination fee, which we expect to book as service revenue in 1Q17. The further good news is that we have already reallocated all of the space to other customers, and it is all currently in the contracting process. We have therefore been able to insulate ourselves from this event. During 2017, we have contract renewals for around 8,200 sq m of capacity, of which around 4,300 sq m relates to a single customer at a single data center. This customer is in the process of renewing for a further term of six years.
At the time of renewal, the customer will change out their IT platform, and we will also undertake some refit. The implementation plan is currently being worked out. However, we anticipate that during the change-out period, there may be some interruption to our billing. Looking further ahead, we do not have any other large contracts up for renewal in the next couple of years. On slide 17, as William mentioned, our first objective for 2017 is to sign up new business which exceeds last year's level. Based on our current sales pipeline, backed up by our secured development plan, we are confident of achieving this target. With regard to revenue, our huge backlog gives us visibility to future revenue growth. However, revenue recognition is a function of how quickly customers move in.
Based on our view of customer move-in schedules, we expect full year 2017 revenue to be in the range of RMB 1.475 billion-RMB 1.575 billion. That's $220 million at the midpoint. For the avoidance of doubt, this includes the termination fee and the potential interruption to billing, which I just talked about. Our guidance implies a growth rate for service revenue of over 50% at the midpoint of the range. For the full year 2017, we expect adjusted EBITDA to be in the range of RMB 465 million-RMB 495 million. That's $70 million at the midpoint. Implying year-on-year growth of over 75% at the midpoint of the range.
With regard to CapEx, taking into account the data centers under construction, the acquisition which we have announced today, and the projects which we are planning to add, we expect total CapEx for the full year to be around RMB 1.8 billion. That's $260 million. With that, I will end the formal part of our presentation. We'd now like to open the call to questions from analysts and investors. Operator, please open the call.
Thank you. Ladies and gentlemen, we will now begin the question and answer session. If you would like to ask a question on the phone, please press star one and wait for a name to be announced. If you would like to cancel your request, please press the pound or hash key. For the benefits of all callers participating in today's call, if you wish to ask your questions to management in Chinese, please also immediately repeat your questions in English. There will be a short silence while participants register for questions. First question comes from the line of Jonathan Atkin from RBC. Please go ahead.
Yes. I was interested in slide 23, where you list your top five customers and two of the five in terms of area committed are not currently generating revenues. Presumably these are new logos. Does this tie into the comment that you made about a U.S. customer committing in the current quarter? If you could provide a little bit more information about that. Thank you.
Hi, John. Nice to hear from you. Yes, you're right. In the third quarter of 2016, we had a tremendous quarter for sales. Around half of the sales in that quarter related to two new customers. They immediately entered our top five. Overall in 2016, because of those significant new customers, around 50% of our new business came from first-time customers. In the current quarter, first quarter 2017, what I mentioned in Beijing is that one of those customers who was a new customer in the third quarter of last year has placed a significant follow-on order for us, they will be present in two markets.
Great. Then, on the revenues, I'm interested in your 2017 guidance for service revenues and if you could talk just a little bit about the split between colocation and managed services.
Yes, John. I think the managed service proportion will go down by a few % simply because we're in a phase where there's very high volume growth, it's impossible for the managed service business to keep up with the pace of growth of high volume cloud customers. Over time, as we leverage the presence of the cloud customers in our data centers to further grow our enterprise customer base and add value to them through a kind of managed cloud access product, I think we'll see that proportion from managed services will gradually go up again.
Thank you very much.
Thank you for the question. Once again, as a reminder, if you'd like to ask question, please press star one and wait for a name to be announced. The next question comes from the line of Jonathan Schildkraut from Guggenheim Securities. Please go ahead.
Hi, this is Michael Hart on the line for Jonathan. Thanks for taking the questions. I guess first, I really appreciated the color you gave about cloud adoption in China and how you're winning with cloud service providers. I thought that was great. You mentioned a little about enterprise coming to meet the cloud supply that you're seeing. I was wondering if you could talk a little more about how you're targeting these enterprises and how your go-to-market model works for them to bring them into your data centers to consume cloud services. Are you using direct sales, channel partners, and things like that? How it could impact your SG&A over time.
Hi, Michael. It's great for you and Jonathan to have joined this call, appreciate that. All of our sales activities are direct sales. There is no channel partner or resale effort like there may be in the U.S. I think it's two-way traffic between the cloud and the enterprise customers. Our enterprise customers want us to help them access the cloud platforms in our data center. As a value proposition, that is unique in China and become a major focus area of our sales and marketing effort to enterprises. On the other side, our cloud customers, ultimately, they would like to penetrate the large enterprise and financial institution customer segments, which have long been our core verticals. Of course, we have a very substantial presence of those kind of customers in our data center.
That's part of the value proposition to our cloud customers to be there. I don't want to be too specific because we will make announcements in due course, but we are developing some ways we say to help the go-to-market strategy of the cloud customers to access the enterprise. William, do you want to comment?
Yes. First of all, I agree with Dan's view. GDS has a long-term direct sell track record. We build our financial institution customer base and other enterprise and multinational customer install base use the direct sell. We have the very strong direct sell team to take care of this kind of significant customer. This is our typical model. As Dan mentioned, we have two ways. In China, a lot of enterprise tries to adapt to the hybrid model right now. By nature, they want close to the cloud access, the multi-cloud. GDS is becoming a cloud hub right now. We are in a very unique position to attract them.
Great. Thank you. That's really helpful. I guess the other question I wanted to ask was about the difference between your total area committed and the total area that's utilized. It looks like there's been a pretty persistent spread between the two, I was wondering is that just that you keep leasing ahead of development projects, or are there customers who are coming in and saying they would rather pre-lease future developments instead of taking down space that may be available today? Thanks.
Yes, Michael, this is a phenomenon that's grown up in the last couple of years, and the answer is both of the things that you said. A substantial part, we call it the backlog, the difference between committed and utilized, maybe in the U.S. you would say leased and occupied, is the backlog. A large part of that right now, 16,000 out of 23,000 sq m, relates to data centers which are under construction, obviously the delivery period has not begun for them. Beyond that, I'd like to say something we have to recognize is the purchasing pattern of these large cloud service providers. They are securing capacity to support business plan, maybe over 12 to 24 months. Pretty much every single large order that goes through the market is for multiple sites.
If you can respond to them in multiple markets, then you put yourself in a different class. Invariably, they have some urgent requirement, very urgent, must have within a few months. At the same time, they want to retain flexibility so that they only need to take delivery when and where they need it. Recently, we signed a significant contract with a financial cloud customer where the contract specified the amount of capacity that that customer is committing to, but it gave them flexibility to select when and where they took that capacity, meaning they could take it all in Beijing in three months' time, or they could take half in Beijing, half in Shenzhen, however they wish, over a front-end period of around 18 months.
Our ability to respond to this and fulfill this kind of requirement is one of the things that makes us quite special in this market. In order to do it, as William said, you need to be ready everywhere. You need to have continuous supply of resource everywhere, and you need to be organized so that you can manage your own costs, your own CapEx, and your own OpEx, so that you only incur that cost on a short lead time before these customers take delivery. Really, this is the formula. This is something that matters a lot to these customers, and I think the way we've been able to organize ourselves to deliver it is really a significant part of our success.
Yeah. What I try to point out is that in China, our competitor, let's say the third party, they are all regional players. We are the only one who has the asset present in all the key markets, which fits the cloud service provider requirement. That's part of our advantage.
Great. Thank you very much.
Thank you for the question. Once again, if you'd like to ask question, please press star one on your telephone and wait for a name to be announced. We have a question from the line of Albert Hung from JPMorgan. Please go ahead.
Hi. This is Albert Hung from JPMorgan. I am asking question on Gokul Hariharan behalf. I want to clarify that, does the CapEx guidance include the Shenzhen 5 acquisition, and is the CapEx front-end loaded or back-end loaded this year?
Hi, Albert. Yeah, the CapEx guidance does include that acquisition, and I should say it includes whatever we do this year, which could be organic or even further acquisitions. Actually, it's fairly well spread over this year. We're in a hurry to develop the resource and bring it to market. There's a lot of pent-up demand still
Understood. How do you see the depreciation translating?
Sorry, Albert, can you clarify your question? You mean the depreciation charge in the income statement?
Yes, correct.
Well, the depreciation goes up every time we bring a data center into service, so we have to start depreciating the asset. As a % of revenue or service revenue, it should remain pretty similar to where it is now. I don't know if that's the question that you're asking.
Great.
Yes.
May I ask, how did you plan to finance your 2017 CapEx? Did you expect to raise more debt, or you rely more on the internal cash?
Yeah. Well, we have the IPO proceeds. We already had some financial resources before the IPO, but we have the IPO proceeds, and we are allocating that to new projects. We certainly have more than enough for everything which is visible today and the acquisition, and more. We will be leveraging up our own equity contribution to these projects. In the past, we've leveraged up at around 60%-70% of project cost. Broadly speaking, that's what we will continue to do in the current year. As I mentioned, we target to raise new debt facilities of about RMB 2 billion in the current year. That compares with RMB 1.6 billion of new debt facilities, which we raised last year. It's a never-ending financing machine.
Great. Thank you. That's all from me.
Thank you for the question. Once again, if you'd like to ask questions, please press star one and wait for your name to be announced. As there are no further questions, I would like to turn the call back over to the company for closing remarks.
Okay. 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 and/or The Piacente Group Investor Relations.
Okay. Thank you. Before we end it, thank you all the investors who support our IPO last year. We will continue working hard to lead GDS' success. Thank you very much.
Ladies and gentlemen, that does conclude the conference call today. Thank you for your participation. You may now disconnect your lines.