Canaan Inc. Q2 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to Canaan Incorporated Second Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. After the management’s prepared remarks, we will have a Q&A session. Please note that this event is being recorded. Now, I’d like to hand the conference over to your speaker for today Mr. Shaoke Li, Board Secretary of the Company. Please go ahead, sir.

Thank you very much and hello everyone. Welcome to Canaan Inc. second quarter 2020 earnings conference call. The Company's financial and operating results were released by our newswire services earlier today and are currently available online. Joining us today are our Chairman and CEO, Mr. Nangeng Zhang; and our CFO, Mr. Quanfu Hong. In addition, Mr. Jingjie Wu, our VP and Mr. Wenjun Zhang, our Executive Assistant, will also be available during the question-and-answer session. Mr. Zhang will start with the call by providing an overview of the Company and the performance highlights for the second quarter of 2020. Mr. Hong will then provide the details on the Company's operating and financial results for the period before we open the call up for your questions. Before we continue, I would like to refer you to our Safe Harbor Statements in our earnings press release, which also applies to this call as well, as we will be making forward-looking statements. Please also note that we will discuss non-GAAP measures today, which are mostly roughly explained and reconciled to the most comparable measures reported on the generally accepted accounting principles in our earnings release and the filings with the SEC. With that, I will now turn the call over to our Chairman and the CEO, Mr. Nangeng Zhang. Mr. Zhang will deliver his remarks in Chinese and I will provide the corresponding English translation. Please go ahead, sir.

Hello, everyone. This is Nangeng Zhang, Chairman and CEO of Canaan Inc. I will now provide a brief overview of our progress in the second quarter of 2020. During the quarter, Bitcoin's price volatility declined compared to the first quarter due to the Bitcoin halving event in May 2020. As Bitcoin's price began to recover after the halving, we saw significant improvements in our financial and operating performances on a sequential basis. Most notably, our total net revenues rose by 160.8% quarter-over-quarter to RMB178.1 million, driven by a 198.5% increase in our total computing power sold and a 153.5% increase in the number of Bitcoin mining machines sold during the quarter. Additionally, we improved our profitability, growing our gross profit to RMB43.3 million in the second quarter from RMB2.4 million in the prior quarter, while significantly narrowing our net loss to RMB16.8 million from RMB39.9 million in the prior quarter. This strong performance demonstrated our ability to rejuvenate our business and foster financial growth as Bitcoin prices stabilized after the halving. Furthermore, China's rainy season brought an abundance of hydropower in the second quarter, leading to cheaper electricity and more profitable mining. Consequently, the favorable environment for Bitcoin and Blockchain has accelerated the rebound in market demand for mining machines. In fact, during the second quarter, we nearly cleared our entire inventory, and all Bitcoin mining machines currently in production for the third quarter have been pre-ordered. We have already begun accepting pre-orders for mining machine deliveries in the fourth quarter of 2020 and early 2021. These pre-orders will lead to a significant increase in customer advances and prepaid expenses in the third quarter. We are encouraged by the strong market demand. Meanwhile, we further enhanced our research and development capabilities to ensure our products remain at the forefront of technology for innovation. After mass-producing the first generation of the Samsung 8-nanometer chip in the first quarter, we completed the R&D process for the second generation of the same chip in the second quarter. During testing, the second generation chip showed a 20% overall improvement compared to its predecessors. We plan to leverage this new generation of the Samsung 8-nanometer chip to start mass production of new Bitcoin mining machines in early September. Additionally, we completed the tape-out process for the SMIC first generation N+1 chip, making it one of the first N+1 chips to successfully tape out at SMIC. By late August, we had already received the N+1 chip from SMIC, and its performance exceeded our expectations. We anticipate beginning deliveries of mining machines with the N+1 chip in mid-fourth quarter. Before refining our product offerings, we also remain committed to expanding our overseas customer base. In Kazakhstan, for example, we have secured multiple large-scale purchase orders from local mining companies, such as A2 Group Limited and AMEC. We are also in the process of tendering several international Bitcoin mining firms, each involving more than ten thousand machines. We are optimistic about securing these projects and will keep the market updated on our progress. As Bitcoin prices stabilized after the halving, the demand for high-quality mining machines became noteworthy. However, the global capacity for wafer fabrication has been affected by various factors such as the COVID-19 pandemic and geopolitical issues. To ensure we can continue delivering our products to customers, we have placed sufficient orders with our production partners. Thanks to our efforts to diversify supply sources since 2019, we are well-prepared to fulfill our customers' orders and drive business expansion going forward. Regarding our AI products, we continue to focus on expanding our AI partnerships and accelerating the monetization of our AI products as the COVID-19 outbreak is gradually controlled in China. We believe the social distancing practices developed during the pandemic will expedite the digitization for government agencies, businesses, and individuals. Aligning with this strategy, we partnered with VergeSense, a US-based workplace management service provider specializing in sensor hardware and SaaS solutions. Through this partnership, our K210 chips will be implemented in VergeSense's new generation of motion sensors designed to analyze safe social distances during the pandemic. Mass production for this new generation of motion sensors began in July. On the previous earnings call, we mentioned developing an intelligent door lock system capable of facial recognition on individuals wearing masks. This system is now market-ready, and orders are increasing. Additionally, in the second quarter, DJI Technology chose our K210 chips for one of its STEM education projects, launched in July, and we expect it to integrate our chips into its products by late 2020 or early 2021. Our AI products developed with leading STEM learning solution providers and other developers have also entered production testing. We are diligently working to develop our next generation AI chip, the K510. This new chip has already garnered many customer requests for testing, and we anticipate starting mass production before the first quarter of 2021. We have also committed to integrating our AI products into our open-source community, aiming to establish an open-source AI application platform. Recently, we announced changes to our organizational structure and the Board of Directors. The new members of our executive team will help us gain a deeper understanding of future trends in the high-tech industry. These changes have ensured that our management has extensive experience in the IT industry, global market strategic planning, and corporate governance. We firmly believe effective corporate governance will enable us to generate maximum value for our company and shareholders going forward. Although the global economy faces uncertainties, we are confident that technology transcends borders and will serve as a vital tool for enhancing societal operational efficiencies and improving everyone's way of life.

This concludes the remarks of our CEO, Mr. Zhang. Now, on behalf of our CFO, Mr. Quanfu Hong, I will provide an overview of our second quarter financial results. Before I start, please note that all numbers are in RMB terms unless otherwise noted. Total net revenue in the second quarter of 2020 decreased by 26.3% to RMB178.1 million from RMB241.5 million in the same period of 2019. The year-over-year decline was primarily attributable to the outbreak of COVID-19 and the Bitcoin halving event in the second quarter of 2020, both of which led to decreases in our total computing power sold and our average selling price per thash in the same period. On a sequential basis, total net revenue grew by 160.9% from RMB68.3 million in the first quarter of 2020. Cost of revenue in the second quarter of 2020 was RMB133.8 million compared to RMB230.8 million in the same period of 2019 and RMB65.9 million in the first quarter of 2020. The year-over-year decrease and quarter-over-quarter increase in the cost of revenues were in line with the change in both our thash sales volume and cost per thash. Gross profit in the second quarter of 2020 increased to RMB43.3 million, representing an increase of 302.5% from RMB10.8 million in the same period of 2019 and an increase of 1,711.5% from RMB2.4 million in the first quarter of 2020. Gross margin in the second quarter of 2020 expanded to 24.3% from 4.5% in the same period of 2019 and 3.5% in the first quarter of 2020. Research and development expenses in the second quarter of 2020 decreased to RMB26.1 million from RMB35.9 million in the same period of 2019 and RMB41.8 million in the first quarter of 2020. The reductions of R&D expenses were mainly due to the decrease in materials used for research and development purposes during the second quarter. As a percentage of total net revenues, R&D expenses in the second quarter of 2020 was 14.6% compared to 14.9% in the same period of 2019 and 61.2% in the first quarter of 2020. Let's now take a look at operating expenses in the second quarter. One, selling and marketing expenses in the second quarter of 2020 were RMB6.5 million compared to RMB5.6 million in the same period of 2019 and RMB4.1 million in the first quarter of 2020. The increase in selling and marketing expenses was mainly driven by higher salaries for our sales and marketing departments. As a percentage of total net revenues, selling and marketing expenses in the second quarter of 2020 was 3.7% compared to 2.3% in the same period of 2019 and 6.1% in the first quarter of 2020. Two, general and administrative expenses in the second quarter of 2020 were RMB29.6 million compared to RMB238.1 million in the same period of 2019 and RMB27.6 million in the first quarter of 2020. In the second quarter of 2019, a total of RMB213.1 million in share-based compensation allocated to general and administrative expenses caused by the excess of appraised fair value over the transfer price of ordinary shares transferred from the existing shareholders to other existing shareholders who were also employees. Consequently, our total operating expenses in the second quarter of 2020 decreased to RMB60.4 million from RMB279.7 million in the same period of 2019 and RMB73.5 million in the first quarter of 2020. Loss from operations in the second quarter of 2020 decreased to RMB18.9 million from RMB268.9 million in the same period of 2019 and RMB71.1 million in the first quarter of 2020. Excluding share-based compensation expenses of RMB0.7 million, the non-GAAP loss from operations in the second quarter of 2020 was RMB80.2 million. The net loss attributable to ordinary shareholders in the second quarter of 2020 decreased to RMB16.8 million from RMB263.1 million in the same period of 2019 and RMB39.9 million in the first quarter of 2020. Non-GAAP adjusted net loss in the second quarter of 2020, which excluded share-based compensation expenses, was RMB60.8 million. Diluted net loss per ADS in the second quarter of 2020 was RMB0.11 compared to RMB1.88 in the same period of 2019 and RMB0.25 in the first quarter of 2020. Turning to our balance sheet, as of June 30, 2020, we had cash and cash equivalents of RMB157 million compared to RMB516.6 million as of December 31, 2019. The decrease was mainly due to higher short-term investments. As of June 30, 2020, we had invested RMB347.6 million in short-term investments compared to RMB11 million in short-term investments as of December 31, 2019. We purchased short-term financial products to receive higher returns but with no withdrawal restrictions. So this concludes our prepared remarks for today. Operator, we are now ready to take questions.

Thank you very much. Our first question comes from an analyst at Charles Investments. Your line is now open.

Yes. Thank you very much. I apologize I don't speak Chinese. So I have the question in English. Can you make any comments on deposits made by customers for orders for your mining equipment?

Our existing customer orders are primarily for the A10 series product, largely due to its maturity. In the second quarter, our sales were mainly based on inventory sales. Starting from the third quarter, we completely sold out our inventory. The new orders are now for future deliveries of our new product series. This approach is standard in our industry, especially for large orders that require a waiting period. We expect to deliver between the third quarter of this year and the first quarter of next year. The delivery time is extended due to the longer processing and manufacturing times at the foundry. Recently, our order volume has increased because our new product series offers improved performance and cost efficiency.

Okay, thank you.

Thank you very much. Your next question comes from Michael Parker from TDF Limited. Michael, you can go ahead.

Thank you. Yes. My question is to the CFO, what international accounting standards does the company work with on tools lease?

Hi. Our accounting principle is fully based on the US GAAP standard.

Okay. Thank you.

Thank you.

Thank you so much. There were no further questions at this time. I'll hand back over to the management for closing remarks.

All right. Thank you for joining us today and we look forward to talking with you next quarter. Thanks.

And that concludes the conference for today. Thank you for participating. You may all now disconnect.