Canaan Inc. Q3 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to Canaan’s Inc. Third 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 question-and-answer session. Please note this event is being recorded. Now, I'll now like to hand over the conference to your speaker host today, Mr. Shaoke Li, Board Secretary of the Company. Please go ahead, Mr. Li.

Thank you very much. Hello, everyone. And welcome to Canaan Inc. third 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 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 quarter. Mr. Hong will then provide the details on the company's operating and the financial results for the period before we open 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 we will be making forward-looking statements. Please also note that we will discuss non-GAAP measures today, which are most 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 CEO, Mr. Nangeng Zhang. Mr. Zhang will deliver his remarks in Chinese, and I will provide the corresponding English translations. 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 third quarter of 2020. Our total net revenue in the quarter decreased by 8.5% quarter-over-quarter to US$24.01 million. In the second quarter, we focused on reducing our inventory and nearly cleared it out as of July. By the end of the second quarter, demand for mining machines in the market had rebounded. Consequently, we ramped up production and continued the tape-out process in the third quarter. However, the waivers that were in the fabrication process during the third quarter will not begin to deliver until the fourth quarter of 2020, resulting in no significant revenue contribution to our third quarter results. At the beginning of the third quarter, the price of Bitcoin continued to rise, reaching US$12,400 and even hitting US$19,000 in the fourth quarter. Thus, the recovery trend in the blockchain market continues to increase demand for our products. By the end of the third quarter, our advanced receipts totaled US$11.14 million, up US$10.98 million from the end of the previous quarter. We also increased our R&D investments in the third quarter, with R&D expenses rising by 23.2% sequentially to US$4.73 million, which underscores our confidence in the company's long-term development. On September 8, we announced a share repurchase program for up to US$10 million worth of our shares. As of October 30, we had bought back 1,225,000 shares for a total transaction value of US$2.43 million, reflecting our confidence in Canaan's long-term business prospects and growth potential. Regarding our mining machines, we leveraged our leading R&D capabilities in the third quarter to launch our A12 product series. This new generation of products has achieved an energy efficiency ratio of 38 joules per terahash, with a total computing power of 90 terahashes per machine, and boasts the lowest unit cost in the industry. By significantly improving the computing power and optimizing the energy efficiency ratio, we have successfully met the market demand for high-powered, low-energy mining machines. In 2021, we plan to launch new product series with energy consumption ratios between 30 and 40 joules per terahash. Looking ahead, we believe that the enhanced performance of our new products will continue to strengthen our competitive advantages, especially regarding cost management, which will further expand our industry leadership. Several factors affected global IT production capacity in 2020. Nonetheless, we remain committed to our business model and collaborations with multiple established IT manufacturers to ensure a sufficient supply of IT products moving forward to better meet customer needs. As I mentioned earlier, we received a substantial number of pre-sale orders in the third quarter. So far in the fourth quarter, our pre-sales volume continues to be strong, and our pre-sale deliveries are already scheduled through the end of the first quarter of 2021. As of the end of November, the total value of pre-sale deliveries for both the fourth quarter of 2020 and the first quarter of 2021 has already exceeded US$45 million. During the third quarter, we saw significant changes in the geographic contributions to our revenue. Specifically, revenue from the Commonwealth of Independent States saw substantial growth, while revenue from the U.S., previously a major overseas market, declined sharply due to the pandemic and other issues. We anticipate a gradual recovery in the U.S. market starting in the second quarter of 2021. In terms of client demographics, we continue to see an increasing presence of specialized corporations in the Bitcoin mining market, with over 90% of our clients being large and medium-sized businesses purchasing more than 1,000 units. Over the last two quarters, we have added numerous new large and medium-sized clients. Now, turning to our developments in AI. In 2020, we accelerated the monetization of our AI business. Earlier this year, we established a partnership with VergeSense, a U.S.-based workplace management service provider specializing in sensor hardware and SaaS solutions. After forming this partnership, we integrated our K210 chips into VergeSense's next-generation hardware sensors, which helped ensure effective execution of social distancing measures due to COVID-19. We received orders for over 4,000 of our AI chips, marking our first international shipment to the U.S. market. Through partnerships with UBTECH Robotics and DJI Technology, we are leveraging our K210 chips' visual processing capabilities to provide AI-driven online education solutions, such as developing unmanned vehicles for programming competitions. Our product developed with UBTECH has launched, and we plan to introduce our DJI product to the market in 2021. We are confident that these products will be competitive in terms of energy consumption and production costs. Additionally, we are actively engaged in smart city projects, collaborating with [indiscernible] IoT technology on its Smart Door Lock initiative. We have won multiple tenders for government contracts related to Smart Door Locks. Our partnership with Hangzhou [ph] has successfully integrated our K210 chips into the smart city operations in Beijing's Haidian District. Currently, our monthly shipment of AI chips remains stable at around 20,000 to 30,000 units. As we maintain this momentum, we expect monthly AI chip shipments to exceed 50,000 in the coming year. Beyond our K210 chips, we have completed the tape-out of our K510 series, which we plan to launch in the first quarter of 2021. The K510 is an innovative AI processor based on the KPU, utilizing our new, independently developed architecture. This chip will feature a more logical configuration, consume less power, offer more peripherals, and be more scalable, addressing real market needs. We see the K510 as a replacement for our previous generation of AI chips and a gateway into new markets. Its low production costs and industry-leading performance will enable it to power products that could disrupt multiple markets such as high-end smart home products, smart retail solutions, and smart security systems. Over the past six months, we focused on monetizing and analyzing market dynamics and policies in both domestic and international contexts, while also accumulating resources and experiences for new business initiatives. Looking ahead, we are fully prepared to develop our Bitcoin mining and digital currency operations legally and compliantly. We expect to establish our Bitcoin mining-related business within the next six months, which will help stabilize our supply chain and streamline our production of mining machines. This new segment will enhance our sales, improve inventory management, expand our profitability, and capitalize on the Blockchain industry's growth. Our mining machines are central to our post-IPO growth strategy. We plan to use them to elevate our market position beyond just hardware manufacturing, building a comprehensive Blockchain ecosystem to provide a complete, convenient, efficient, and reliable solution for investors looking to engage in this industry's growth. In light of global economic uncertainties, we will continue to maintain transparency while leveraging our technology to improve lives and contribute to a more efficient society. Thank you.

This concludes the remarks of our CEO, Mr. Zhang. Now on behalf of our CFO, Mr. Hong Quanfu, I will provide an overview of our third quarter financial results.

Before I start, please note that all numbers are in RMB terms unless otherwise noted. Total computing power sold in the third quarter was 2.9 million terahashes, representing a year-over-year decrease of 20.7% from 3.7 million terahashes in the same period of 2019 and a quarter-over-quarter increase of 13.4% from 2.6 million terahashes in the second quarter of 2020. The total net revenue decreased by 75.5% year-over-year and 8.5% quarter-over-quarter to RMB163 million from RMB670.6 million in the same period of 2019 and RMB178.1 million in the second quarter of 2020. Cost of revenues in the third quarter of 2020 was RMB180 million compared to RMB524.4 million in the same period of 2019 and RMB134.8 million in the second quarter of 2020. The year-over-year decrease in cost of revenue was in line with the change in the Company’s sales volume of terahashes and cost per terahash. The quarter-over-quarter increase was primarily due to the investor inventory write-down of RMB44.9 million and the increase in sales volume. As a result, we reported a gross loss of RMB17 million in the third quarter of 2020 compared to a gross profit of RMB146.2 million in the same period of 2019 and a gross profit of RMB43.3 million in the second quarter of 2020. Research and development expenses in the third quarter of 2020 were RMB32.1 million compared to RMB38.1 million in the same period of 2019 and RMB26.1 million in the second quarter of 2020. The quarter-over-quarter increase was mainly due to the increase in materials used in the third quarter of 2020 in order to better perform in the coming bull market. As a percentage of total net revenues, research and development expenses in the third quarter of 2020 were 19.7% compared to 5.7% in the same period of 2019 and 14.6% in the second quarter of 2020. Let's now take a look at the other operating expenses in the third quarter. Selling and marketing expenses in the third quarter of 2020 decreased by 49.4% year-over-year and 51.2% quarter-over-quarter to RMB3.2 million from RMB6.3 million in the same period of 2019, and RMB6.5 million in the second quarter of 2020. The reductions were mainly driven by the decreased salaries of the staff in the company's sales and marketing department. As a percentage of total net revenues, sales and marketing expenses in the third quarter of 2020 were 2% compared to 0.9% in the same period of 2019 and 3.7% in the second quarter of 2020. General and administrative expenses in the third quarter of 2020 totaled RMB40.6 million compared to RMB28.2 million in the same period of 2019 and RMB29.6 million in the second quarter of 2020. Consequently, our total operating expenses in the third quarter of 2020 were RMB75.9 million compared to RMB72.7 million in the same period of 2019 and RMB62.2 million in the second quarter of 2020. Loss from operations in the third quarter of 2020 was RMB92.9 million compared to income from operations of RMB73.5 million in the same period of 2019 and loss from operations of RMB18.9 million in the second quarter of 2020. Excluding share-based compensation expenses of RMB1.6 million, non-GAAP loss from operations in the third quarter of 2020 was RMB91.2 million. Net loss attributable to ordinary shareholders in the third quarter of 2020 was RMB86.4 million compared to a net income of RMB94.6 million in the same period of 2019 and net loss of RMB16.8 million in the second quarter of 2020. Non-GAAP adjusted net loss in the third quarter of 2020, which excluded share-based compensation expenses, was RMB84.8 million. Basic and diluted net loss per ADS in the third quarter of 2020 were both RMB0.55. In comparison, basic and diluted net earnings per ADS in the same period of 2019 were both RMB0.65. Basic and diluted net loss per ADS in the second quarter of 2020 were both RMB0.11. Turning to our balance sheet. As of September 30, 2020, we had cash and cash equivalents of RMB177.4 million compared to RMB516.6 million as of December 31, 2019. The decrease was mainly due to the higher short-term investments as the Company had invested RMB204.6 million in short-term investments as of September 30, 2020, compared with RMB11 million in short-term investments as of December 31, 2019. The company purchased short-term financial products to receive higher returns but at the same time can withdraw at any time. This concludes our prepared remarks for today. Operator, we are now ready to take questions.

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. Your first question comes from Zheng Jialiang from HashKey Capital. Please go ahead with your question.

Thank you, Zhang and Hong, and also to management. I have a question regarding the new business that I'm unsure how to describe. For the mining business, is it geared towards self-operation or is it simply a mining pool for external clients? Thank you.

Our new business continues to focus on running our own Bitcoin mining operation. We plan to use our Bitcoin mining machines to hold Bitcoin currencies as part of our long-term business strategy. Regarding the mining pool, we are still engaged in that through partnerships. Currently, we do not have plans to operate our own mining pool due to compliance issues, but we will continue to monitor the situation.

My second question is, how long will the tariff on this new business be in effect, and where do you plan to expand this new business? Thank you.

We have actually been preparing for the business for quite a while, and we are finishing off the preparation process. Currently, we are looking at either late first quarter 2021 or early second quarter of 2021 for the launch. In terms of location, we're looking at the overseas market, specifically in Asia, Europe, and North America.

My third question is regarding how many resources the company will invest into this new business, including how much the team and capital will be allocated to this new venture. I would also like to know the size of the mining farm. Thank you.

In terms of our investments in the new business, we are adopting a more cautious approach. We are exploring investments in new locations, operations, and human resources. We prefer to partner with local entities and invest in certain local resources. Currently, we are not constructing facilities in local markets. To clarify on cash investments, we will utilize our partnerships. We believe that cash investments will represent a small fraction of our overall investments, particularly in mining machines. The scale of our mining operations will be influenced by market conditions, and in response to market fluctuations, we will prioritize expanding our mining business. We anticipate that 10% to 20% of our mining machines will be allocated to this sector. When the market is strong, we expect only 10% to 20% of our capacity to be dedicated to the mining business, but in a struggling market, that percentage will rise.

Okay, thank you. My thinking is that our product will prioritize our clients first. When the market is fluctuating, our suppliers’ mining machines will be allocated to our own mining farms, correct?

Yes. When our sales are performing well, we expect 10% to 20% of our mining machines to be allocated to our mining business. However, when the market isn't doing well, we plan to increase that allocation.

My question is about the supply chain. It's well known that current supply chain issues have affected the output of the mining machine factory. Our orders have been delayed to the first quarter, and this seems to be a trend across the entire mining machine industry. What does management project for the supply chain situation next year, and how will this development impact Canaan’s production? Thank you.

To summarize our supply chain process: In the first half of 2020, our production faced challenges due to global trade issues. The Bitcoin home market was not very strong, and inventory levels were low. However, in the second half of the year, demand for semiconductors increased, and the price of Bitcoin rose as well. Despite this, we encountered some production setbacks stemming from issues we anticipated from the first half, which is why we are committed to collaborating with multiple manufacturers. For the first half of 2021, we expect our production to continue to increase. Our pre-sale orders are set for delivery in the second quarter of next year, driven by rising market demand. Currently, our machine production process takes 90 to 120 days, but we aim to produce several tens of thousands of mining machines next year. By operating our own Bitcoin mining business, we will enhance our supply chain process, allowing us to build our inventory even during turbulent market conditions.

All right. Thank you. I’ll now hand the conference back to the management team for their closing remarks.

Thank you all for joining us today and we look forward to talking to you next quarter.

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.