Canaan Inc. Q3 FY2021 Earnings Call

Thank you. Hello, everyone. Welcome to our 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. James Cheng. In addition, Mr. Jingjie Wu, our SVP, Mr. Shaoke Li, our Secretary of the Board, and our IR Senior Director will be available during the question-and-answer session. Mr. Zhang will start the call by providing an overview of the Company and performance highlights for the quarter. Mr. Cheng will then provide 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 statement 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 more thoroughly explained in our earnings release. With that, I will now turn the call over to our Chairman and CEO, Mr. Nangeng Zhang. Please go ahead, sir.

Thank you.

Okay. Let me summarize. In the third quarter, thanks to our team's efforts, we achieved strong structural results on multiple fronts. We generated 1,317.6 million RMB in total revenues, which is an increase of 708.2% year-over-year and up 21.8% quarter-over-quarter, reaching a new historical high. Our profitability also improved, with our gross margin increasing to 56.3% during the quarter. Non-revenue totals reached 467.2 million, setting a new record for our IPO. This performance comes despite significant challenges presented by recent regulatory and policy changes that negatively affected the mining machine sales market. We credit our success in facing these challenges to the forward-thinking strategies our management team has been implementing. Since our IPO in 2019, we have continuously expanded our business locally and diversified our geographic presence while adhering to our compliance philosophy. Additionally, we have enhanced our collaboration with key clients in mining machine sales through joint mining, further broadening our cooperation. On the supply side, we maintained strong relationships with our suppliers, improving our communication and securing capacity from wafer production to packaging and testing, ensuring the supply for our production needs. As a result, we managed to navigate semiconductor supply instability, as well as constraints on electricity and international logistics toward the end of the quarter. Importantly, we remain committed to enhancing our R&D efforts and attracting talented individuals to strengthen our product development team, thereby boosting our technological capability and overall growth.

We have enhanced our curing capacity from wafer production to packaging and testing, ensuring a stable supply for our production. This allowed us to navigate the semiconductor supply challenges, as well as issues with electricity and global logistics towards the end of the quarter. Moreover, we are committed to strengthening our R&D initiatives and attracting top talent to develop our product team, which will enhance our technological capabilities and drive our growth.

In terms of our mining machine sales, we believe that the 6.7 million terahash per second of computing power delivered to our clients during the third quarter of 2021 marks an increase of 128.4% year-over-year and 12.9% quarter-over-quarter, achieving a new historical high for quarterly sales performance. In the first nine months of 2021, we shipped our mining machines to 26 countries and regions, creating a geographically diversified business. We also enhanced our presence in several overseas markets where demand is concentrated, such as the U.S. We have received repeat orders from several large-scale mining companies in these overseas markets and established long-term cooperation with them. In the third quarter, 24 million terahash per second of computing power sold came from repeat customers, reflecting their continued trust in our product performance, delivery capabilities, and service quality. Meanwhile, we are in discussions with these clients about potential partnerships to further integrate into the industry value chain and promote renewable energy mining across these markets.

Established long-term cooperation with them. In the third quarter, 24 million terahash per second of computing power sold was ordered by repeat customers, demonstrating their continued recognition of our product performance, delivery capabilities, and service quality. At the same time, we are in discussions with these clients regarding potential partnerships to expand deeper into the industry value chain to drive mining operations, advocating for renewable energy mining in all of these markets.

The average selling price of our computing power slowed in the third quarter. Although it decreased compared to our previous quarter, we currently expect our average selling price to continue to drive growth for our top-line performance in the fourth quarter, similar to what we saw in the third quarter.

The average selling price of our computing power slowed in the third quarter. Although our previous quarter showed different results, we currently expect our ASP to continue to serve as a growth driver for our top-line performance in the fourth quarter compared to the third quarter.

In terms of our supply chain, we continue to strengthen our cooperation with stronger partners and secure their capacity through upfront payments. Our adequate cash position, which resulted from the past and future sales of our mining machines, has enabled us to secure a sufficient supply of resources and production capacity for chips.

We are pleased with our top-line performance in the fourth quarter compared to the third quarter. In terms of our supply chain, we continue to strengthen our cooperation with stronger partners and secure their capacity through upfront payments. Our adequate cash position, which resulted from the past and future sales of our mining machines, has enabled us to secure a sufficient supply of resources and production capacity for chips.

For our Bitcoin mining business, we adhere to our philosophy of operating in accordance with applicable laws and regulations, and we opt to collaborate with established, compliant partners in international markets. We can utilize our supply chain advantages to distribute machines to the facilities of strategic partners that have lower electricity costs. Given the changing dynamics in the industry, we will periodically adjust our business operations to implement our development strategy and capitalize on market opportunities. As part of this, we will continually modify the distribution of mining machines between sales and our mining operations.

We will adjust our business operations from time to time to implement our development strategy and seize market opportunities. To do so, we will constantly adjust the allocation of mining machines between sales and the mining business.

We are currently operating mining machines with a total computing power of approximately 32,000 terahash per second. We have delivered mining machines with 850,000 terahash per second computing power for our mining firm and are gradually putting them into operation. Additionally, we have negotiated contracts with partners for about 1 million terahash per second of extra computing power, and we are preparing to ship these machines to the mining firms by the end of January 2022. Furthermore, we are in talks with several partners for mining projects with a total capacity of around 200 megawatts.

We have machines with 850,000 terahash per second computing power for our mining firm and gradually put them into operation. In addition, we have negotiated contracts with partners for approximately 1 million terahash per second of additional computing power. And we are preparing to ship out these machines to the mining firms by the end of January 2022. Furthermore, we are negotiating with several partners for mining projects with a total capacity of about 200 megawatts.

For our AI business, we have seen rapid growth momentum in terms of total sales of AI chips, which includes a 451% increase in the first 9 months of 2021 from the same period of last year. We have also made solid progress in the research and development of our new generation of AI chips.

Furthermore, we are negotiating with several partners for mining projects with a total capacity of about 200 megawatts. For our AI business, we have seen rapid growth momentum in terms of total sales of AI chips, which includes a 451% increase in the first 9 months of 2021 from the same period of last year. We have also made solid progress in the research and development of our new generation of AI chips.

Our R&D expenses reached RMB 92.76 million in the third quarter, which is a 188.8% increase compared to the same period last year. We have continued to grow our R&D team by attracting top talent through our initiatives to improve our employer branding, using both experienced professionals and campus recruits. In the third quarter, we added 33 technical staff, representing 19% of the total headcount in our R&D team as of September 30, 2021. The total number of R&D staff at the end of the third quarter rose by 70% year-over-year. Additionally, we have made consistent advancements in the research and development of the next generation of mining machines.

We have made steady progress in the research and development of the new generation of mining machines.

After the completion of our previously announced share repurchase program in September 2021, our Board of Directors approved a new share repurchase program of up to $20 million. As of today, we have repurchased about 0.6 million ADS in a total amount of over $4.6 million. We have strong faith in Canaan's growth potential and will remain committed to creating value for our shareholders.

Our Board of Directors approved a new share repurchase program of up to $20 million. As of today, we have repurchased about 0.6 million ADS for over $4.6 million. We have strong faith in Canaan's growth potential and will remain committed to creating value for our shareholders.

During the quarter, we experienced regulatory changes, continuous supply constraints in the global semiconductor industry, and other challenges posed by the market environment. However, despite those challenges, we leveraged our team's collective efforts, as well as our effective network of customers and supply partners to navigate the difficult market dynamics. As such, we delivered a historically best quarterly performance in the third quarter based on the foundation of our success in the previous quarter. I would like to take this opportunity to express my gratitude towards everyone at Canaan for their hard work and dedication, as well as our partners, clients, and investors for their continued support and vote of confidence.

I would like to take this opportunity to express my gratitude towards everyone at Canaan for their hard work and dedication, as well as our partners, clients, and investors for their continued support and vote of confidence.

Going forward through our pathway endeavors, we aim to sustain our growth trajectory to create increasing value for all of our shareholders. We now expect our revenue in the fourth quarter of 2021 to increase by 35% to 50% on a sequential basis. Please note that this forecast reflects our current and preliminary views on the market and operational conditions, which are subject to change.

We appreciate your continued support and vote of confidence. Going forward through our pathway endeavors, we aim to sustain our growth trajectory to create increasing value for all of our shareholders. We now expect our revenue in the fourth quarter of 2021 to increase by 35% to 50% on a sequential basis. Please note that this forecast reflects our current and preliminary views on the market and operational conditions, which are subject to change.

This concludes my prepared remarks. I will now turn the call over to our CFO, James.

Thank you, Mr. Zhang, and hello, everyone, this is James speaking. The third quarter presented challenges; however, we delivered strong performance with record highs in various operating and financial metrics. I'm pleased to share our results with you. In Q3, we achieved another record high in revenue and further increased our profit level. We reported total net revenues of RMB 1,317.6 million and a gross profit of RMB 741.7 million, resulting in a gross margin of 56.3%. We also marked a new high in our net income with a non-GAAP adjusted net income of RMB 587.5 million. From a revenue standpoint, we sold a record high computing power of 6.7 million terahash, while our average selling price per terahash improved by 7% sequentially; increases in both volume and price contributed to driving our revenue to a new level. In terms of our sales pipeline, our pre-orders maintained a contract liability of RMB 1,026.7 million as of quarter-end, compared to RMB 430.4 million as of December 31, 2020. Gross profit was RMB 741.7 million, compared to a gross loss during the same period in 2020, representing a sequential growth of 73.3%. It’s important to note that the demand for our computing power is significantly influenced by Bitcoin prices and their outlook, which can be challenging to predict. Additionally, we are facing pressures from rising costs from our suppliers, which may affect our margins to some extent. Consequently, our gross margin rates are always subject to a combined effect from the volatility in the sector. As we previously disclosed, we have kicked off our mining business and now we have 32,000 terahashes in mining operation. As of the third quarter's end, we were holding 23.86 Bitcoins. Please be advised that our mining income and the cryptocurrencies are initially recorded at the price when we generate them through our mining operation. Our digital assets are recorded on the balance sheet, net of any impairment losses incurred at initial recognition. Gains are not recorded until realized upon disposal of such digital assets. Therefore, the digital asset value on our balance sheet does not reflect its value appreciation in case of an increase in Bitcoin price. Regarding the plan for our mining business, as Ms. Zhang just shared, we also have 850,000 terahashes computing power under deployment that covers the trend. We are under discussion with a few partners to secure additional power and operating capacity. Looking forward, we will continue to allocate Bitcoin mining machines to our mining business sector and we will continuously disclose the progress. Research and development expenses were RMB 92.8 million, reflecting a 188.8% increase year-over-year. This rise was mainly due to higher staff costs in technology departments and additional expenses related to new product development. We will maintain our commitment to R&D and carefully oversee expenses on various projects. In the third quarter, we incurred minimal income tax expense. I want to highlight that as we utilize the deferred tax assets accumulated from prior operating losses, we anticipate significant income tax expenses in our upcoming profitable quarters. Overall, while we achieved solid results for the quarter, we remain vigilant. We recognize the risks and fluctuations in our dynamic industry and aim to manage these challenges with our flexible operating strategies. Now, I would like to briefly walk you through our financial results for the quarter. Total net revenues increased by 708.2% year-over-year, and increased by 21.8% quarter-over-quarter to RMB 1,317.6 million. Gross profit was RMB 741.7 million, up 73.3% sequentially. Total operating expenses in the third quarter were RMB 278.4 million compared to RMB 75.9 million in the same period of 2020, and RMB 262.4 million in the second quarter of 2021. Income from operation was RMB 463.3 million, up 179.9% sequentially. Net income attributable to ordinary shareholders was RMB 467.2 million, up 179.3% sequentially. Non-GAAP adjusted net income was RMB 587.5 million, up 83.6% sequentially. Non-GAAP adjusted net income or loss excludes share-based compensation expenses. Basic and diluted net earnings per ADS for the quarter were RMB 2.68 and RMB 2.64, respectively. As of September 30, 2021, the Company had cash and cash equivalents of RMB 1,698.5 million, up 334% compared to RMB 391.3 million as of December 31, 2020. This concludes our prepared remarks. We are now open for questions.

Congratulations on the impressive Q3 earnings and the Q4 guidance. The CEO mentioned that the Chinese government has tightened regulations on mining operations in Mainland China. What do you think will be the impact on the cryptocurrency mining industry, and how did this affect sales in Q3? Is there a possibility for this to be transferred to overseas customers?

First, congratulations on the very strong Q3 earnings and the Q4 guidance. The CEO already mentioned that the Chinese government tightened regulations for the shutdown of mining operations in Mainland China. In your view, what is the impact on the cryptocurrency mining industry, and how did it affect sales in Q3? Can this be transferred to the overseas customers?

If we look at the computing power statistics of the Bitcoin network, by the end of the third quarter, nearly all of the computing power from mining firms in Mainland China has been removed. Afterwards, most of the continuing mining farms, along with the computing power, have relocated to overseas markets. However, as of now, the Bitcoin network's total computing power still has not recovered to its highest level in the industry.

The Bitcoin network's total computing power has not yet returned to its previous peak levels.

There will be some market developments regarding the short-term volatilities in the price of Bitcoin. However, we can see that the Bitcoin price has fully recovered from the temporary losses as of now.

The Bitcoin network's total computing power has not yet returned to its peak level in the industry. There will be some market developments regarding short-term price volatilities, but currently, the Bitcoin price has fully recovered from its temporary losses.

Typically, although the regulatory changes had a negative impact on the sale of mining machines in the short term, the market reacted and adjusted accordingly during the quarter. As industry players, we redirected this ongoing computing power to the overseas market. The overall global demand for mining machines is starting to rise again. We have also noticed that the financing conditions for miners in the overseas market are improving. Many large-scale overseas operations are actively investing in mining. Therefore, the demand for computing power remains relatively stable.

The market had already reacted and adjusted in a timely manner during the quarter. As industry players, we allocated this continued computing power to the overseas market. The overall global demand for mining machines resumed its upward trajectory. We have also observed that the financing environment for miners in the overseas market is improving. Many large-scale overseas players are actively investing in mining initiatives. So overall, the demand for computing power is relatively stable.

Additionally, our financial performance showed strong growth this quarter, and we expect even greater sequential growth in the fourth quarter. We believe our efforts to expand in overseas markets have helped us mitigate the effects of recent regulatory changes. I hope I answered your questions. Thank you.

The CEO mentioned that some aspects can already be locked in. Could you provide more details about your collaboration with your partner in 2022, specifically regarding cost operations? Are you currently working on that? Additionally, do you expect further increases in prices in the coming year due to supply constraints?

as markets have enabled us to offset the impact of regulatory changes. I hope I answered your questions. Thank you. Martin Chen, Analyst, the CEO already mentioned that we can lock some agreements. Could you elaborate more on your collaboration with your partner in 2022, in terms of cost operations, and are you on track? And do you foresee further increases in the price of goods in the next year due to supply constraints?

We have implemented a comprehensive growth strategy and formed long-term partnerships with several major foundries. Our effective collaboration with these foundry partners has ensured a consistent supply of wafers for our production. As our yield continues to improve in 2021, we can assure the performance of our mining machines while increasing our production capacity. We are also actively pursuing additional production capacity to satisfy the growing demands from our clients. With one of our foundry partners, we have secured wafer supplies through prepayments for the second quarter of 2022.

Our smooth cooperation with these foundry partners has secured stable wafer supplies for our production. As our yield continues to improve in 2021, we are able to reassure the performance of our mining machines while improving our production capacity. We are also actively seeking additional production capacity to meet the increasing demands from our clients. With one of our foundry partners, we have secured wafer supplies through prepayments for Q2 in 2022.

On top of that, we continue to refine the fabrication process, and the improvements in our yield rate have been encouraging. We have achieved slightly higher results in all processes throughout the fabrication line, such as packaging. As a result, we were able to improve the overall product yield, and thus our gross margins in the third quarter.

We continue to refine the fabrication process, and the improvements in our yield rate have been encouraging. We have achieved slightly higher performance in all processes throughout the fabrication line, such as packaging. As a result, we were able to improve the overall product yield, and thus our gross margins in the third quarter.

While we acknowledge that the ongoing industry-wide supply constraints are creating a seller's market, thereby increasing labor costs on natural supplies from our foundry partners in the upper stream of the industry value chain, we face an unstable wafer supply. We are exploring a variety of flexible strategies with our foundry partners to secure our wafer supply. These strategies may include accepting price increases under certain conditions to ensure our supply. As wafer supplies improve across the semiconductor industry, we will continue to negotiate future labor prices with our partners. We believe that a reasonable range of price increases will further strengthen our position. In 2022, we will keep upgrading our fabrication process and enhancing the performance and cost efficiency of our products. I hope I answered your questions.

We will continue to negotiate future labor prices with our partners. We believe that a reasonable range of price increases will further solidify our goals. In 2022, we will continue to upgrade our fabrication process and improve the performance and cost efficiency of our products. I hope I answered your questions.

Thank you.

We have heard that there are plans to release regulations on cryptocurrency mining. Do you see this having a significant impact on your mining business?

Eases will further solidify our position. In 2022, we will continue to upgrade our fabrication process and improve the performance and cost efficiency of our products. I hope I answered your questions. Thank you. And we have heard that there are new regulations on cryptocurrency mining, do you see this as a material impact on your mining business?

Yes, we noticed the recent policies and believe they will promote sustainable development in the cryptocurrency mining industry in the country. Under the new guidelines, mining companies must obtain approval from the government to secure electricity supply. We have learned from our recent communications with customers that large companies with technological capabilities and sufficient funding will benefit from this policy. Our current top three customers in Kazakhstan, which are also large-scale companies, will have obtained the necessary approvals from the Kazakhstan Ministry of Energy to operate mining businesses, ensuring our business development in the country. Additionally, this policy will effectively prevent unqualified and small mining companies from engaging in speculative and market-disturbing activities, benefiting our largest clients in Kazakhstan.

Our current top three customers in Kazakhstan, who are large-scale companies, will have received the required approvals from the Kazakhstan Ministry of Energy to operate mining businesses, thereby supporting our business growth in the country. Additionally, this policy will help prevent unqualified and small mining firms from engaging in speculative and disruptive activities, benefiting our largest clients in Kazakhstan.

I want to emphasize that our global operations extend well beyond just one region, as we have already established a presence in Central Asia, Southeast Asia, Europe, and North America. Notably, North America represents about 30% of our international market, with the bulk of long-term revenue coming from public companies. These companies include Molson, Iris Energy, and Highest Block Chain.

Our global operations reach far beyond our current markets, as we have established a foothold in Central Asia, Southeast Asia, Europe, and North America. Most notably, North America accounts for approximately 30% of our overseas market, with the majority of the long-term partnerships coming from public companies. These companies include Molson, Iris Energy, and Highest Block Chain.

Hope I answered your question. Thank you.

Could you elaborate more on your incoming profits from your mining business and how your holding and trading strategy for Bitcoin could influence your financial spending in the future?

The majority of the long-term benefits come from public companies. These companies include Molson, Iris Energy, and Highest Block Chain. Hope I answered your question. Thank you. And could you elaborate more on your incoming profits from your mining business, and how your holding and trading strategy for Bitcoin could influence your financial spending in the future?

It is worth reiterating that compliance with laws and regulations is the foundation on which we explore our mining business in overseas markets with extreme caution at the early stage. We are currently operating mining machines with a total computing power of approximately 32,000 terahash per second. After the initial test, we can now effectively execute many aspects of the business, such as legal, tax, and operations. In addition, we have delivered mining machines with 857 terahash computing power to our partners' mining farms, which have been set up for operation. We have also signed contracts with mining partners for approximately 1 million TH/s of additional computing power, and scheduled the shipment of these mining machines by the end of January of next year. Furthermore, we are negotiating with a number of North American business partners to join mining projects in North America with an electricity consumption capacity of 400 megawatts.

We are providing machines with 857 terahash computing power to our partners' mining farms, which are now operational. Additionally, we have secured contracts with mining partners for around 1 million TH/s of extra computing power and have planned to ship these machines by the end of January next year. Moreover, we are in discussions with various North American business partners to participate in mining projects in North America with a capacity of 400 megawatts for electricity consumption.

As of September 30, we hold 23.86 Bitcoins. Our current strategy is to hold our Bitcoin, and we will not trade them in the short-term. However, we do not rule out the possibility of trading them in the future.

As of September 30, we hold 23.86 Bitcoins. Our current strategy is to hold our Bitcoin, and we will not trade them in the short-term. However, we do not rule out the possibility of trading them in the future.

According to our policy, the value of Bitcoin we hold is recorded at acquisition costs, and we measure the asset on our balance sheet. For subsequent valuations, we acknowledge impairment losses if the value falls below the initial costs. If the value increases, we do not register any gains on the balance sheet. Only when the Bitcoins are sold will we recognize the actual gains.

According to the information provided, the value of Bitcoin we hold is recorded at acquisition costs and we recognize impairment losses if the value decreases below the initial costs. We do not record any gains on the balance sheet if the value increases. Actual gains will only be recognized when the Bitcoins are sold.

Thank you.

Thank you. My last question is about the tenants mining cost in the third quarter.

We recognize impairment losses if the asset value is lower than the initial costs. However, if the value increases, we do not record any gains on the balance sheet. Actual recognition will occur only when the Bitcoins are sold. Thank you. My last question is about the tenants mining cost in the third quarter.

The costs of mining in the finalized stage in the third quarter were approximately 39% of mining revenue, resulting in a gross margin of 61%. This margin is slightly higher than that of our mining machine sales. However, as we pursue various collaborations, the gross margin is expected to fluctuate with changes in Bitcoin prices and through our partnerships with mining collaborators.

The costs of mining in the finalized stage in the third quarter was about 39% of mining revenue, and the gross margin was 61%, which is slightly higher than the gross margin of our sales of mining machines. However, going forward for different collaborations, the gross margin will continue to be subject to change in the price of Bitcoin where it is harvested and these different ways of collaborating with mining partners.

Thank you. As there are no further questions, I would now like to turn the call back to the management for any closing remarks.

Thank you. Once again, for joining us today. If you have further questions, please feel free to reach out through the contact information provided on our website.

Thank you. That concludes the call today. Thank you, everyone for attending. You may now disconnect. Thank you all.