Canaan Inc. Q1 FY2022 Earnings Call

Thank you for joining us for Canaan Inc.'s First Quarter 2022 Earnings Conference Call. This event is being recorded. I will now turn the call over to Ms. Xi Zhang, Investor Relations Manager of the Company. Please proceed, Ms. Zhang.

Thank you, operator. Hello, everyone, and 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 Jin Cheng. In addition, Mr. Xiaoming Lu, our SVP, Mr. Leo Wang, IR Senior Director, and Mr. Clark Soucy, IR Director, will also 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. Today's call will include forward-looking statements. These statements include, but are not limited to, our outlook for the company, and statements that estimate, or project future results of operations, or the performance of the company. These statements speak only as of the date hereof and the company assumes no obligation to revise any forward-looking statements that may be made in today's press release, call, or webcast, except as required by law. These statements do not guarantee future performance and are subject to risks, uncertainties, and assumptions. Please refer to the press release and the risk factors and documents we file with the SEC, including our most recent annual report on Form 20-F for information on risks, uncertainties, and assumptions that may cause actual results to differ materially from those set forth in such statements. In addition, during today's call and webcast, we will discuss both GAAP financial measures and certain non-GAAP financial measures, which we believe are useful as supplemental measures of the company’s performance. These non-GAAP measures should be considered in addition to and not as a substitute for or in isolation from GAAP measures. You can find additional disclosure regarding these non-GAAP measures including reconciliations with comparable GAAP measures in our earnings press release, which is posted on the company's website. With that, I will now turn the call over to our Chairman and CEO, Mr. Nangeng Zhang. Please go ahead, sir.

Against the backdrop of the expected increase in U.S. interest rates, the first quarter of 2022 saw a continued trend for both lower and more volatile bitcoin prices that began in late 2021. At the same time, the increase in the bitcoin network's total computing power and relatively sharp energy price increases from geopolitical conflicts led to a decrease in ROI per terahash of computing power. Additionally, the resurgence of the COVID-19 pandemic in multiple cities across China and the corresponding pandemic prevention and control measures negatively impacted our supply chain, production, and logistics. Despite these challenges, our team achieved encouraging results on multiple fronts. We are committed to our globalization strategy, deepening customer relationships and services, maintaining steady operations in our supply chain, and advancing our research and development for new products. This quarter, we sold a total of 4.3 million terahash per second in computing power, resulting in revenues of RMB1.36 billion and a net income of RMB442 million. Our revenues were primarily driven by the delivery of 4.3 million terahash per second of computing power. As we previously mentioned, the local government implemented a nearly three-week lockdown for all residents and businesses in the city where our mining machine factory and warehouses are located, preventing us from delivering orders during this period and creating a backlog that extended into the second quarter. Unexpected logistical disruptions resulted in revenues for the quarter falling short of our expectations. Nevertheless, we made positive strides in sales of our mining machines and continued to secure international orders, with solid demand from energy-abundant regions such as Central Asia, North America, and Australia. During the first quarter, we obtained customer orders from Laos. While we actively engaged new clients, we also fulfilled a significant portion of orders from existing clients. To optimize our market exploration and better serve our customers, we established an international headquarters in Singapore, which has earned recognition and support from the Singapore Economic Development Board. This represents a milestone in our globalization strategy, as we grow into a more globalized and culturally diverse technology company. We are also building a team of local talents to drive our business expansion in Singapore and Southeast Asia. As we gradually establish our after-sales service system overseas, we are getting closer to our customers and making progress in our globalization efforts. Additionally, we recently expanded our sales channels by launching an online store for overseas retail customers, providing them convenient access to our products. Regarding our pre-sales of computing power, due to delivery delays during the first quarter, we currently have a total of 9.96 million terahash of computing power to be delivered and RMB1.77 billion of advances from customers as of the end of the first quarter. Our production and logistics have gradually resumed throughout the second quarter following the local government's adjustments and guidelines for resumption of production. As of today, we have delivered most of the orders that were backlogged from the first quarter. During the first quarter of 2022, our overseas mining operations faced challenges due to the COVID-19 pandemic, logistics congestion, and inadequate power supplies. By the end of the first quarter, our deployed computing power in Kazakhstan exceeded 2.4 million terahash per second, but the number of active machines showed volatility, resulting in mining capacity during the period ranging from 0 to 0.8 million terahash per second. During the quarter, we mined a total of 113.94 bitcoins, and by the end of the quarter, we held 166.96 bitcoins. In addition to closely monitoring local energy supplies, we are proactively collaborating with our partners to evaluate alternatives for optimizing resource allocation. Despite the mentioned headwinds, bitcoin mining remains a significant component of our business development strategy. This segment allows us to balance computing power allocation, engage more deeply in the bitcoin mining industry value chain, and better understand customer needs. Overall, we believe that the long-term development of our mining business will diversify our revenue sources and optimize our operations. Therefore, we will continue to execute our strategy with a more prudent and agile approach to developing our mining business, while mitigating risk by deploying machines across various localities. In terms of research and development, we recently launched our new mining machine model, the Avalon 1266, which has been optimized based on our existing fabrication node, outperforming previous models with a computing power of 100 terahash per second. Simultaneously, our research and development for the next generation of bitcoin mining machines is progressing smoothly. We have completed the design work for some programs and are at a critical stage toward mass production. Due to various uncertainties affecting our research and development and mass production progress, we will disclose specific performance parameters for our new generation of mining machines and commence pre-sales only after we successfully complete the full testing process. On the topic of our AI chip business, we maintain an open-source philosophy and recently made our Kendryte K510's software development kit and documentation publicly available. We have provided dozens of AI model applications in the software development kit storage. Developers can add their own data and train on the K510 to create different user experiences based on real-world scenarios. As we overcome challenges and strive to expand our business and advance our research and development in new products, we are aware that uncertainties from recurrent COVID-19 outbreaks and macroeconomic headwinds have adversely affected our stock price. Given our strong fundamentals and cash position, we recently announced a share repurchase program under which we may repurchase up to $100 million worth of outstanding ADS over the next 24 months, set to commence in the upcoming window period. We completed the share repurchase plan authorized in September 2021 ahead of schedule, and this new program demonstrates our confidence in the company's long-term outlook. Updates on the program will be provided in future earnings releases. By the end of the first quarter, the company had cash and cash equivalents of RMB2.64 billion, showcasing our sufficient cash liquidity for operations. Given the inherent capital needs of our business, we have been exploring long-term financing options to mitigate potential operating risks. Accordingly, we entered into an at-the-market offering agreement for an ATM equity offering program with H.C. Wainwright, which is yet to be executed. However, we have set up the necessary financial instruments to offer us the flexibility to raise capital at relatively lower costs in the open market when market conditions improve. We will provide updates on its utilization in our future earnings releases, prioritizing shareholder interests and the general market when considering financing facilities and making proactive adjustments based on market conditions. Broadly speaking, we have been monitoring the challenges that Chinese ADR companies face under the Holding Foreign Companies Accountable Act. On May 4 of this year, we were provisionally identified under this act and may be conclusively identified in the future, raising some shareholder concerns over potential delisting. We have proactively addressed our inclusion on the SEC's list and will continue to comply with all relevant laws and regulations in both China and the United States. We have observed progress in discussions between the Chinese and U.S. governments and hope an agreement regarding inspections and audits might be reached soon. As a company generating most of its revenues from overseas, we will uphold and enhance our robust corporate governance and compliance with local regulations. We will continue to engage with capital markets and actively explore potential solutions to safeguard our stakeholders' interests. In conclusion, we have navigated numerous unexpected challenges and volatilities during the first quarter of 2022. Although our topline results were adversely impacted by pandemic-related delivery delays, our business remained steady, achieving encouraging outcomes. These results stem from our commitment to supporting long-term development and expanding our market while strengthening customer collaboration. Facing likely challenges or unforeseen obstacles in the future, we will persist in executing our agile and flexible operating strategy, aiming to ensure sustainable supplies in response to market fluctuations and bitcoin volatility. We strive to maximize shareholder returns through maintaining healthy operational cash flows, judiciously allocating our mining machines between sales and our mining business, and actively fostering our AI chip development. Meanwhile, we will continue to support our business globalization while enhancing customer service through a more client-focused after-sales system. Looking ahead to the second quarter of 2022, we recognize that considerable uncertainties persist in the market environment. Based on our current assessment, we expect total net revenue for the second quarter of 2022 to range between RMB1.6 billion and RMB1.8 billion, reflecting an increase of 48% to 67% compared to the second quarter of 2021. Please note that this forecast is based on our current and preliminary views on market and operational conditions and is subject to change. This concludes my prepared remarks. I will now turn the call over to our CFO, James.

Thank you, Mr. Zhang, and good day everyone, this is James. As Mr. Zhang mentioned, the first quarter of 2022 was a challenging one for our company, and facing various unexpected obstacles, we still managed to deliver solid results for our investors. In the first quarter of 2022, we recorded 4.3 million terahash in total computing power sold, representing a year-over-year increase of 119%. Our revenues were RMB1,356 million, increased by 237% compared with the same period of last year. As we expected, our topline results were not able to meet the previous guidance we projected in our fourth quarter financial report, due to the postponement of order deliveries from our warehouses. This is because of the unfortunate resurgence of the COVID-19 pandemic since mid-March and subsequent overall lockdown measures in the city where our mining machine factory and warehouses are located. Since the end of March, although we swiftly prepared to resume production and delivery under the guidelines of the local government, our delivery schedule for the first quarter has been materially delayed due to the nearly three weeks of halted operations. Amongst the backdrop of these difficulties, we maintained our international business development and dynamic pricing strategy. Therefore, we continued to engage new and existing clients, and managed to sustain a relatively high average selling price in the first quarter of 2022. With our relentless efforts to resume normal operations as of today, we have delivered most of the delayed machine orders from the first quarter. Our mining business is gradually ramping up, but still facing headwinds from the power supply shortage. This resulted in a considerable portion of our deployed mining machines not being online in the first quarter of 2022. During the quarter, our mining computing power online varied in a rough range of 0 to 0.8 million terahash. During the first quarter of 2022, we generated 113.94 bitcoins and held 166.96 bitcoins as of the quarter's end. As winter has ended, the power shortage situation is improving. Since the second quarter of this year, more and more machines are gradually coming online. Our gross profit for the quarter grew 327% year-over-year to RMB830 million. As mentioned in previous quarters, due to the continued wafer shortage across the semiconductor industry, the inevitable increase in wafer price further weighed on our profit margin, which narrowed to 61% in the first quarter of 2022, still higher than the average level of 57% in the full year 2021, but declining from 68% in the fourth quarter of 2021. To further strengthen our supply chain, we have made prepayments to our foundry partners to secure their production capacity throughout the year 2022. We are also grateful for all of our foundry, testing and packaging partners' great efforts, as they strived to continue the supply for us despite the serious resurgence of COVID-19 in their cities during the first quarter of 2022. In the face of challenging supply environment and recent bitcoin price downward fluctuations, we expect our gross margin may further come under pressure in the coming quarters. We reported a net income of RMB442 million in the first quarter of 2022, a healthy bottom line result, considering the impacted topline performance and increased production costs. Please also note that, as we have utilized part of deferred tax assets as of the first quarter of 2022, we incurred higher income tax expenses. We also expect an increasing tax burden for our profitable quarters going forward. I would now like to comment briefly on our share repurchase programs. During the first quarter of 2022, we repurchased a total of 2.1 million ADSs with an aggregate value of US$10.3 million, representing an average repurchase price of US$4.81 per ADS. Earlier on March 16, we announced an up to US$100 million share repurchase program effective over the next 24 months. This new program follows on the heels of our recently completed US$20 million buyback that we authorized in September of 2021 and completed ahead of schedule. Recently in the capital markets, we have been under pressure from both cryptocurrency price fluctuations and delisting suspicions. We consider it a good timing to focus on repurchasing shares, which helps to protect value for our shareholders. We are committed to delivering value to our investors, and this enhanced buyback program indicates the confidence that both the management team and the Board of Directors have in the company over the long run. Last month we also entered into an at-the-market offering agreement, providing for an at-the-market equity offering program to access to capital in the public market, with H.C. Wainwright. Please note that as of now, we do not currently expect to sell any ADS under the ATM program at this point in time. In light of the recent industry fluctuations and negative market sentiment, we are focused on executing our aforementioned buyback program to drive value for our shareholders. As of the end of the first quarter, we had cash and cash equivalents of RMB2,643 million, demonstrating a solid cash position that enables us to sustain our operations and business resilience. We will be cautious and prudent with any use of the ATM facility. Any share sales executed by the ATM facility will be disclosed in future quarterly earnings reports regularly. While Mr. Zhang has already discussed the potential delisting issue, we sincerely hope a detente will be reached on the audit matter by the respective regulatory authorities. Please be assured that we are carefully monitoring the situation and exploring potential practical measures to protect the interests of our investors. Now, I would like to briefly walk you through our financial results for the quarter. Revenues were RMB1,356.1 million equals to US$213.9 million, representing an increase of 236.7% from RMB402.8 million in the same period of 2021. Gross profit was RMB829.8 million, which equals to US$130.9 million, representing an increase of 327.2% from US$194.2 million in the same period of 2021. Total operating expenses in the first quarter of 2022 were US$251.5 million, which equals to US$39.7 million, representing an increase of 21.0% from RMB207.9 million in the same period of 2021. Income from operations in the first quarter of 2022 was RMB578.3 million, which equals to US$91.2 million, compared to a loss from operations of RMB13.7 million in the same period of 2021. Net income attributable to ordinary shareholders in the first quarter of 2022 was RMB441.6 million, which equals to US$69.7 million, compared to a net income of RMB1.2 million in the same period of 2021. Non-GAAP adjusted net income in the first quarter of 2022 was RMB543.4 million, which equals to US$85.7 million, representing an increase of 279.5% from RMB143.2 million in the same period of 2021. Basic and diluted net earnings per ADS for the quarter were RMB2.57, which equals to US$0.41. Contract liabilities as of March 31, 2022, were RMB1,769.9 million, which equals to US$279.2 million, increasing from RMB1,340.7 million as of December 31, 2021. This concludes our prepared remarks. We are now open for questions.

Thank you. We will now begin the question-and-answer session. Our first question comes from Hans Chung from D.A. Davidson. Please ask your question.

Hi, management and team. Thank you for taking my questions. I have several questions to ask, starting in English and then I will translate into Mandarin myself. First, what would our revenue have been without the impact of the COVID-19 control measures for the March quarter? Have production and delivery fully recovered at this time? Also, given China's zero COVID policy, does the company have any backup plan in place to address the risks related to potential lockdowns or supply disruptions? Thank you.

Since the beginning of March this year, the pandemic has worsened in several cities across China. In response, local governments have implemented various pandemic prevention and control measures. On March 14, we were informed by the local government in the area of our factory that a five-day quarantine lockdown would be enforced for all residents and businesses in the city. We fully anticipate that our business performance will be impacted. Subsequently, the quarantine policy was extended until the end of March. During this time, local logistics and our deliveries were halted, causing delays in inventory delivery that negatively affected our revenue recognition in the first quarter of 2022. After March, the local government transitioned to different levels of control measures based on the severity of the COVID-19 outbreak while encouraging businesses to resume normal operations. Throughout this period, we have maintained close communication with the local government and have worked diligently to resume normal production and inventory delivery. So far, we have nearly completed deliveries that were delayed from the first quarter of 2022. Additionally, we are making new efforts in various operational areas, such as warehousing, logistics, and supply chain. For instance, we have set up an international headquarters and warehouses in Singapore to manage parts of our global business, which strengthens the stability of our supply chain. This setup not only serves as a response to the uncertainty caused by the COVID-19 pandemic but also represents a significant advancement in our globalization strategy. Excluding the effects of COVID-19 control measures, we believe we can achieve the guidance we previously projected for our fourth quarter.

Thank you for your insights. I have a second question. Can you elaborate on the mix and pricing trends of past achievements in comparison to future contracts? It seems that we may have a higher mix of spot treatment due to gross margins that are better than expected. How is this trend projected to evolve in the coming quarter, especially given the current bearish environment in the bitcoin market? Additionally, what does the longer-term trend look like in terms of mix?

Due to our dynamic and flexible operating methods, the proportions of spot sales and future contract sales vary from quarter to quarter. The first quarter is typically a low season due to tight energy supply in the northern hemisphere during winter and an increase in holidays. Additionally, considering the recent market volatility, we anticipate a smaller proportion of spot sales in the second quarter of 2022. If bitcoin prices continue to face downward pressure, we may allocate more of our computing power to our mining operations. As mentioned in previous quarters, we are not focused on fixing the mix between spot sales and future contracts. Instead, we aim to maximize shareholder returns by dynamically adjusting the allocation of our mining machines to spot sales, future contract sales, and our mining operations based on bitcoin prices and market volatility.

Thank you. Can you share with us your overseas market development, particularly the business in North America? What have you achieved so far, and what challenges have you encountered? Additionally, when can we expect a meaningful ramp-up in the market? Thank you.

As we have mentioned before, we established an international headquarters in Singapore to manage operations such as research and development, warehousing, and supply chain. The Singapore Economic Development Board has approved this initiative and supported us with favorable policies. We are particularly focused on our growth in North America among our overseas businesses. The region's abundant energy supplies, especially the rapid growth of clean energy and the wide acceptance of cryptocurrencies, are drawing more miners to invest in and develop mines. In early April this year, we participated in Bitcoin 2022, a conference in Miami, where we engaged in meaningful discussions and built connections with various mining companies and industry partners. We are in the process of forming local teams in North America, with some team members already on board. They are assisting us in expanding our business in several areas, such as sales and forming partnerships in the mining sector. Importantly, we are enhancing our after-sales services to offer ongoing assistance closer to our customers. Overall, we place significant emphasis on the North American market and are actively working to expand our presence. However, we anticipate facing various challenges during this second phase of our startup. We hope that our sustained efforts will yield strong results. We will share more updates about our progress with our shareholders at the appropriate time. Thank you.

Thank you. With Bitcoin being weaker in the second quarter, could you talk about how that impacts your mining machine sales and the average selling price?

Okay. Let me translate for Mr. Zhang.

As we mentioned earlier, we expect our total net revenues for the second quarter of 2022 to be between RMB1.6 billion and RMB1.8 billion. This forecast reflects our current view on market and operational conditions, but it is subject to change due to significant uncertainties in the market environment. We have observed that the bitcoin price has been fluctuating and has declined from its previous highs. Since May, the bitcoin price has also been influenced by macroeconomic factors, including the Fed's interest rate increases. We have adjusted our mining machine pricing to help our customers cope with the downward pressure from bitcoin prices. By expanding our global market presence and enhancing our after-sales services, we have strengthened our customer relationships and bolstered our mining machine sales while attracting new orders. By the end of the first quarter of 2022, our advances from customers reached RMB1.77 billion. Even accounting for orders delayed by the COVID-19 pandemic, customer advances remain high, providing a solid foundation for our second-quarter revenue this year. Our experience shows that mining revenues, demand for mining machines, and their prices are all influenced by bitcoin price volatility, which has always been a challenge in this industry. With over nine years of experience, we have developed the ability to handle this challenge. We will continue to respond to market volatility and unexpected situations with agile and prudent operations and stable supplies. We expect bitcoin price volatility to persist during this Fed interest rate hike cycle. However, we remain optimistic about the long-term prospects for bitcoin and its associated super-computing technology. Thank you.

Thank you for that information. I have a follow-up question. You mentioned that the supply chain was affected in various cities in China. Could you elaborate on your logistics strategy, including the warehouses you've set up? What are your expectations for future supplies?

Okay. Thank you. Let me translate.

Our partners, including foundry, testing and packing partners located in the greater Yangtze River and Pearl River Deltas, were fully prepared and had backup plans for the resurgence of the COVID-19 pandemic. They did not suspend their business operations and continued to supply for us. I would like to express our gratitude for the great support from our partners. Okay. On the other hand, we have secured production capacity this year through upfront prepayments to our foundry suppliers. As announced in the earnings press release, our prepayments were RMB1.89 billion as of the end of the first quarter this year, reaching a new historical high. In the severe market environment brought by the COVID-19 pandemic, we and our supply chain partners are supporting each other to navigate through the tough time. We have a stable and solid relationship with our suppliers, and we remain cautiously optimistic for maintaining a stable supply. We are also in progress towards exploring and acquiring the technology and production capacity for more advanced nodes. Hope that answers your question. Thank you.

Yes. Thank you very much.

Can you hear me?

Yes.

Okay. So my question is, most of your customers are institutional buyers, so why have you built up your online store targeting retail customers?

As a matter of fact, customers can always buy mining machines from us regardless of the quantity, even just one machine. Putting customers as our priority and reducing friction in the transaction process and related costs is a very important aspect of our sales system. Now, small and micro scale customers and those who would like to purchase a sample machine can make a purchase in our online store. They can even settle with bitcoin in the region where such settlement is legally permitted, enjoying a quick and very convenient experience. In addition, our online store is important for raising the transparency of machine models and prices for our customers. Going forward, we will further develop our sales channels, and gradually improve after-sales services in the global market. Whether customers are small or micro scale, or mid and large scale, they can all enjoy an upgrade to every aspect of our service. Hope that answers your question. Thank you.

You launched a new generation of mining machines, the Avalon 1266, at the beginning of April. When will you start its mass production and sales?

We presented a new mining machine model, the Avalon 1266, to miners during the Bitcoin 2022 Miami Conference. Our model 1266 is an upgrade on the current design and fabrication node, with about 10% improvements in the power efficiency and performance. As a result, this new mining machine produces overall computing power of 100 terahash per second. Additionally, we will keep propelling forward the upgrades in our processing and design, and expedite the progress of introducing more advanced nodes, thus bringing more competitive products to the market. Hope I answered your question. Thank you. Operator, I think we can conclude the call. Thank you.

Right. Thank you very much. So this is all the time we have for questions. I will now turn the call back to the management for closing remarks.

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

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