Canaan Inc. Q3 FY2022 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to Canaan Inc.'s Third Quarter 2022 Earnings Conference Call. After the management's prepared remarks, we'll have a question-and-answer session. Please note that this event is being recorded. Now I'd like to hand the conference over to your speaker host today, Mr. Clark Soucy, Investor Relations Director of the company. Please go ahead, Clark.

Thank you, Mel. 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. Jin Cheng James. In addition, Mr. Xiaoming Lu, our SVP; Mr. Leo Wang, IR Senior Director; and Ms. Xi Zhang, IR Manager, 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 up the call 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 thereof, 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 Securities and Exchange Commission, 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'll 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 results. You can find additional disclosures regarding these non-GAAP measures, including reconciliations with comparable GAAP results 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.

Hello, everyone. This is Nangeng, CEO of the company. Our CFO James and I are delighted to share our quarterly results in English from New York. Since the beginning of the third quarter of this year, the cryptocurrency and blockchain industry have been experiencing a great deal of turbulence, especially during the past weeks; there is a lot going on in the industry. And now that we are together on this conference call, we want to take this opportunity to speak openly with our investors and stakeholders. Market conditions have become more severe since the beginning of the third quarter of 2022. The Bitcoin price continues to decrease, impacted by the Federal Reserve’s interest rate increases and market expectations of further hikes. Meanwhile, Bitcoin’s total network hash rate remained at a high level, and the miners’ incomes decreased. We are fully aware of the great difficulties in the mining industry. The current situation resembles similar difficult cycles we have previously navigated through. However, the situation is different today as we are facing more challenges, such as globally surging energy prices, miner credit risks, and the high financing costs caused by excessive leverage and high operating expenses for new miners. These factors have led to serious issues in miners’ operations. Furthermore, what has been happening in the industry has eroded industry confidence. Turbulence in the industry is inevitable in the short term. On top of these headwinds, mining machine inventories in some regions remain high. All of these factors will negatively impact customer demand for and the pricing of our mining machines in the near term. What I want to emphasize is that although currently, participants in the industry are enduring a particularly difficult time, we remain confident of navigating through the Bitcoin cycle. What we are going through now will turn into a valuable experience for us to develop our business as the industry evolves. During these difficult times, we continue our investment in R&D to increase our products' hash rates and energy efficiency. In late October, we released two models of our new generation of mining machines, making a breakthrough in computing power and energy efficiency. Regardless of whether we are in bull or bear market environments, we will launch new products and develop our business strategy. This commitment demonstrates our confidence in the market’s long-term prospects. Regarding the sale of mining machines, in late October, having received the full testing results, we immediately launched our new generation mining machines, Avalon Made A13 series. Specifically, two models are introduced, the A1346 and A1366. Model A1346 features a hash rate of 110 terahash per second and a power efficiency of approximately 30 joules per terahash. Model A1366 is equipped with a hash rate of about 130 terahash per second and power efficiency of approximately 25 joules per terahash. Both models’ computing power and the power efficiency demonstrate a significant improvement over the previous generation of mining machines. After our new products hit the market, we quickly coordinated our supply chain to move forward with our mass production. We expect to commence mass production and start shipments at the end of this year or early next year. Through prepayments, we have secured production capacity for next year. This allows us to continuously provide high-performance products with reliable quality and superior services for our clients. As for our existing mining machine products, we delivered a total of 3.45 million terahash per second of computing power, generating revenues of approximately RMB940 million. Our global headquarters in Singapore continues to attract local tech titans, who join us and further enhance its operations. The headquarters has already established R&D, operations, finance, supply chain, and other functions. Our Singapore-based chip design team has contributed significantly to the development of our new products as well as the mass production process. The Southeast Asia supply chain, headquartered in Singapore, is performing well and has been steadily fulfilling shipments since it entered operation during the previous quarter. It provides diversified parts for our production process and logistics that demonstrates our commitment and ability to continue our internationalization. Although the overall market is relatively sluggish this year, we have built a strong foundation of trust and cooperation with our industry-leading business partners. Meanwhile, we also insist on serving our small and mid-sized customers in a variety of flexible ways. Our online store for retail customers further augmented our sales systems to address demand from all types of customers. Since its launch in the second quarter, it has fulfilled customers' orders from 21 countries and regions worldwide. By the end of the third quarter, having shipped our prepared orders, our total computing power to be delivered has decreased to 1.01 million terahash per second. Under current market conditions, the industry is facing stronger headwinds and more uncertainty; most customers are taking a wait-and-see approach. Soft demand for mining machines has dropped to a low point. However, with the current market challenges, our business is likely to face higher pressures over the next two quarters. At this point, facing a severe winter in the industry, profitability is no longer our first priority. We will get through this difficult time and prepare for the future by shifting our focus to the stability of cash flows, reducing unnecessary expenses, and continuing to invest in the research and development of new products. During the current downturn, we are strengthening operations of our mining business for the long term. With our operational flexibility, we are propelling forward our mining business in overseas markets. Mining supports mutual efficiency and maximizes synergies within our mining machine sales and our mining business. Notably, our mining collaborations in the United States went up to 260,000 terahash per second of computing power online during this quarter. At the same time, the electricity supply for our mining operations in Central Asia has further improved, enabling more stable operations for our deployed mining machines. Consequently, our mining business’ total online computing power is approximately 3.2 exahash per second, generating mining revenue of RMB 62 million in the third quarter, up 19% quarter-over-quarter. After using a portion of our Bitcoins to cover mining costs, we hold 535.5 Bitcoins in total at the end of this quarter. The balance demonstrates an increase of 188.7 Bitcoins from the end of the last quarter. We are also actively exploring the geographical diversification of our mining business to mitigate concentration risk while steadily expanding our global layout at the scale of our mining business in a bearish market. Let's now turn to our AI chip business. During the third quarter, sales of our AI chips improved compared to the previous quarter. Our downstream manufacturers resumed building up their inventories. As a result, our AI chips business sales grew by 52% quarter-over-quarter. However, weak end-user demand for consumer goods remained a headwind to our AI chip sales performance. On the other hand, we have achieved good progress in terms of growth in the development ecosystem. For example, our proprietary AI development platform has been utilized for learning and practical development by college students from over 100 universities across China. At the same time, we have drawn many potential development platforms actively participating in constructing the risk profile ecosystem. We will continue to closely collaborate with our downstream and technology partners in the industry, uphold our open-source philosophy, and prepare for its potential growth in the demand for the AI field. During this quarter, we continued to make good progress on our current share repurchase program approved in March, under which we may repurchase up to US$100 million worth of our outstanding ADS or Class A ordinary shares over 24 months. We have repurchased 3.4 million ADS for a total of US$11.2 million from August 12 to November 4 this year. As of November 4, 2022, we have repurchased over 6.2 million ADS for a total of US$21.5 million with an average price of US$3.46 per ADS. Our ongoing execution of this buyback program delivers increased value to our shareholders and shows our confidence in the company's current and long-term prospects. Overall, during the third quarter, we faced a difficult environment. Under this macroeconomic and industry headwinds, many miners encountered operating difficulties leading to the decline in demand for mining machines, lower mining machine prices, and more. To overcome these challenges, we worked diligently to deliver products and further strengthen positive sentiment in the market, achieving our current asset guidance. In addition, we successfully completed the shipping progress for the new generation of computing power chips and launched our new series of mining machines. Looking ahead, with the rising interest rates and other macroeconomic dynamics, we continue to expect downward pressure on Bitcoin prices and erode industry confidence. There is also the possibility of further energy price increases during the coming winter. Considering these combined headwinds, weaker demand in the mining industry is expected. As a result, we expect our performance to come under further pressure, at least during the next two quarters. Based on our current projections, we expect our total revenues for the fourth quarter of 2022 to be approximately RMB310 million. Please note that this forecast reflects our current and preliminary views on the market and the operational conditions, which are subject to change. It has been almost 10 years since Canaan’s inception, and we have navigated through many different cycles; regardless of macro environments, we remain firmly committed to always doing our utmost to develop new products and pursue superior computing power and efficiency. We will continue to push forward on our internationalization, adhering to our prudent operating strategy. We endeavor to enhance synergies between our machine sales and mining business. At the same time, we will keep a conservative approach to our capital management and streamline our cash outflows while continuing our investments in R&D and the related operations. It's paramount for us to sustain operations across the bull and bear market cycles, upholding our responsibility and commitment to our shareholders. 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, and I am with our CEO in New York City. As we discussed in August on our second quarter earnings call, in the third quarter of 2022, as we expected, the overarching industry environment started to negatively impact our demand and average selling price. We reported a total revenue of RMB978 million in the quarter, meeting our guidance range despite the year-over-year and sequential decrease. Specifically as the Bitcoin price further decreased to $16,000 recently, we expect the overall demand for mining machines to remain constrained. In the third quarter, we delivered a total computing power sold of 3.5 million terahash per second. In response to the softening market, we lowered our selling price too, leading to a certain decline in the average selling price for the quarter. As a result of the combined effect, sales of our Bitcoin mining machines decreased to RMB940 million for the quarter. In a challenging market downside cycle, we take the mining business as a hedge against the weakening mining machine sales. It has helped us better utilize our machine inventory and bring in additional revenue. Specifically, our mining business generated mining revenue of RMB62 million, representing a quarter-over-quarter increase of 19%. In the third quarter, we started mining in the United States by deploying a trial batch of mining machines. Our increase in Bitcoin production is also due to further improved electricity supply in our mining operations in Kazakhstan. Collectively, we have 3.2 exahash per second of total computing power deployed for our mining business as of the end of the third quarter. After paying certain direct costs, especially electricity bills with Bitcoins mined, we held 535.5 Bitcoin at quarter’s end, representing 188.7 additional Bitcoin compared to 346.8 Bitcoin balance as of June 30, 2022. We remain prudent in machine deployments and are thoroughly exploring multiple geographical regions with favorable mining conditions to diversify our mining operation. Please also note that with the increase of our deployed machines for mining, we expect to have more machine depreciation in our total cost. Our AI revenue, realizing a sequential increase of 52%, reached RMB2.4 million in the third quarter. The total AI chip sales performance reflected a softer demand for its end-user consumer IoT products. Our gross profits for the third quarter was RMB234 million, reflecting the impact at the top-line level. Additionally, as we lowered the selling price of some older generation machines to even below their costs, we incurred an inventory write-down of RMB221 million in the third quarter. Resulting from the complex effects of declining ASP, inventory write-down, and a relatively flat product cost, our gross margin was further squeezed to 23.9% for the third quarter. Please note that if we had not implemented this inventory write-down, our sales margin for the third quarter would have been 46.5%. In the third quarter, we continued to enhance our research and development. We launched our new generation mining machines in October as we propelled the commercialization of our R&D efforts. We also made upfront payments to secure the production capacity for advanced node wafers to ensure a stable supply in the future. As the vast majority of our sales contracts were denominated in US dollars, we recorded a foreign exchange gain of RMB101 million in the third quarter due to the depreciation of RMB against US dollars. Conversely, if RMB appreciates against the US dollars in the future, we will incur foreign exchange losses correspondingly. For our bottom line, our net income reduced to RMB 61 million in the third quarter. Turning to our balance sheet, as of September 30, 2022, the company had cash and cash equivalents of RMB2003 million. The decrease in cash balance was primarily due to upfront prepayments for securing wafers and payments of operating and tax expenses, which was partially offset by cash inflow from the spot sales of mining machines during the third quarter. With the rollout of mass production for the new generation of mining machines, we expect our cash balance by the end of this year to further decrease as we make additional prepayments to secure production capacity. We don't have any interest-bearing debt. In a downward market, it's critical for us to preserve cash and sustain cash flows. We will continue to closely monitor our cash balance and manage it prudently. From August 13, 2022 to November 4, 2022, we used approximately US$11.2 million to repurchase 3.4 million ADS under our current stock repurchase program approved in March 2022. With an average repurchase price of US$3.29 per ADS, in light of an increasingly volatile macro environment, we may reevaluate our repurchase program in accordance with our cash balance. Looking into the near term, with the unfavorable factors that may become even worse in the market, including constrained Bitcoin prices, US rates hike, and high energy costs. Recently, the Bitcoin price has continued to decline after a series of industry incidents. As such, we expect lingering very soft demands in the near term for worldwide total hash rate expansion and mining machines purchase. To conclude, the third quarter was a difficult one. We strived to maintain sufficient cash balance and seek opportunities in the market downturn. As a company, while the macroeconomic factors and the industry trends are out of our control, we endeavor to control the decisions and efforts we make to streamline our business operations, maintain cash flow, and effectively manage our liquidity level to sustain our operation, which is our minimal and optimal strategy during the hard time. Now I would like to briefly walk you through our financial results for the quarter. Revenues in the third quarter of 2022 were RMB978.2 million, US$137.5 million, representing a decrease of 48.8% from RMB1,652.7 million in the second quarter of 2022 and a decrease of 25.8% from RMB1,317.6 million in the same period of 2021. Gross profit in the third quarter of 2022 was RMB234.2 million, US$32.9 million, representing a decrease of 74.8% from RMB929.7 million in the second quarter of 2022 and a decrease of 68.4% from RMB741.7 million in the same period of 2021. Total operating expenses in the third quarter of 2022 were RMB275.0 million, US$38.7 million, representing an increase of 1.7% from RMB270.5 million in the second quarter of 2022 and a decrease of 1.2% from RMB278.4 million in the same period of 2021. Net income attributable to ordinary shareholders in the third quarter of 2022 was RMB61.1 million, US$8.6 million, representing a decrease of 19.0% from RMB608.9 million in the second quarter of 2022 and a decrease of 88.1% from RMB512.5 million in the same period of 2021. Non-GAAP adjusted net income in the third quarter of 2022 was RMB166.3 million, US$23.4 million, representing a decrease of 75.8% from RMB688.2 million in the second quarter of 2022 and a decrease of 71.7% from RMB587.5 million in the same period of 2021. Basic and diluted net earnings per ADS for the quarter were RMB0.36 and US$0.05. Contract liabilities as of September 30, 2022 were RMB 300 million, US$42 million, decreasing 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. Your first question comes from the line of Shuang Sun from Guosheng Securities. Please go ahead, your line is open.

So you have established headquarters in Singapore. Have you considered being a completely foreign company?

So you have established headquarters in Singapore, have you ever thought about being a completely foreign company?

So considering the recent decline of Bitcoin price, we will have an inventory write down; when will it occur?

Thank you. We will now begin the question-and-answer session. Your first question comes from the line of Shuang Sun from Guosheng Securities. Please go ahead, your line is open. Shuang Sun: So you have established headquarters in Singapore, have you ever thought about being a completely foreign company? Nangeng Zhang: [Indiscernible] Shuang Sun: So considering the recent decline of Bitcoin price, we will have an inventory write down; when will it occur?

How is your total sales and future contract sales ratio?

Please go ahead, your line is open. So you have established headquarters in Singapore, have you ever thought about being a completely foreign company? So considering the recent decline of Bitcoin price, we will have an inventory write down; when will it occur? How is your total sales and future contract sales ratio?

What’s the progress of collaboration with foundries?

Thank you. We'll now move on to our next question. Please stand by. Our next question comes from the line of Kevin Dede from H.C. Wainwright. Please go ahead, your line is open.

Thank you. We'll now move on to our next question. Please stand by. Our next question comes from the line of Kevin Dede from H.C. Wainwright. Please go ahead, your line is open.

Thank you. We'll now move on to our next question. Please stand by. Next question comes from the line of Jiaer Zhu from China Renaissance Securities. Please go ahead. Your line is open.

Thank you. We'll now move on to our next question. Please stand by. Next question comes from the line of Jiaer Zhu from China Renaissance Securities. Please go ahead. Your line is open.

Thank you. We'll now move on to our next question. Please stand by. Next question comes from the line of Jiaer Zhu from China Renaissance Securities. Please go ahead. Your line is open.

Thank you. We'll now move on to our next question. Please stand by. Next question comes from the line of Jiaer Zhu from China Renaissance Securities. Please go ahead. Your line is open.

Thank you. We'll now move on to our next question. Please stand by. Our next question comes from the line of Hans Chung from D.A. Davidson. Please go ahead.

The line is open for the next question.

Thank you. We'll now move on to our next question. Please stand by. Our next question comes from the line of Hans Chung from D.A. Davidson. Please go ahead.

Your line is open. Please go ahead.

Thank you. We'll now move on to our next question. Please stand by. Our next question comes from the line of Hans Chung from D.A. Davidson. Please go ahead.

Thank you. We'll now move on to our next question. Please stand by. Our next question comes from the line of Hans Chung from D.A. Davidson. Please go ahead.

Thank you. We'll now move on to our next question. Please stand by. Our next question comes from the line of Michael Legg from the Benchmark Company. Please go ahead, your line is open.

Our next question comes from the line of Hans Chung from D.A. Davidson. Please go ahead.

Thank you. We'll now move on to our next question. Please stand by. Our next question comes from the line of Michael Legg from the Benchmark Company. Please go ahead, your line is open.

Thank you. We'll now move on to our next question. Please stand by. Our next question comes from the line of Michael Legg from the Benchmark Company. Please go ahead, your line is open.

Thank you. As there are no further questions now, I'd like to turn the call back over to the company for any closing remarks.

Thank you. Hello, everyone, this is Clark. Once again, thank you very much for joining us today for the call. If you have any further questions, please feel free to reach out to us through the contact information provided on our IR website. Thanks again.

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