Earnings Call Transcript - CAN Q3 2024

Operator, Operator

Ladies and gentlemen, thank you for standing by and welcome to Canaan Inc.'s Third Quarter of 2024 Earnings Conference 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 that this event is being recorded. Now I'd like to hand the conference over to your speaker host today, Ms. Gwyn Lauber, Investor Relations Director of the company.

Gwyn Lauber, Investor Relations Director

Thank you. Hello, everyone, and welcome to the earnings conference call. Joining us today are our Chairman and CEO, Mr. Nangeng Zhang; and our CFO, Jin 'James' Cheng. Leo Wang, Vice President of Capital Markets and Corporate Development, and Xi Zhang, Senior Manager of IR, will also be available during the question-and-answer session. Our CEO will start the call by providing an overview of the company and performance highlights for the quarter. Our CFO will then provide details on the company's operating and financial results for the period before we open up the call for questions. Before we begin, 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 operating results or the performance of the company. These statements speak only as of today 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 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 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'll now turn the call over to our Chairman and CEO, Mr. Nangeng Zhang.

Nangeng Zhang, CEO

Hello, everyone. This is Nangeng, the CEO of Canaan. Thank you for joining our conference call. James and I are pleased to share our third quarter results and recent developments. I believe everyone is excited about the Bitcoin price reaching new heights, and I share that excitement. Q3 2024 marked our first complete quarter post-halving. During this period, the global Bitcoin mining market faced challenges due to price volatility, with the average Bitcoin price declining by over 7% compared to the previous quarter. However, the total network hash rate grew by more than 10%. This resulted in historically low hash prices, putting pressure on miners' profits. Despite these challenges, we efficiently executed our plans, focusing on every detail. Throughout Q3, we continued delivering our A14 products and completed the transition to mass production of our A15 series, expanding our global sales reach and optimizing our mining operations. These efforts allowed us to meet and slightly exceed our targets, achieving $73.6 million in total revenue. Innovation is the cornerstone of our business. Our ongoing R&D investments enable us to consistently deliver high-performance products that meet market demands and drive growth. This quarter, we initiated small-scale delivery of our new A15 series ahead of schedule by improving internal processes and collaborating closely with our partners. We have made significant enhancements to both the performance and yield rate of the A15 series. The top model in the A15 series, the A15 Pro, provides 215 terahashes per second with power efficiency as low as 16.8 joules per terahash. We are confident in our ability to scale up mass production for the A15 series and continue expanding our product line while developing customized solutions. An example of this is our partnership with CleanSpark, providing A1566I Immersion Cooling Miners that deliver 249 terahashes per unit. These mining solutions have proven reliable and durable, even in high-temperature environments. For consumer products, we are integrating household appliance concepts with decentralization principles. Following the success of our Nano 3 product, we are developing more consumer-level products to make mining accessible to the general public. The development of our A16 series is on track. We will share specific details after completing full machine testing. The A16 series will utilize more advanced process nodes, aiming for power efficiency in the range of 10-plus joules per terahash. For air-cooled machines, we expect computing power to approach 300 terahashes per second. Our mining machine sales, primarily from the A14 series, reached 7.30 million terahashes per second, up 93.8% year-over-year and 16.4% quarter-over-quarter, marking our highest sales volume in the past 11 quarters. Despite the Bitcoin price decline, strong sales volume drove product revenue to $64.58 million, the best in two years. Since launching our A15 series, we have received significant positive feedback from customers and successfully delivered around 1,500 units this quarter. Our inventory mix has improved, positioning us well to meet the expected rise in customer demand, with scheduled deliveries extending through February 2025. Our multi-dimensional sales system continues to drive global sales. In North America, we secured an order from CleanSpark for 3,800 A1566I Immersion Cooling Miners for fourth-quarter delivery. Agreements with HIVE for 11,500 units of A1566 miners and our previous order with Cipher for 6,600 units of A15 are on schedule. These partnerships demonstrate our ongoing product promotion and sales system development in North America. We have witnessed increased customer demand in regions with energy advantages, like Asia and Africa, with power deliveries to these regions rising over 50%. This quarter, we delivered over 10,814 miners to customers in the Middle East, contributing to our brand presence in those markets. Our Nano 3 heater has accumulated orders of 17,000 units, with over 10,000 shipped this quarter, reaching customers in 79 countries and receiving positive responses. In mining operations, we faced challenges but achieved stable revenue of $9 million, outperforming the industry average. We produced 147 Bitcoins this quarter, a 5% increase from the previous quarter, supported by the expansion of our projects in Africa during favorable weather conditions. Our mining operations achieved a gross margin of 22%. In North America, we engaged in negotiations with several mining partners, announcing a 30-megawatt joint mining project with Luna Squares in Texas, involving 3,480 A14 and 5,654 A15 units expected to go online in Q1 2025. Our joint venture with Stronghold is also on track to come online by year-end. We have secured $30 million in preferred stock financing to support our goal of reaching 10 exahashes per second in deployed computing power in North America by mid-2025. By the end of the quarter, our Bitcoin holdings increased to 1,231 Bitcoins, reflecting our mining operations' steady growth and our confidence in Bitcoin's long-term value. We are optimistic about our future contributions to the company as market conditions improve. Looking ahead to Q4, we will continue improving the yield and ramping up production capacity for the A15 series, with large-scale deliveries planned. Recent bulk orders for the A1566 model are expected to sustain into early next year, and we are adjusting pricing to align with market conditions. We expect the primary R&D work for the A16 series to conclude this quarter. As winter approaches, we plan to unveil new products combining home heating with decentralized mining, providing practical value and economic rewards to customers. Our mining operations in North America are progressing, and we are focusing on making 2024 a successful year. Based on these factors, we maintain a cautiously optimistic outlook for Q1 2024, expecting revenue to be around $80 million. The market shows signs of stabilization after recent developments, and we believe the current bull market is just beginning. We are prepared with our high-performance A15 series products for mass delivery, and we will continue investing in new product development to meet diverse customer needs. We are committed to advancing our strategies in key markets, leveraging our compliance advantages as a US-listed company, and positioning ourselves to take advantage of market opportunities together with our customers and partners. Thank you for your attention. I will now turn the call over to our CFO, James.

James Cheng, CFO

Thank you, Nangeng, and good day, everyone. This is James, CFO of Canaan. I'm very glad to share our Q3 financial results with you together with our CEO. As Nangeng stated at the top of the call, the third quarter of 2024 was a challenging quarter, given that it was the industry's first complete quarter post-halving. The average Bitcoin price declined by over 7% sequentially, but the total network hash rate grew by more than 10%. As a result, miners' margins were further squeezed. Facing this challenging quarter, we continued with the bulk delivery of A14 products, further improved the performance and yield and energy efficiency of the A15 series, and completed the mass production introduction for the A15 series. We strived to expand sales globally and continuously optimize operations. Let me give a quick summary of our financial performance in quarter three. First, with continuing large-scale deliveries of our A14 series, we achieved total revenue of nearly $74 million, which beat our guidance of $73 million, marking year-over-year growth of around 121%. This was the highest revenue that we generated in the past five quarters. Moreover, our penetration into the North American market enabled some important breakthroughs. By the date of this earnings call, we have secured some significant orders for our A15 series from customers, including listed mining companies in North America, such as HIVE and CleanSpark. Together with Cipher and Stronghold, more and more listed companies are choosing our A15 series products for their mining operations. Secondly, compared to the overall situation of the industry, our mining performance this quarter exceeded our expectations despite the unfavorable average Bitcoin price because of our ongoing expansion in mining operations. We mined 147 Bitcoins and generated $9 million of mining revenue in this quarter, with an average revenue per Bitcoin mined of over $61,000. Our self-mining hash rates reached around 4.6 exahash per second, which helped our owned Bitcoin accumulate to a record high total of 1,212 Bitcoins, a sequential increase of 98 Bitcoins. We are committed to our plan of reaching 10 exahash capacity in North America by mid-2025, and we have taken significant steps towards this target, including our upcoming collaboration with Luna Square, which added about 1.6 exahash in Texas, and our collaboration with Stronghold, which added about 0.9 exahash in Pennsylvania. Thirdly, our inventory balance declined significantly this quarter, reaching its lowest point in the past three years. As the percentage of inventory value from our older series sharply reduced, our inventory structure was further optimized. As of the end of quarter three, the inventory value of the A13 series was lower than 20% of the total inventory value. At this point, we are prepared to meet more of our customer needs with newer models. Let's start to take a look at the profit and loss. As I said, in quarter three, our total revenue was around $74 million. Revenue from machine sales was around $64 million. We delivered a total computing power sold of 7.3 million terahertz per second, representing a year-over-year increase of around 94%, marking our highest sales volume in the past 11 quarters. The average selling price, or ASP, increased by 12% year-over-year, from $7.9 per terahash per second to $8.8 per terahash per second. Driven by the increased computing power sold and ASP, revenue from machine sales increased by around 117% year-over-year. From the product side, our large-scale delivery of A14 series contributed nearly 80% of machine sales revenue. The A15 series started small batch delivery in the quarter, and we have secured significant orders for this product line from key clients in North America such as CleanSpark and HIVE. From the sales side, our multi-dimensional global sales system made positive progress in several key regional markets during the quarter. In quarter three, our customers from the Middle East and North America contributed 39% and 16% of our machine sales revenue. Turning to the revenue from our Avalon Nano 3 mining heater, which diversified our product revenue streams. In quarter three, we delivered over 10,000 Nano 3 heaters and recognized around $1.4 million in revenue from the sales. The accumulated orders for Nano 3 achieved nearly 17,000 units by the date of this earnings call, primarily from customers in North America and Europe. For our mining machine sales, we accrued $22.9 million for inventory write-down and prepayment write-down in this quarter, representing a year-over-year decrease of 58%. The decrease was driven by ongoing stock clearance in the quarter. These non-cash write-downs are made under U.S. GAAP rules impacting our gross profit, but there is no impact on our cash balance. Excluding the above write-downs, we would have achieved a gross profit of $1.1 million for mining machine sales. The write-downs are mainly from A13 series inventory value reduction, according to the latest market price. Mining revenue was $9 million in quarter three, a year-over-year increase of 175%. We mined 147 Bitcoins in the quarter, a year-over-year increase of 26%. This increase was primarily driven by the computing power installed for our mining business, which reached 4.6 exahash per second at the end of the quarter. We also further expanded our mining business in Africa, where our installed hash rates reached 3.5 exahash per second at the end of quarter three. Our average revenue per Bitcoin in quarter three was over $61,000, which decreased by 7.5% primarily due to the decline in Bitcoin prices in quarter three. Gross profit margin for our mining business was 22%. Please note here that mining profit or loss is defined as mining revenues net of costs for energy and hosting without consideration of depreciation for the deployed machines. Now turning to the expenses. Our operating expenses totaled $35 million, decreasing 19% year-over-year. Staff costs, including share-based compensation, decreased 17% year-over-year, mainly driven by organizational optimization performed in Q4 last year. We recorded $6 million in impairment of our A13 series machines deployed in our mining operations as a result of increased Bitcoin mining difficulty post-halving. Excluding this impairment, our operating expenses were about $29 million, remaining steady during 2024. As mentioned in quarter one, we chose to early adopt the FASB new accounting rules on cryptocurrency assets since January 1, 2024. This new rule has allowed cryptocurrencies to be carried at their fair market value. The price of Bitcoin increased to around $63,500 on September 30, 2024, versus around $62,000 on June 30, 2024, contributing to an aggregate gain on critical current assets of $2.5 million during the third quarter. Despite a challenging post-halving hash price, our Q3 operating loss was around $57 million, narrowing 50% year-over-year, and adjusted EBITDA loss narrowed by 50% year-over-year to $34 million. In quarter three 2024, we issued the third tranche of the Series A preferred shares financing and recognized it as a convertible liability according to U.S. GAAP accounting rules. The financing incurred an excess of fair value over proceeds received and a fair value change. This non-cash accounting treatment hit our Q3 bottom line with a total of $27 million. In order to represent our performance more accurately and more comparably, we exclude the impact of the accounting treatment from our non-GAAP measures. Turning to our balance sheet and cash flow, in quarter three, we received $50 million from our preferred shares financing, and we paid $30 million to secure our wafer supply. During the quarter, the cash outflow of $69 million for production and operation was offset by a cash inflow of $42 million from sales, $7 million from export VAT refunds, and $5 million from secured loans. Consequently, at the end of quarter three, we held a cash balance of $72 million, an increase of approximately 8% compared to the end of quarter two. As of the end of quarter three, our accounts receivable balance was $1 million, a decrease of 83% compared to December 31, 2023. We will continuously evaluate market demand and adopt corresponding credit policies with caution. Now turning attention to our Bitcoin assets, Bitcoins held as our own holding asset kept growing in this quarter, reaching a record high of 1,212 Bitcoins as of September 30. This is 98 more than the 1,114 at the end of last quarter. On September 30, the fair market value of our owned Bitcoins totaled around $77 million. As of yesterday, at a $92,000 Bitcoin price, the value of our owned Bitcoin exceeded $110 million, and our holdup gain was around $64 million, higher than the original value of the Bitcoin that we gained from mining operations. This is an exciting reward for our long-term value creation and patience. In this quarter, we pledged 17 bitcoins for long-term secured loans with an aggregate carrying value of $2 million at what we believe is a reasonable interest level. The secured loans enable additional liquidity for production, expansion, and operation. We also transferred 100 bitcoins for a fixed-term product with a fixed annual return rate. In the future, under the premise of adhering to our holding strategy, we will explore more ways to increase capital liquidity through our owned crypto assets. We expect our Q4 revenues to be $80 million, which is expected to be the best quarter of 2024. We believe a friendlier environment for cryptocurrencies is coming. The Bitcoin price has been rising rapidly since November, and today's highest point is exceeding $94,000, an increase of nearly 47% compared to the price before the halving. However, the growth is still continuing to break historical highs. We believe that the rising price of Bitcoin will stimulate the profit of miners and the demand for mining machines will steadily increase. Mining machine products with high computing power, low power consumption, and stable performance will be chosen and trusted by customers, just like our A15 series. We are expecting deliveries of new machines to be allocated to both self-mining and sales to customers. We are always strongly committed to investing in new product research and development to meet the diverse needs of various customers, promoting sales and operations strategies in key markets such as North America, and participating in Bitcoin mining collaboration in various forms as we work to achieve our extension goal of 10 exahash capacity in North America. We have strong confidence that we will work with our customers and partners to seize the huge market opportunities in the bull market. This concludes our prepared remarks. We are now open for questions.

Operator, Operator

We will now start the question-and-answer session. Our first question comes from Kevin Cassidy with Rosenblatt. Your line is open.

Kevin Cassidy, Analyst

Yes, thanks for taking my question, and congratulations on the good quarter. You described a lot of demand picking up. How would you compare this to, say, when the halving event in 2020 and then you had a very strong year in 2021? How does 2025 look like as far as visibility and the amount of demand you're seeing?

Nangeng Zhang, CEO

Thank you for your question. Overall, I think the patterns are quite similar. About six months before the halving, buyers will be motivated by lower equipment prices, tending to purchase large quantities of machines for a final round of pre-halving buying. However, demand usually drops significantly as the halving approaches and immediately afterward. Once the market stabilizes again, and when the Bitcoin price is recovered, demand typically rebounds. That said, there are some differences between the two events. The timing of halving, Bitcoin price trends, industry inventory levels, and the overall scale of demand have all changed. Despite these differences, the key takeaway is that demand continues to grow. Market fluctuations have lessened, and customers have become more professional in their operations. I think for 2025, some capacity and geographic conflicts will influence demand, and different regions may have different demands in 2025.

Kevin Cassidy, Analyst

Thank you for that answer. And just what systems do you have in place to ensure you're capable of meeting demand, make sure there's no shortage of the ASICs or boundary space, and even just the assembly of the mining rigs?

Nangeng Zhang, CEO

Yes, we've been focused on developing new products, delivering models with approximately 17 joules per terahash power efficiencies this year. We also participated in market trends early and secured our production capacity by placing advanced orders to the foundries. Close collaboration with our partners has further improved the yield rates and shortened production cycles. These interactions require financial support. At the end of September, we completed $15 million financing to invest in self-mining and joint mining sites in the US. Because we know the bull market is coming, we have to have our supply chains ready for customer orders. Recently, compliance is rising inversely; the bull market is already there. So we secured another financing arrangement. This reflects our advantage of being a listed company, allowing us to deploy capital swiftly to expand capacity and meet growing market demand. I think the wafers we placed in September will start to deliver at the end of this year, but usually, the production will take about close to five months. We are doing everything we can to shorten that time. Next year, product performance will need to improve further. I believe a range of 10 to 15 joules per terahash is achievable. This requires continued investment in chip development. Additionally, we also have to refine the entire product ecosystem. This includes machines of different power levels, whether targeting B2B or B2C customers, different cooling methods, and system integration, as well as both software and hardware. Over the past few months, we have conducted extensive product development work, and this will continue in the coming months.

Kevin Cassidy, Analyst

Yes, thank you.

Operator, Operator

Thank you. Our next question comes from Nick Giles with B. Riley Securities. Your line is open.

Nick Giles, Analyst

Hey, good morning, everyone. Congratulations on the recent deals with North American customers. I was wondering if you could expand on your growth efforts in this market. What targets do you have in the coming quarters, either on an exahash sold basis, gross revenue, or percentage of total revenue? I'll start there. Thanks.

Nangeng Zhang, CEO

Thank you. I think the rising Bitcoin price has triggered recovery in market demand, and we anticipate even stronger demand next year. In the first quarter, we achieved 7.3 million terahash per second in computing power sold, marking a 93.8% year-over-year increase and 16.4% sequential growth, taking a record high over the past 11 quarters. Recently, we announced large-scale orders with North American publicly traded mining companies CleanSpark and HIVE, reflecting a notable recovery in demand. As Bitcoin price surpassed $85,000, we began adjusting our sales prices in line with fair market value and increasing the upfront payment required for contract sales orders. We believe the Bitcoin bull market is still in its early stages, and moving forward, we will actively adapt our pricing policies and sales strategies to align with shifting market supply and demand dynamics.

Nick Giles, Analyst

Thank you for that, Nangeng. My next question is just around R&D spending expectations in 2025. How should we think about the split between the A16 series and other initiatives?

Nangeng Zhang, CEO

Yeah, I think we focus on our miner series development. But on the other side, I have something to share. I have closely monitored advancements in AI and engaged in discussions with industry leaders about the direction of this rapidly evolving field. In the last two years, I think the AI space and its ecosystem have emerged as clear winners. This reminds me of the Bitcoin mining boom that began in 2011. The question now is how can Canaan position itself to ride this wave of technological progress? Canaan has a strong foundation in areas like Edge AI product development, chip design, and operational computing infrastructure. This gives us multiple avenues to participate. Making the right business decisions requires foresight. So today I think the demand for large model training is consolidating among a small number of major companies. In just two or three years, there might be fewer than 10 companies globally that have comparable large models. That means the competition in large model training hardware is essentially over, and the winners are already clear. The next major opportunity will likely emerge as AI applications based on these models become mainstream, leading to a sharp increase in demand for inference compute power that exceeds training requirements. However, this shift will take time. At this stage, it would be wise to invest heavily in designing and producing chips and devices, specifically for today's large models. So our best preparation right now is already underway, accelerating infrastructure deployment, particularly in regions like North America. By the middle of next year, we aim to deploy 200 megawatts in the first phase and continue to expand power resources afterward. The current Bitcoin full-year cycle has just begun, and I believe this is a locked window for us to lay a solid foundation.

Nick Giles, Analyst

So, Nangeng, I really appreciate all the insights and commend you on your foresight in those segments. So, continue best of luck.

Operator, Operator

Thank you. Our next question comes from Kevin Dede with H.C. Wainwright. Your line is open.

Kevin Dede, Analyst

Hi, Nangeng. Hi, James. Thanks for having me on the call. Nangeng, I was hoping you could look a little bit at the A14 versus A15 series and the demand you're seeing. Obviously, with the increase in compute density, heat becomes a greater issue, and I'm wondering what you're seeing on the demand side for air-cool versus immersion as your orders shift from A14 to A15?

Nangeng Zhang, CEO

Okay. Firstly, hello. I think the A14 series is very close to being phased out because the A15 has significant advantages. The power efficiency of the A14 is about $22 to $23 per exahash, while the A15 is now lower than $17. This reflects more than 20% improvement. We are switching all our capacity from A14 to A15. For demand, I think the A15 is seeing much greater demand because its performance is comparable to our competitors, and the machine is super stable. We tested it under temperatures exceeding 50 degrees Celsius with our air-cooling system. In our liquid cooling systems, the water-cooled models are running close to 400 terahash today, so everything about A15 is much better. In terms of machine cooling methods, I think that the liquid cooling model is increasing. Many of our customers are trying to use machines to generate heat, especially in the winter. We have multiple customers working with us using our liquid cooling models to generate hot water. The operating temperature ranges from 55 degrees Celsius to over 70 degrees Celsius. This makes it very valuable equipment in many different regions. Additionally, due to the noise factor, customers are also opting for liquid cooling systems. By the end of this year, we plan to announce our liquid or water cooling system to the public, possibly next month or in January 2025.

Kevin Dede, Analyst

And Nangeng, thank you for all the insights on AI development. I appreciate your perspective immensely. I'm curious, though, do you think you're going to hold back on further development until you see a path to develop an ASIC to address that market? I just want to ensure I understood your comments correctly.

Nangeng Zhang, CEO

In my view, the model training is relying currently on systems like NVIDIA's H100 or other advanced models. Most inference customers are using ASIC technology. This reminds me that in the early days of Bitcoin mining, people began with CPUs, then transitioned to GPUs. Today, AI players are primarily using GPUs for token generation. We are currently at this stage. Personally, I have plans to explore how to generate AI tokens using ASIC technology. However, the downside is that the demand for inference has not yet surpassed that of training requests. As mentioned, investing heavily over the next one or two quarters in ASIC-focused AI technology is a wise move. I will continue to monitor the industry closely.

James Cheng, CFO

Thank you, Kevin. I think that's a wonderful question. As a listed company, we are very proud to be on NASDAQ. So we have various fundraising strategies at our disposal. For the company, we usually balance between different methods of fundraising, just like we have demonstrated in the past. We can do preferred shares or at-the-market offerings. Additionally, we can use our Bitcoins to generate liquidity. So to answer your question honestly, we prefer to issue preferred shares because it is straightforward and transparent. If the market demand is strong, an at-the-market offering might be more suitable. Last but not least, with Bitcoin prices at an all-time high, we can consider using more bitcoins for pledging. However, we also have to consider utilizing these bitcoins for other methods of generating cash flow. For example, using some for financing to generate interest is also something we are exploring. We are still learning about all these methods and haven't fixed our approach for fundraising, but we can try all available options and listen to our shareholders' suggestions to find the best path forward.

Kevin Dede, Analyst

Thank you, James. I appreciate it. Congratulations on the quarter.

James Cheng, CFO

Thank you.

Operator, Operator

Thank you. Our next question comes from Mike Grandel with Northland. Your line is open.