Earnings Call Transcript - CAN Q2 2022

Operator, Operator

Ladies and gentlemen, thank you for standing by and welcome to Canaan Inc.'s Second Quarter 2022 Earnings Conference Call. 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.

Clark Soucy, Investor Relations Director

Thank you. 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. Edward 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 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 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 disclosure 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.

Nangeng Zhang, Chairman and CEO

During the second quarter of 2022, the bitcoin price fell from approximately $45,000 to around $20,000 due to two rounds of interest rate increases by the Federal Reserve. Energy prices surged from geopolitical conflicts, further affecting both mining income and the demand for mining machines. Consequently, the total computing power of the bitcoin network experienced a slight decline. Additionally, cities housing our main offices faced a resurgence of the COVID-19 pandemic, leading to large-scale lockdowns and pandemic control measures that negatively impacted our operations during the quarter. Despite these challenges, our team effectively managed to navigate the difficulties, ensuring our employees remained healthy and had access to essential supplies. We continued to fulfill client orders, achieving a total computing power of 5.5 million terahash per second sold. With our growing mining business contributing, we recorded total revenues of RMB1.65 billion for the quarter, aligning with our previous expectations. We also achieved a net profit of RMB609 million in the second quarter. In terms of mining machines sales, we worked closely with our customers, delivering the same computing power of 5.5 million terahash per second, generating revenues of RMB1.6 billion. Sales from mining machines significantly drove revenue growth, which increased by 48.6% year-over-year and 21% quarter-over-quarter. We diligently addressed the demands of our customers. Following the launch of our online store for overseas retail customers in late May, we received orders from around the globe. As our customer base expands into international markets, we've worked hard to enhance our support systems. Our overseas headquarters in Singapore has set up R&D, finance, and operational teams, launching a comprehensive supply chain system for assembly, warehousing, and logistics this quarter. This makes our Singapore office a vital support center for our overseas activities. By the end of the second quarter of 2022, we had 4.75 million terahash per second of computing power pending delivery and customer advances totaling RMB1.02 billion. While these orders provide a solid revenue foundation for the near term, we recognize that bitcoin prices remain under pressure, and energy costs are rising. Consequently, mining companies are expected to face significant revenue and financial challenges. Given these circumstances, we predict demand for computing power will weaken in the next one to two quarters, adversely affecting our sales revenue in the latter half of 2022. Although our sector is navigating tough times, we retain confidence in bitcoin's long-term viability and its underlying blockchain and supercomputing technologies. We continue to invest in R&D, enhance our supply chain capabilities, and strive to deliver high-quality, advanced products to the market. Our research on the next generation of mining machines is on track, currently approaching mass production. Due to various uncertainties in the development and production phases, we must await testing results before revealing specific performance details of our new machines. Regardless of bitcoin price fluctuations, we have consistently prioritized R&D investments. Despite current volatility, we remain optimistic about bitcoin's future value. At this stage, launching the new generation of mining machines and achieving mass production is crucial for our innovation efforts. Our new offerings will assist clients in boosting mining efficiency and preparing for future challenges while maximizing returns. Given the current environment of declining bitcoin prices, it is essential to remain adaptable and actively develop our mining operations internationally. During the quarter, our improved electricity supply enabled us to mine 245.11 bitcoins, holding a total of 346.84 bitcoins by quarter-end. Even as bitcoin prices fell, we generated mining revenue of RMB52.1 million, with a quarter-over-quarter increase of 60.9%. In response to the challenging market landscape, we are exploring more opportunities for regional diversification in our mining business, forming partnerships in North America, Southeast Asia, and other areas to expand our scale and reduce costs. Moving on to our AI chip business, the COVID-19 control measures in major cities led to slower inventory turnover for consumer products, negatively affecting our AI chips revenue in the second quarter. As these measures ease in the third quarter, downstream clients are improving their sales and rebuilding inventories. We've also enhanced our sales initiatives for AI chips, and our sales are beginning to recover. Notably, our K510 CRB Customer Reference Board Development Kit recently received AWS IoT Core Certification from Amazon, making it easier for clients to integrate AWS IoT software on the K510 platform and develop new products. This certification also allows our product to feature on the AWS website, boosting our brand visibility. This quarter, we made significant progress on our share buyback program approved in March, under which we may repurchase up to $100 million of our outstanding ADS over the next 24 months. As of August 12, 2022, we repurchased over 2.0 million ADS for a total of $10.3 million, averaging $3.63 per share, which is lower than the current stock price. Our actions reflect our commitment to enhancing shareholder value and confidence in the company’s future. On June 23, 2022, we announced an agreement to buy back outstanding warrants for about $6.61 million, which we have paid in full. Upon completing the warrant certificate cancellation, our outstanding ADS will decrease by $4.72 million, with more details to come following the process's completion. We did not pursue any financing activities this quarter given the current market dynamics and pressure on our stock price; thus, our focus remains on the repurchase program. We acknowledge investors' concerns regarding the potential delisting risk under the Holding Foreign Companies Accountable Act. We are actively exploring solutions to safeguard our shareholders' interests and maintain our listing status, ensuring compliance to support our long-term growth. As a public company primarily generating revenues overseas, we will enhance our governance and operational capabilities to comply with relevant laws and regulations while maintaining effective communication with capital markets. During the second quarter, we faced several simultaneous challenges, including COVID-19 outbreaks, a fluctuating geopolitical and economic landscape, and declining bitcoin prices. Despite these uncertainties, we consistently communicated and collaborated with partners and maintained steady performances. Nonetheless, we recognize that macroeconomic adversities, particularly falling bitcoin prices and rising energy costs, have put pressure on the entire bitcoin mining sector, significantly affecting miners' demand for computing power for the foreseeable future. As a result, we anticipate further pressure on our performance in the coming one to two quarters. Based on current conditions, we expect our total revenues for the third quarter of 2022 to be between RMB900 million and RMB1.1 billion, reflecting a decrease of 17% to 32% compared to the third quarter of 2021. This forecast captures our preliminary outlook on the market and operational conditions, which are subject to change. Over the past nine years, we've navigated various bitcoin price cycles, and our management team has extensive experience managing in environments of declining bitcoin prices. We respect the market, and even during periods of growth, we prioritize balance sheet health. Currently, we carry no interest-bearing debt, and our mining machines and cryptocurrencies are uncollateralized. These financial strengths, along with our cash position, empower us to pursue our mining and business strategies steadily, even in unfavorable conditions, ensuring the welfare of our employees and partners while continuously improving our products and services. Market downturns also offer us an opportunity to refine our new products, steadily expand our markets, and optimize our supply chain and logistics. We will keep enhancing our international operations and fortifying our aftersales service system to better serve our customers. Additionally, we will adopt a flexible strategy to prudently develop our mining business while strengthening synergies between our machine sales and mining operations. This concludes my remarks, and I will now turn the call over to our CFO, James.

James Cheng, CFO

Thank you, Mr. Zhang, and good day, everyone. This is James. In the second quarter of 2022, we reported total revenues of RMB1,652.7 million, representing a 21.9% quarter-over-quarter increase and a 52.8% year-over-year growth, meeting our guidance range. During the quarter, the bitcoin price further sank to below US$20,000 from about US$45,000 in late March. Despite this soft market sentiment, we strive to achieve this top line performance primarily due to the delivery of 5.5 million terahash per second of computing power for our clients. The relatively high average selling price was secured with contract sales in previous quarters which also contributed to the top line results. Our AI chip business recorded revenue of RMB1.6 million for the quarter due to softer demand from integrated product providers and lowered customer orders. This is because the stock to app electronic product inventory that will embed our chipsets during the quarter when the pandemic related lockdowns negatively impacted their supply chains and the consumption of these retail electronic products. As the pandemic quarantine control measures gradually eased and the retail started to recover, we are having more progress in our AI chip sales in July and early August. Our mining business with an improved power supply generated 245.11 bitcoins in the second quarter which contributed RMB52.1 million in revenue representing a sequential revenue increase of 60.9%. We had 346.84 bitcoins on hold as of the quarter's end compared with 166.96 bitcoins as of March 31, 2022. Due to the ongoing energy instability, a portion of our deployed mining machines have not been consistently online and we are facing increasing energy costs for our operations. Under the evolving marketing environment, we are prudently exploring other geographical regions with favorable mining conditions to diversify our operations. Above all, our gross profit for the quarter increased by 12% sequentially and 117.3% year-over-year to RMB929.7 million. As a result of the complex effect of slightly decreased average selling price and increased product cost due to wafer price rises, our gross margin for the quarter narrowed to 56.3% from 61.2% in the first quarter of 2022. In the second quarter, we continued our efficient expense management with consistent investments in research and development. Notably, we have built an R&D team at our Singapore overseas headquarters by leveraging the advantage of low curtailment. From a profit and loss perspective, we have several material non-operating items related to accounting treatment for the quarter. First, we incurred a RMB30 million impairment for our cryptocurrency assets in the quarter due to the bitcoin price decrease compared with the first quarter's end. I would like to reiterate that bitcoins are initially recorded at the price when we generate them; our digital assets are recorded on the balance sheet, net of any impairment losses incurred since initial recognition. Hence are not recorded until realized upon disposal of such digital assets. Secondly, during this quarter due to the depreciation of RMB against the U.S. dollars, we also recorded a foreign exchange gain of RMB114.3 million, as almost all of our revenues were generated from overseas markets in U.S. dollars. Should the RMB appreciate against the U.S. dollars in the future, we expect to incur corresponding foreign exchange losses. Last but not least, the change in fair value of warrant liability brought us a gain of RMB25 million in the second quarter, as we completed the repurchase of all outstanding warrants in late June. We don't expect any gains or losses from such fair value change in the foreseeable future. As a result of these factors, we realized a solid net income of RMB608.9 million for the second quarter, achieving a 37.9% increase quarter-over-quarter and a 148.6% growth year-over-year. Turning to our balance sheet. As of the end of the second quarter, we have customer advantages of RMB1,017.5 million together with our cash generated from product sales we have an aggregate of RMB2,640.7 million in cash and cash equivalents as of June 30, 2022 maintaining relatively flat compared with the end of the first quarter. Our cash level provides us with a solid position to navigate challenging market environments, enables us to carry out prudent exploration in expanding our global presence and continues our share repurchase program. As of August 12, 2022, we have repurchased a total of US$2.8 million ADS with an aggregate value of US$10.3 million and an average repurchase price of US$3.63 per ADS under our current stock repurchase program approved in March 2022. This stock buyback demonstrates our firm confidence in the company's long term growth prospects. Moreover, as mentioned earlier, we reached an agreement with our warrant holder to repurchase all 4.72 million outstanding warrants in late June for an aggregate of US$6.61 million. The repurchase of outstanding warrants enables us to capitalize on the current valuation and grants us more financing flexibility in the capital markets in the future. Under the current marketing environment, we will continue our conservative approach in the capital market and prioritize the share repurchase program to drive value for our shareholders. Looking forward, we see that to continue with a lower bitcoin price level coupled with increasing energy costs and logistics expenses significantly jeopardize our clients' demand and cash flow. But we expect a considerable decrease in both product orders and average selling price. Taking into account the relatively high level of production costs, we expect an average gross margin decrease in the second half of this year. Subsequently, we expect our bottom line performance to experience a substantial decrease or even loss making in certain scenarios if the bitcoin price continues to fluctuate at a low price level. Maintaining respect for the market, we will continue our prudent and agile operating strategy to navigate the current market dynamics and strengthen our supply chains and develop and advance new products for future opportunities. Now I would like to briefly walk you through our financial results for the quarter. Revenues in the second quarter of 2022 were RMB1,652.7 million, US$246.7 million representing an increase of 21.9% compared to the first quarter and an increase of 52.8% from RMB1,081.8 million in the same period of 2021. Gross profit in the second quarter of 2022 was RMB929.7 million, which means US$138.8 representing an increase of 12% from US$829.8 million in the first quarter of 2022 and an increase of 117.3% from RMB427.9 million in the same period of 2021. Total operating expenses in the second quarter of 2022 were RMB270.5 million, which means that US$40.4 million representing an increase of 7.7% from RMB251.2 million in the first quarter of 2022, and an increase of 3.1% from RMB262.4 million in the same period of 2021. Income from operations in the second quarter of 2022 was RMB659.3 million, which was US$98.4 million representing an increase of 13.9% from RMB578.6 million in the first quarter of 2022 and an increase of 298.4% from RMB165.5 million in the same period of 2021. Net income attributable to ordinary shareholders in the second quarter of 2022 was RMB608.9 million which means US$90.9 million, representing an increase of 37.9% from RMB441.6 million in the first quarter of 2022 and an increase of 148.6% from RMB245 million in the same period of 2021. Non-GAAP adjusted net income in the second quarter of 2022 was RMB688.2 million, US$102.7 million, representing an increase of 26.6% from RMB543.4 million in the first quarter and an increase of 115% from RMB320.1 million in the same period of 2021. Basic and diluted net earnings per ADS for the quarter were RMB3.53 which is US$0.53. Contract liabilities as of June 30, 2022, were RMB1,017.5 million US$151.9 million, decreasing from RMB1,340.7 million as of December 31, 2021. This concludes our prepared remarks. We are now open for questions.

Operator, Operator

Thank you. We will now take our first question. Please stand by. The first question is from Jiaer Zhu from China Renaissance Securities. Please go ahead.

Jiaer Zhu, Analyst

We have observed a notable decline that we experienced during the first quarter of this year. I would like to inquire if there are any significant customers placing capital orders, and what the implications are for our outlook on demand, gross profit margin, and average selling price for the second half of the year. Additionally, how do we plan to respond to this downturn and further grow our international market? Thank you.

Nangeng Zhang, Chairman and CEO

Our future contract sales require our clients to prepay at least 50% of the total payment to secure mining machines. By the end of the second quarter, our customer advances reached RMB1.017 billion. So far, we have seen very limited cases of payment defaults. Future contract sales have always been a part of our business model, and we negotiate these contracts to lock in prices for future orders. This model has been acknowledged by both our clients and us. Even when Bitcoin prices rise significantly, we will still deliver mining machines at the agreed-upon prices. Our current prepaid orders provide a strong foundation for our third quarter revenue. However, we have noticed a notable decline in demand for computing power deployment by miners, influenced by factors such as the falling Bitcoin price and rising energy costs. In response, we have adjusted our prices. As you may have seen in our online shop, the average selling price for retail has been reduced to US$30 per terahash. Therefore, we anticipate a downward trend in both sales and prices of computing power in the latter half of the year. As mentioned in our earnings release, we estimate the third quarter’s revenues to be between RMB900 million and RMB1.1 billion. Meanwhile, we have observed that some of our experienced clients are not significantly affected operationally or financially. They intend to increase their computing power deployment at this low point in Bitcoin and mining machine prices, and we are actively communicating with these clients. We will continue to monitor market conditions closely and cautiously explore mining collaboration opportunities at the right time. Our operations will be adjusted flexibly in response to shifts in Bitcoin prices and market dynamics, and we will dynamically allocate computing power for spot sales, future contract sales, and our mining business. Over the past few years, we have encountered significant fluctuations in Bitcoin prices and bear market cycles. Even though the current market is not ideal, we remain focused on our long-term growth.

Jiaer Zhu, Analyst

No, if we have - still further plans to expand our overseas markets on the self-mining business?

Nangeng Zhang, Chairman and CEO

To answer your question, we continue to closely communicate and collaborate with overseas clients. As energy prices rise globally, we have experienced stronger demand in regions with abundant energy resources and favorable pricing. Our team is actively attending bitcoin and mining industry conferences in North America and other areas to improve communication and promote our products with business partners and clients in the industry. During the quarter, our international headquarters in Singapore has established research and development, finance, and other operational teams, and launched a supply chain system that includes assembly, warehousing, and logistics. This is expected to provide additional support and convenience for the growth of our business abroad. Our online store aimed at overseas retail markets has already received numerous orders and prepayments from North America, Europe, Australia, Southeast Asia, and other regions since its launch over a month ago. Although total sales volume remains modest, we've noticed global interest in Bitcoin mining from clients. The online store also allows us to broaden our reach to customers and enhance our brand promotion.

Jiaer Zhu, Analyst

Thank you. That's very clear.

Operator, Operator

Thank you. We'll now take our next question. Please standby. It is from the line of Michael Legg from The Benchmark Company. Please go ahead.

Michael Legg, Analyst

Thanks and congratulations on weathering this tough environment. Can you talk a little bit about your build out in the U.S. and how that's going, please?

Nangeng Zhang, Chairman and CEO

Thank you for your question. We place a high priority on the North American market and have observed a growing interest in investing in and establishing mining farms by bitcoin miners in the region. This trend is driven by the widespread acceptance of cryptocurrency and the availability of abundant energy resources, particularly the fast growth of clean energy. This year, we actively engaged in numerous bitcoin industry conferences in the United States, where we had meaningful discussions and established connections with mining companies and business partners. We now have team members located in North America to support our business growth, including sales and exploring mining opportunities. We're also developing local warehousing and logistics to facilitate our business expansion. Additionally, we have set up repair centers and are improving our local and after-sales services for clients. Currently, in North America, we are in discussions with several mining farm partners, adopting a cautious strategy. We have initially secured resources for mining sites that can accommodate 5,000 units of mining machines through typical deposits to pursue mining operations in this new area in the future. The mining business serves as a vital complement to our mining machine sales, allowing us to flexibly allocate our inventories between sales and mining operations to optimize our returns through responsive operations.

Michael Legg, Analyst

Great, thank you very much. I appreciate it.

Operator, Operator

Thank you. We'll now take our next question. Please standby. It is from the line of Kevin Dede from H.C. Wainwright. Please go ahead.

Kevin Dede, Analyst

I would - I understand a strong interest in continuing to develop new machines and new technology would be continued spending on R&D. What I would like to understand is how you see semiconductor development and machine technology improving such that efficiency improves and your opinion on the inclusion of immersion capability? Thank you.

Nangeng Zhang, Chairman and CEO

In the mining machine business, a key focus for the future is the vertical integration of products and solutions, covering the entire system from chip to site and enhancing mining computing power across the industry value chain. Currently, our product offerings mainly consist of mining machine hardware, with limited capabilities in providing solutions for deployment, operation, and maintenance of these machines on mining sites. Our observations indicate that the industry still lacks standardization in products, streamlined deployment for better operations, and cost reductions while maximizing the use of waste and clean energy. We aim to continuously integrate and develop our products and services vertically. Semiconductor technology is at a pivotal point in transitioning from FinFET to GAA or nanosheet types of 4D technology. This application for mining machines is essential in stabilizing advanced fabrication technology, and the industry is actively working on this. Thank you.

Kevin Dede, Analyst

Thank you very much.

Operator, Operator

Thank you. That's all the time we have for questions. I will now turn the call back over to management for closing remarks.

Clark Soucy, Investor Relations Director

So thank you everyone very much for attending our earnings conference call today. Please feel free to reach out to our IR team. Thank you.

Operator, Operator

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