Earnings Call Transcript - CAN Q4 2020

Shaoke Li, Board Secretary

Thank you very much. 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. Tong He. In addition, Mr. Xiaoming Lu, our SVP, will also be available during the question-and-answer session. Mr. Zhang will start the call by providing an overview of the Company and the performance highlights for the quarter. Mr. He will then provide details on the Company’s operating and financial results for the period, before we open the call up for your questions. Before we continue, I would like to refer you to our safe harbor statement in our earnings press release, which also applies to this call as we will be making forward-looking statements. Please also note that we will discuss non-GAAP measures today, which are more roughly explained and reconciled to the most comparable measures reported under Generally Accepted Accounting Principles in our earnings release and the filings with SEC. With that, I will now turn the call over to our Chairman and CEO, Mr. Nangeng Zhang. Mr. Zhang will deliver his remarks in Chinese, and I will provide corresponding English translation. Please go ahead, sir.

Nangeng Zhang, Chairman and CEO

Hello, everyone. This is Nangeng Zhang, Chairman and CEO of Canaan Inc. I will now provide a brief overview of our progress in the fourth quarter and the full year of 2020. During the fourth quarter, Bitcoin prices continued to rise, driving market demand for mining machines. Our strategic approach has allowed us to build a market presence in previous quarters. We optimized our customer base composition and secured many orders from long-term partners, ensuring strong cash flows. As of December 31, 2020, our total contracted orders reached $174 million, with $66 million in customer advances, representing a sequential increase of $54 million from the third quarter. We also began mass production and delivered the next-generation A12 series mining machines, and we have already started delivering this new product service at scale in the fourth quarter of 2021. We strengthened our mining machine business by expanding market operations, investing in R&D, and improving supply chain management. Our increased investment in AI chips has allowed us to make significant progress in developing top-tier AI chips and facilitating their commercial applications. In total, we received orders for 172,000 mining machines in 2020, with 92,000 machines ordered in the fourth quarter alone. Notable orders include 13,000 machines from Blue Energy Invest and 1,350 from Octo Credit. We have also begun collaborations with several respected mining machine customers in Northern Europe. By the end of the first quarter of 2021, we recorded orders for over 156,000 mining machines with more than $238 million in customer advances. This includes orders from a Canadian crypto miner and a leading U.S.-based miner. To enhance services for our global customers, we built a global customer service network and opened our first international service center in Kazakhstan in the fourth quarter. We plan to establish more service centers in North America and other regions to provide timely after-sales service worldwide. Our investments in product development and R&D reached $21 million in 2020. We have a team of experienced engineers and a complete design flow. We continuously recruit talented individuals with competitive compensation and working conditions. We also refined our supply chain during the quarter, focusing on our new IC manufacturing partner to improve chip yield, power consumption, and computing performance to expected levels. In 2021, we will continue developing new generations of chips. Our AI business segment saw a significant increase in chip usage across markets in 2020, with deliveries tripling year-over-year. We expect our AI segment revenue will maintain a high growth rate in 2021. We have identified significant market opportunities for customer growth products with AI chips, particularly the growing adoption of AI vision chips. In 2020, the production output of China’s smartphone sector exceeded RMB 1 trillion, with a potential market size expected to reach RMB 5.8 trillion. To address these opportunities, we have a three-tier product plan focusing first on low-cost consumer chip solutions, then medium computing power vision chips for smart applications, and high computing power vision chips for advanced sectors. Our roadmap for AI chips is informed by specific applications and corresponding market demand for computing power, leading to multiple product lines. We completed the tape-out process for the K510 series in the fourth quarter and are commissioning these chips for the mid to high-end AIoT market, with significant market interest and some pre-orders. We plan to start mass production of the K510 series in the second half of 2021. Meanwhile, the K230 series, an upgrade of the K210 series, has been optimized based on customer feedback for better computing power and flexibility. For the first half of 2021, we expect future contract sales of our mining machines to contribute approximately 70% to 80% of total revenues, with adjustments in the second half based on market conditions and production capacity. Our mining machine production capacity for the first half has already been fully presold through future contracts. Therefore, starting in the second quarter of 2021, we will allocate several thousand mining machines to our own mining business, focusing on the A12 and A11 series for an additional combined computing power between 350 Thash to 450 Thash. From the second half of 2021 onward, we plan to dedicate at least 10% of our total monthly production capacity of mining machines to our Bitcoin mining business. The actual number of mining machines will adjust based on our partners' development, mining farm conditions, Bitcoin prices, and our production capabilities. If Bitcoin prices and our production capacity remain stable, we expect the total computing power for our Bitcoin mining business to reach between 2 EH to 4 EH by year-end. 2020 was crucial for Canaan as we navigated external challenges like the COVID-19 pandemic and supply chain obstacles. We continued optimizing our management structure while adding personnel and independent directors to strengthen corporate governance. Finally, I want to thank all of our employees for their hard work, as well as our business partners and investors for their continued trust and support during this challenging year. In 2021, we are committed to improving societal efficiency and quality of life.

Tong He, CFO

This concludes the remarks for our CEO, Mr. Zhang. I will provide an overview of our fourth quarter and full year financial results. Before I start, please note that all numbers are in RMB terms unless otherwise noted. Total net revenue decreased to RMB 38.2 million from RMB 463.2 million in the same period of 2019 and RMB 163 million in the previous quarter. The decrease was due to a few factors. First, we started mass production of our new product series during the first quarter, which only began to ramp up in sales in the period. Meanwhile, we have almost sold out our inventory of our older production in the third quarter of 2020. Cost of revenue decreased to RMB 29.2 million from RMB 1.14 billion in the same period of 2019, and RMB 180 million in the third quarter of 2020. The fluctuation in our cost of revenues was in line with the changes in our sales volume of Thash and cost per Thash. As a result, we reported a gross revenue of RMB 9.1 million in the fourth quarter of 2020 compared to a gross loss of RMB 673.4 million in the same period of 2019 and a gross loss of RMB 17 million in the previous quarter. Research and development expenses were RMB 40.1 million compared to RMB 63.6 million in the same period of 2019 and RMB 32.1 million in the previous quarter. The year-over-year reduction was mainly due to the changes in materials that we used for R&D purposes. The sequential increase was driven by the higher salary and welfare benefits for R&D personnel. Let’s now take a look first at other operating expense in the fourth quarter. Selling and marketing expenses were RMB 6.1 million compared to RMB 7.7 million in the same period of 2019 and RMB 3.2 million in the previous quarter. The changes in our selling and marketing expense were primarily due to travel expenses and salary changes in our sales and marketing department. G&A expenses decreased to RMB 33.9 million from RMB 56.4 million in the same period of 2019, and decreased RMB 40.6 million in the previous quarter. The reduction was mainly driven by lower share-based compensation during the fourth quarter of 2020. Consequently, our total operating expense in the fourth quarter of 2020 was RMB 80.1 million compared to RMB 127.7 million in the same period of 2019 and RMB 75.9 million in the previous quarter. Loss from operations was RMB 71 million from RMB 801.2 million in the same period of 2019 and RMB 92.9 million in the previous third quarter. Net loss attributable to ordinary shareholders was RMB 72 million compared to RMB 798.2 million in the same period of 2019 and RMB 86.4 million in the previous quarter. Non-GAAP adjusted net loss, which excludes share-based compensation expense, was RMB 73.1 million. In comparison, non-GAAP adjusted net loss was RMB 750.5 million in the same period of 2019 and RMB 84.8 million in the previous quarter. Diluted net loss per ADS was RMB 0.46 compared to RMB 5.3 in the same period of 2019 and RMB 0.55 in the previous quarter. Now, turning to our results in the full year of 2020. Total computing power sold in the full year of 2020 decreased by 37.1% to 6.6 million Thash/s from RMB 10.5 million Thash/s in 2019, as a result of increased scarcity of Bitcoin price and our product, which is unclear of our older product series inventory during the first nine months of 2020. Consequently, total net value in 2020 decreased to RMB 447.7 billion from RMB 1.42 billion in 2019. Cost of revenues in 2020 decreased by 78.9% to RMB 409.9 million from RMB 1.94 billion in 2019. As a result, our gross profit in 2020 was RMB 37.8 million compared to a gross loss of RMB 516 million in 2019. Total operating expense in 2020 decreased by 45.8% to RMB 291.6 million from RMB 538.5 million in 2019. Loss from operations in 2020 narrowed to RMB 253.9 million from RMB 1.05 billion in 2019. Net loss attributable to ordinary shareholders in 2020 was RMB 215.1 million compared to RMB 1.03 billion in 2019. On a non-GAAP basis, our adjusted net loss in 2020, which excluded share-based compensation of RMB 3 million was 212.1 million. Net loss per ADS in 2020 was RMB 1.38 compared to RMB 7.21 in 2019. Turning to our balance sheet. Contract liabilities as of December 31, 2020, increased to RMB 430.4 million from RMB 8.3 million as of December 31, 2019. The increase was driven by increased down payment for the sales order of our Bitcoin mining machine, which are scheduled for delivery in 2021 and beyond. As of December 31, 2020, we had cash and cash equivalents of RMB 391.3 million compared to RMB 516.6 million as of December 31, 2019. The decrease was mainly due to higher short-term investments as we had invested RMB 62.4 million in short-term investments as of December 31, 2020, compared with RMB 11 million in short-term investments as of December 31, 2019. Notably, we purchased short-term financial products to receive higher returns and can withdraw at any time. Looking forward, we are convinced our expense in 2020 will enable us to improve our financial performance significantly in 2021. As the price of Bitcoin started to resume its upward trajectory since the fourth quarter of 2020, consequently, we expect our total net revenue in first quarter of 2021 to exceed RMB 400 million. Please note that the forecast only reflects our current expectations and preliminary views on the market and operational conditions, which are subject to changes, particularly regarding the potential fluctuations in the price of Bitcoin as well as the impact of COVID-19 on the global economy. This concludes our prepared remarks for today.

Operator, Operator

We have the first question from the line of an unidentified caller. Please go ahead.

Unidentified Analyst, Analyst

My first question is about our new generation Bitcoin mining machine that CEO Zhang mentioned. I would like to know which foundry partner we are collaborating with and which technology node we are using. Is there a launch schedule for this new machine?

Nangeng Zhang, Chairman and CEO

Okay. Let me provide a translation. We are one of the few companies in our industry that has multiple foundry partners, and we are currently collaborating with them on our next generation chips. Each year, we typically launch around two to three products, and this year will be no different. We assess our selection of foundry partners based on various factors like technology, market conditions, and capacity. Work is currently underway, but at this moment, we cannot share any further details regarding the launch schedule.

Unidentified Analyst, Analyst

My second question is about our capacity. We know that current capacity is very tight. How much wafer capacity can we procure each month? Do we have any updates on our wafer capacity?

Nangeng Zhang, Chairman and CEO

We believe that various inherent issues in the Bitcoin mining sector led to a shortage of chip supply. Mining machine manufacturers typically use Bitcoin prices as benchmarks to gauge future market demand for their products, which influences their production volumes. During the second half of 2020, low Bitcoin prices caused many manufacturers to cut back on their investment in production. Consequently, when Bitcoin prices rebounded later that year, the industry faced a significant supply shortage. Additionally, recent limitations in the semiconductor manufacturing sector have contributed to the chip shortage in 2021, exacerbating the supply issues. While we cannot disclose the exact number of chips in production currently, one of our strategies to tackle this issue is to maintain partnerships with several foundry partners and to expand our collaborations, which has yielded positive results in our ability to keep pace with demand. Moreover, we are actively collaborating with large mining companies globally, including publicly traded firms and institutions that have secured long-term purchase orders for mining machines. This approach ensures we can reliably receive chips from our foundry partners, helping us mitigate the technical shortages caused by the volatility in Bitcoin prices.

Unidentified Analyst, Analyst

My follow-up is that we have a strong relationship with our advanced foundry partners in Mainland China, which allows us to secure a significant amount of wafer capacity from them. Are there any competitors that we expect to challenge this capacity in 2021, and what is our strategy to safeguard it?

Nangeng Zhang, Chairman and CEO

Okay. So first, there will, of course, be competitors, especially given the high Bitcoin prices. But we have already established a strong competitive advantage through our extensive experience, collaborations with multiple foundry partners, an integrated supply chain, and a large global client base. This is why we captured significant market share for mining machines in new markets during the first half of 2021. We view the supply chain similarly to design, where good design necessitates ongoing and greater investments in research and development. Regarding production capacity screening, which has similar requirements, we need to increase our investments in supply chain, technology, and engineering in the current market environment in 2021. We are actively looking for marketing opportunities to enhance our cash position and strengthen our product development capabilities. Our approach to product designs across multiple nodes simultaneously provides us with added flexibility when negotiating or coordinating with these partners to ensure capacity.

Unidentified Analyst, Analyst

My next question is about our current yield rate. The CEO has already mentioned that our yield rate has achieved certain milestones. How do we expect improvements in the second quarter or the second half of the year, and what will be the impact of these improvements on our machine shipments?

Nangeng Zhang, Chairman and CEO

The yield rate can be influenced by various factors and is also a significant and confidential trade secret. Generally, when launching new products, especially when beginning a partnership with a new collaborator, it requires some time for production capacity and yield rate to increase. We are diligently working to reduce this break-in period as much as possible. Thanks to the efforts of our employees, colleagues, and partners, we effectively completed this challenging break-in process in the second quarter of 2021.

Unidentified Analyst, Analyst

And my last question is about our Ethernet mining machine. Do we have any plans to launch our ETH machine in 2021 or 2022?

Nangeng Zhang, Chairman and CEO

Our R&D is currently in progress, but at this point, we can’t really disclose any more information than that.

Operator, Operator

Next question is from the line of indiscernible.

Unidentified Analyst, Analyst

We know that the selling price of mining machines and the price of Bitcoin are closely linked, but Bitcoin's price has risen significantly since the fourth quarter of last year. Why didn't this impact our fourth quarter financial report and guidance?

Nangeng Zhang, Chairman and CEO

Okay. To answer your question, the price of mining machines moves with Bitcoin prices only for the machines that are ready for delivery. Since the second half of last year and the first half of this year, most of the mining machines we sold were sold as futures contracts with a fixed price, which was actually lower than the prices of our existing machines.

Unidentified Analyst, Analyst

According to the news, a company called Integrated Ventures purchased 600 mining machines from our company for approximately $2.70 million, with each mining machine costing around $4,500. May I ask what the Bitcoin price was at the time of the deal? Additionally, were all 600 mining machines prepaid orders, and what is the general price for mining machines sold on credit at this price?

Nangeng Zhang, Chairman and CEO

To answer that question, the order was made in February. We sold the mining machines at different prices, which can be quite complex. Generally, for mining machines sold at a given time, future prices could be significantly lower than the price of existing machines, and sometimes similar or even higher. This variability depends on the timing of when we sign the contracts and when we deliver the machines, along with various other factors. Typically, future contracts should be priced around 60% to 80% of the existing machine price.

Unidentified Analyst, Analyst

My question is about our expectations for sales volume in 2021. How many prepaid orders do we currently have? Also, what is the average selling price of mining machines based on the current Bitcoin price?

Nangeng Zhang, Chairman and CEO

We have previously mentioned this number in my prepared remarks. As I stated earlier, we have recorded orders for over 156,000 mining machines with more than RMB 238 million in advances from our customers as of the end of the first quarter of 2021. Just to clarify, that $50 to $100 is the price for each Thash.

Unidentified Analyst, Analyst

My question is about the Company's plans to engage in Bitcoin mining activities. What is the current status? How many mining exchanges do you intend to utilize for mining by the end of the year? Additionally, what is the Company’s share of the network computing power? How do you expect our computing power to compare to other mining companies by the end of the year?

Nangeng Zhang, Chairman and CEO

We are advancing our mining business. We have already established an operation center in Singapore to oversee the operations. Kazakhstan is also a key focus for us, along with North America. We have always prioritized compliance in our mining operations, which is why we maintain regular communication with our lawyers, auditors, and other independent agencies to ensure we comply and minimize our operational risks. Our production of mining machines has been fully booked for the first half of 2021. We expect to deploy thousands of these machines for our mining business in the second quarter, yielding total computing power between 350 Thash and 450 Thash. In the second half of 2021, we will adjust this figure based on market conditions and our production capacity. We plan to deploy over 10% of our total production capacity each month for our mining operations. We will keep track of the progress of other mining companies we partner with and monitor Bitcoin prices for real-time adjustments. Assuming no significant changes in Bitcoin prices and our production capacity, we anticipate deploying an additional 2 to 4 extra hash of total computing power for our mining business by year-end.

Unidentified Analyst, Analyst

My last question is, what’s the plan for the mine Bitcoin, are you going to hold or exchange for U.S. dollars or any other kind of consideration?

Nangeng Zhang, Chairman and CEO

So, as I mentioned earlier, we are committed to ensuring that all of our operations remain compliant. Following our guidance, we plan to hold our Bitcoin for the long term. However, we may also consider selling the Bitcoin. This approach allows us to benefit from the growth of the industry.

Operator, Operator

Thank you. There are no more questions at this moment. I will hand the call back to the management for closing remarks. Thank you.

Shaoke Li, Board Secretary

Okay. Thank you all for joining us today. We look forward to talking to you next quarter. Thank you.

Operator, Operator

Thank you. Ladies and gentlemen, that does conclude your conference for today. Thank you for participating. You may all disconnect now. Thank you.