Earnings Call Transcript - CAN Q1 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by and welcome to Canaan Inc First Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. After the management prepared remarks, we will have a question-and-answer session. Please note this event is being recorded. Now, I would like to hand the conference over to your speaker host today Mr. Shaoke Li, Board Secretary of the Company. Please go ahead, sir.

Shaoke Li, Board Secretary

Thank you very much and hello everyone and welcome to Canaan Inc’s first quarter 2020 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. Hong Quanfu. In addition, Mr. Jianping Kong, our Co-CEO; and Mr. Jingjie Wu and Ms. Li Zhang, our Senior Vice President, will also be available during the question-and-answer session. Mr. Zhang will start with a call by providing an overview of the Company and the performance highlights for the first quarter of 2020. Mr. Hong will then provide the 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 Statements 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 mostly roughly explained at the written files to the most comparable measures reported on the general accepted accounting principles in our earnings release and the filings with the SEC. With that, I will now turn the call over to our Chairman and the CEO, Mr. Nangeng Zhang. Mr. Zhang will deliver his remarks in Chinese and I will provide the corresponding English translation. Please go ahead, sir.

Nangeng Zhang, Chairman and CEO

Hello. I am Nangeng Zhang, Chairman and CEO of Canaan Inc. I would like to provide a brief overview of the company in the first quarter of this year. This call is only a month after the last one, and since the Bitcoin halving occurred on May 12th, the market shows stable and rising Bitcoin prices, leading to stable computing power. We have successfully completed the halving in Bitcoin history, and the upcoming rainy season is expected to rebalance market demand for mining machines. In Q1 this year, due to COVID-19, our total net revenue was RMB68.3 million, reflecting a 44.6% increase compared to the same period last year. This growth in total net revenue aligns with our computing power sales, which increased from 700,000 terahash per second to 900,000 terahash per second in Q1 2020, representing an 18.4% year-on-year rise, along with an increase in average selling price. In the first quarter, our gross profit was RMB2.38 million, while we reported an operating loss of RMB71.1 million, which includes RMB41.8 million in R&D expenses, a year-on-year increase of 33%. The decline in our gross profit margin is attributed to the market conditions during Q1, particularly due to low Bitcoin prices and the impending halving. We have implemented several management retirements and product upgrades, and we anticipate an improvement in gross profit margin in the coming months as the market recovers. On behalf of the team, I would like to sincerely thank all the medical and community workers who continue to fight on the front lines against COVID-19, ensuring the safety of the public and the functionality of society. We appreciate our safe working environment. In our mining business, we initiated mass production and shipments based on the Samsung 8-nanometer chip during Q1 this year and produced several tens of thousands of these units. The mass production of 14-nanometer miners developed with SMIC is set to begin in Q2. We are also progressing with next-generation process development with Samsung and SMIC, and the development of 5-nanometer process ASICs with TSMC is advancing quickly. We continuously optimize the universality of hardware and the design of our software in the mining business. We believe the design of our mining machines can cut costs, shorten design cycles, and make it easier for customers in development and maintenance. The Avalon 1066 Pro is our first product under this concept that is currently available to our clients, with the Avalon 1146 Pro set to follow soon. To enhance competitiveness in real-world operations, we are preparing to launch immersion cooling mining, which will enhance thermal performance while reducing noise levels, thus increasing energy efficiency and extending the lifetime of the miners. We also offer a SaaS platform to lower energy barriers and reduce maintenance efforts for our clients. Our unwavering goal is to provide products that excel in performance, reliability, practicality, and accessibility. As COVID-19 affects both individual and institutional investors, particularly Wall Street investors entering the Bitcoin trading and mining market, we've noticed media reports of notable traders like Paul Tudor Jones getting involved with Bitcoin futures and a favorable stance from Galaxy Digital. Additionally, we see more major players taking interest in our products and services, indicating a recovery in market confidence. The rainy season from May to October will provide cheaper hydroelectric power, which will exert downward pressure on thermal power prices, resulting in overall cost reductions for mining operations. These factors combined should drive demand for miners and positively impact payments. We are also pleased to announce that our AI chip K210 has received a hardware specialist certificate from Forester's IC chip industry report in Q2 2020, recognizing its strong performance, low power consumption, suitability for a variety of application scenarios, and ease of access. In April, support for K210 was integrated into the Linux 5.7 kernel, which allows more developers to use this mainstream operating system to create applications with our AI chip. This opens a standardized development environment that reduces time-to-market and eases the learning curve for users. For example, just two days after our announcement, a team of three RISC-V developers in the GitHub community shared support for K210 in the Rust programming language. We have enhanced the synergy between algorithms, hardware configurations, and software design by developing smart gate control and incorporating mask detection, facial recognition, and liveness detection features. Our product meets numerous application needs in banks, schools, communities, and commercial and industrial parks, generating significant customer interest. The positive feedback marks a promising beginning for our AI business, in which we are committed to open-sourcing K210. We find that the product offerings and open-source toolchain are attracting both domestic and international developers, fostering a vibrant and skilled developer community. In corporate management, we have refined our management procedures, linking the governance system and organizational structure to corporate culture. We conducted performance reviews to ensure product quality, manage risks, and optimize capital allocation to benefit our shareholders. Our R&D team, averaging 32 years old with eight years of experience, is both passionate and skilled. Our management team possesses extensive expertise in R&D, corporate governance, and strategic planning within the IT industry, along with international business experience. These factors are crucial assets for our future growth. Supercomputing is our business, while social impact drives our purpose. Despite increasing macroeconomic uncertainties, we continue to experience strong growth momentum. Through technological and product innovations, we strive to create a better future for all. Thank you.

Shaoke Li, Board Secretary

Thank you, Nangeng. I will now go through our first-quarter financial results on behalf of our CFO, Mr. Quanfu Hong. Before I start, please note that all numbers are in RMB terms unless otherwise noted. Total net revenue in the first quarter of 2020 increased by 44.6% to RMB68.3 million from RMB47.2 million in the same period of 2019. The growth was mainly driven by increases in total computing power sold and the average selling price per Thash. Cost of revenues in the first quarter of 2020 increased to RMB65.9 million from RMB46.8 million in the same period of 2019, which was in line with the increased sales volume of Thash. Gross profit in the first quarter of 2020 increased to RMB2.4 million compared to RMB0.5 million in the same period of 2019. Gross margin in the first quarter of 2020 expanded to 3.5% from 1% in the same period of 2019. As a leading provider of supercomputing solutions, we remain committed to continuously enhancing our technology and refining our product offerings in the quarter. Consequently, our research and development expenses in the first quarter of 2020 increased to RMB41.8 million from RMB31.3 million in the same period of 2019. As a percentage of total net revenues, R&D expenses in the first quarter of 2020 were 61.2%. Let’s now take a look at our operating expenses in the first quarter. Sales and marketing expenses in the first quarter of 2020 increased to RMB4.1 million from RMB2.3 million in the same period of 2019. This increase was due to the increased headcount in the company’s sales and marketing department. As a percentage of total net revenues, S&M expenses in the first quarter of 2020 were 6.1%. General and administrative expenses in the first quarter of 2020 increased to RMB27.6 million or 40.4% of total net revenues from RMB24.8 million or 52.6% of total revenues in the same period of 2019. G&A expenses in the first quarter of 2020 increased mainly due to higher issuance fees in this period. Total operating expenses in the first quarter of 2020 were RMB73.5 million compared to RMB58.5 million in the same period of 2019. Loss from operations in the first quarter of 2020 was RMB71.1 million compared to RMB58 million in the same period of 2019. Excluding share-based compensation expenses of RMB1.7 million, non-GAAP loss from operations in the first quarter of 2020 was RMB69.4 million. Net loss attributable to ordinary shareholders in the first quarter of 2020 was RMB39.9 million compared to RMB67.9 million in the same period of 2019. Non-GAAP adjusted net loss in the first quarter of 2020, which excluded share-based compensation of RMB1.7 million, was RMB38.2 million. Diluted net loss per ADS in the first quarter of 2020 was RMB0.25 compared to RMB0.5 in the same period of 2019. Turning to our balance sheet, as of March 31, 2020, we had cash and cash equivalents of RMB264.4 million compared to RMB516.6 million as of December 31, 2019. The decrease was mainly due to higher short-term investments as of March 31, 2020, where the company invested RMB173.4 million in short-term investments compared with RMB11 million as of December 31, 2019. As mentioned earlier, given the evolving nature of the COVID-19 pandemic and the uncertainties surrounding the Bitcoin halving event, the company currently has very limited visibility on the potential impacts on our business and the markets in which we operate. As a result, the company will not issue a business outlook for the second quarter of 2020, since Canaan believes that it is not appropriate to provide a financial forecast that could be materially different due to the rapidly changing market and operational conditions. This concludes our prepared remarks for today. Operators, we are now ready to take questions. Thank you.

Operator, Operator

Thank you. We will now begin the question-and-answer session. The first question comes from Zheng Jialiang with HashKey Capital. Please go ahead.

Zheng Jialiang, Analyst

Thank you. Zheng Jialiang. Am I heard?

Shaoke Li, Board Secretary

Yes. We hear you clearly.

Zheng Jialiang, Analyst

My first question is about per Thash revenue. I think Thash revenue in the first quarter of 2020 has decreased from RMB160 million in the first quarter of last year to around 76 Thash per Renminbi. I understand there have been some reasons related to new product releases this quarter. I would like to know the details about how this occurred. Thank you.

Nangeng Zhang, Chairman and CEO

Okay. This is Nangeng Zhang. I’m here to translate Nangeng Zhang’s answers to your questions. We recognized that in December, the overall ADS price experienced a slight decline, and the market was not performing well, a trend that continued into January of this year. Despite these circumstances and market conditions, Canaan managed to generate sales, although there was a small impact on the unit price per Thash. Since February, we know that the COVID-19 outbreak had a significant effect on China, particularly as logistics and cash flow nearly came to a halt. Between February and March, we did witness some rises in BTC prices, but the impact of the COVID-19 outbreak was still substantial during this period. As a result, we observed a price drop; however, we are optimistic that in the upcoming months, especially in the last two quarters, we will introduce new products. We are confident that in the second half of the year, we will experience an increase in sales and a favorable unit price per Thash. Thank you.

Zheng Jialiang, Analyst

I would like to inquire about the second quarter since the company will not provide a business outlook for the upcoming quarter. What are your expectations regarding Canaan's revenue for the second quarter? Thank you.

Nangeng Zhang, Chairman and CEO

Okay. We know that in China, sales will begin around May 22, which is almost next week. Sales are occurring even after the recent halving. We are seeing a rise in inquiries and demand for our products, with more potential orders expected in the upcoming weeks. While our CFO cannot provide specific details today, I can share this positive news, and I am confident that we will see improved performance from Canaan in the second quarter. Thank you.

Zheng Jialiang, Analyst

My third question relates to the write-down of inventory and prepayment of about RMB329 million from the last fourth quarter. Will this quarter or next quarter show a write-back to your balance sheet? When can this repayment be written back, given that it relates to the same period last year?

Quanfu Hong, CFO

Please allow me to translate for Mr. Hong. Our annual report is very close to today’s call. The market hasn't changed much within this short timeframe. We will assess future market conditions and sales performance to determine if and when we might reverse that impairment. We believe that if sales improve, we will certainly take that step.

Unidentified Analyst, Analyst

I would like to know about the new product regarding Canaan’s 5-nanometer ASIC 9-nanometer power machine. Is there a concrete timeline for the new product? Thank you.

Nangeng Zhang, Chairman and CEO

Okay. This is Nangeng Zhang and I will take your questions. Regarding the new product, we have not stopped R&D even during the COVID-19 outbreak, but we believe that with 5-nanometers, which is a more advanced technology, it will take a longer time to reach mass production. We expect that this type of product will enter mass production next year. Currently, looking at our products, the power efficiency will be around 40 joules or lower; it will become a mainstream product. In the upcoming second semester, our stock will be around 42 joules high, which is the product we will introduce in that period. Additionally, we are exploring further new product developments in the second semester, aiming for mainstream products with power consumption below 30 joules. We are currently collaborating with all three foundries: SMIC, Samsung, and TSMC. Thank you.

Unidentified Analyst, Analyst

My next question is about how management views the market, particularly with the older generation of miners being replaced and the increasing demand for new generation miners due to the Bitcoin halving and the upcoming fall season. How do you evaluate the situation? Thank you.

Nangeng Zhang, Chairman and CEO

Okay. This is Nangeng Zhang. I’ll take the question. Regarding the older generation miners phasing out, on average, these miners consume around 100 watts. As a result, they are naturally unable to perform effectively. Considering the current environment with many deals coming in, and the halving that has already happened, we are seeing increased power demand. Therefore, there is strong market demand for miners, though they face competition from second-hand miners, which broadly affects the average unit sales price in the short term. However, I believe that long-term demand for new miners will continue to grow, and new miners should lead the mining industry. Thank you.

Unidentified Analyst, Analyst

I would like to know about the policy changes and certain provincial requirements in the mining industry. Do these policies have any impact on our miner sales? Thank you.

Nangeng Zhang, Chairman and CEO

Thank you. I’ll address the question. This is Nangeng Zhang. We are aware of recent government policies regarding miners. So far, we have not noticed any significant impact on the industry. However, we understand that hydroelectricity plays a vital role in mining provinces, particularly in China and Vietnam, specifically in Guizhou and Sichuan provinces. We have seen these governments releasing new policies encouraging hydroelectricity for mining operations. We are pleased to see this development and will continue to evaluate any new policies published in the coming days. Thank you.

Unidentified Analyst, Analyst

I would like to know about the new SaaS platform we launched in April, called Canaan Cloud. Can you explain the sales and marketing strategy for this solution? Additionally, what programs do you offer for clients? Thank you.

Nangeng Zhang, Chairman and CEO

We have noticed an increase in miner sales coming from key clients and Bitcoin participants, each with different demands. Premium service and strong solutions are becoming increasingly essential. This year, we began improving our software offerings by introducing a SaaS management system that caters to these changing needs. It's akin to Amazon Cloud. Canaan Cloud enables customers to request hash rates instead of requiring physical mining equipment. This innovation reduces the barrier to entry for our clients, allowing them to engage with the mining industry without the direct complexities of mining operations via our SaaS platform. Thank you.

Unidentified Analyst, Analyst

Thank you.

Operator, Operator

Thank you. And this concludes today's conference call. Thank you for attending today's presentation. You may now disconnect your lines.