Canaan Inc. (CAN) Q3 2020 Earnings Call Transcript

Canaan Inc. (NASDAQ: CAN) Q3 2020 conference call dated Nov. 30, 2020

Corporate Participants:

Shaoke Li — Secretary to the Board of Directors

Nangeng Zhang — Chairman of the Board and Chief Executive Officer

Analysts:

Zheng Jialiang — HashKey Capital — Analyst

Presentation:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to Canaan Inc.’s Third Quarter 2020 Earnings 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 this event is being recorded. Now — I’d now like to hand over the conference to your speaker host today, Mr. Shaoke Li, Board Secretary of the Company. Please go ahead, Mr. Li.

Shaoke Li — Secretary to the Board of Directors

Thank you very much. Hello, everyone, and welcome to Canaan Inc.’s third 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. Quanfu Hong. In addition, Mr. Jingjie Wu, our VP 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. Hong will then provide details on the Company’s operating and the financial results for the period before we open up — 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 most roughly explained and reconciled to the most comparable measures reported on the Generally 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 CEO, Mr. Nangeng Zhang. Mr. Zhang will deliver his remarks in Chinese and I will provide the corresponding English translations. Please go ahead, sir.

Nangeng Zhang — Chairman of the Board and Chief Executive Officer

Hello, everyone. [Foreign Speech] Hello, everyone. This is Nangeng Zhang, Chairman and CEO of Canaan Inc. I will now provide a brief overview of our progress in the third quarter of 2020. [Foreign Speech] Our total net revenue in the quarter decreased by 8.5% quarter-over-quarter to $24.01 million. In the second quarter, we focused on reducing our inventory and we had almost cleared out our inventory as of July. By the end of the second quarter, the demand for mining machines in the market had re-bounced [Phonetic], and as such, we continued to ramp up our production and tape-out the process in the third quarter. However, the waivers that were in the fabrication process during the third quarter will not be started to deliver until the fourth quarter of 2020. Consequently, these waivers did not make a significant revenue contribution to our third quarter results.

As of the beginning of the third quarter of 2020, the price of a Bitcoin maintained its upside momentum, reaching $12,400 in the period, and in fact, proceeding to [Phonetic] $19,000 during the fourth quarter of this year. As such, the blockchain market recovery trends continued to boost the demand for our products.

By the end of the third quarter, our advanced receipts totaled $11.14 million, representing an increase of $10.98 million from the end of the previous quarter. We also continued to increase our R&D investments during the third quarter, and our R&D expenses increased by 23.2% on a sequential basis to $4.73 million, further demonstrating our confidence in the long-term development of the Company.

[Foreign Speech] On the September 8, we announced the share repurchase program of up to $10 million worth of our shares outstanding. As of October 30, we had already bought back 1,225,000 shares, which represented a total transaction value of $2.43 million under the program and that continued to illustrate our confidence in Canaan’s long-term business prospects and the growth potential.

[Foreign Speech] On the mining machine front, we continued to leverage our leading R&D capabilities in the third quarter to launch our A12 product series. This new generation of product has achieved an energy efficiency ratio of 38 joule terahash, a total computing power of 90 terahash per machine and the lowest unit costs in the industry. By significantly improving the computing power and optimizing the energy efficiency ratio of our new products, we have successfully fueled the market demand for mining machines with high computing power and low energy consumption ratio. In 2021, we plan to launch new product series with energy consumption ratios that range from 30 joules per terahash to 40 joules per terahash. Looking ahead, we believe that the enhanced performance of our new products will continue to bolster our competitive advantages, especially in terms of cost management, which will serve — further extend our industry leadership. A number of factors impacted the product production capacity of the global IC industry in 2020. Nevertheless, we have remained committed to both our fabless model and the maintenance of our collaboration with multiple established IC manufacturers, enabling us to ensure the sufficient supply of IT products going forward to better meet customer needs.

[Foreign Speech] As I mentioned earlier, we received a large number of pre-sale orders in the third quarter. So far in the fourth quarter, our pre-sales volume has maintained its strong momentum, while our pre-sale deliveries have already been scheduled through the end of the first quarter of 2021. As of the end of this November, the aggregate value of total pre-sale order deliveries for both the fourth quarter of 2020 and the first quarter of 2021 had already exceeded $45 million.

[Foreign Speech] During the third quarter, we experienced the significant changes in our revenue’s geographic composition. In particular, revenue contributions from the Commonwealth of Independent States — state markets increased significantly during the period. Meanwhile, as a result of pandemic and other issues, revenue contributions from the U.S., which had previously been one of our major overseas markets dropped sharply in the third quarter. As of now, we expect the U.S. market to begin its gradual recovery in the second quarter of 2021. In terms of client demographics, we have continued to see the increasing dominance of specialized corporations in the Bitcoin mining market. In fact, more than 90% of our clients are large and medium-sized corporations that have made the purchase of more than 1,000 units. Over the last two quarters, we have also been active in addition of many new large and the medium-sized clients.

[Foreign Speech] Now, turning to our progress on the AI front. In 2020, we have accelerated the monetization of our AI business. Moreover, earlier in this year, we established a partnership with VergeSense, which is a U.S.-based workspace management service provider, specializing in sensor hardware and SaaS solutions. After establishing this partnership, we implemented our K210 chips in VergeSense new generation of hardware sensors, which helped to better ensure the proper execution of social distancing practices in response to the outbreak of COVID-19. In fact, we received orders for more than 4,000 of our AI chips, the delivery of which will represent our first international delivery of AI chips for the U.S. market.

[Foreign Speech] Currently, so our partnership with both UBTECH Robotics and DJI technology, we are leveraging our K210 chips visual processing capabilities to provide AI-powered online education solutions. For example, these solutions were utilized to develop unmanned vehicles, which students then used to participate in programing competitions. We have already launched this product jointly developed with UBTECH and we plan for our product jointly developed with DJI to enter the market in 2021. We are confident that these products will have strong competitive edge in terms of both power consumption and the production costs.

[Foreign Speech] At the same time, we are actively involved in smart city projects. So our collaboration with [Indecipherable] IoT technology and its smart door lock project, for example, we have won a number of tender processes for government contracts of smart door locks. Additionally, so our partnership with Hangzhou [Phonetic] smart city, we have successfully integrated our K210 chips as well as the successor products of our K210 chips into the smart city operations of Beijing, Haidian district.

[Foreign Speech] Currently, our monthly shipment of AI chips has remained stable at around 20,000 to 30,000 chips per month. In the coming year, as we maintain this momentum, we expect our monthly AI chip shipments to stabilize to more than 50,000 per month.

[Foreign Speech] Beyond our K210 chips, we have also completed the tape-out process of our K510 series, and we expected to launch this highly anticipated series in the first quarter of 2021. As an innovation AI-specific processor-based on the KPU, the K510 chip utilized our brand new and independently developed GU [Phonetic] structure. In light of these advances, the K510 will ultimately have a more logical configuration, consume less power, and have more peripherals and be both more scalable and more capable of fulfilling the real needs of the market. We see the K510 as both a replacement of our previous generation of AI chips and the ticket through which we will enter into new market. With its low production costs and industry-leading performance, the K510 is capable of powering product with the potential to disrupt multiple markets such as high-end IPCs, smart home products, smart retail products, and smart security systems.

[Foreign Speech] In the past six months, we focused on monetizing and analyzing both market dynamics and market policies in domestic and international markets. Meanwhile, we also continued to accumulate industry resources and experiences for the development of our new business initiatives. Looking ahead, we believe that we are fully prepared to develop our Bitcoin mining business and the whole digital currencies in a manner that in both legal and compliance. [Foreign Speech] In fact, we expect to fully establish our Bitcoin mining related business over the next six months. This will serve to further stabilize our supply chain as well as streamline our mining machine production. At the same time, this new business segment will also enable us to further improve our sales, enhance our inventory management, expand our profitability, and tape into the blockchain industry’s [Indecipherable] growth potential.

[Foreign Speech] Our mining machines are cornerstone of our post-IPO business growth strategy and we plan to use these machines to further propel our own market positioning beyond the role of hardware equipment manufacturers. By building a full-size blockchain ecosystem, we will be able to provide a complete convenient, efficient, and reliable one-stop solution for those investors who would like to participate in this industry’s growth.

[Foreign Speech] In the phase of global economic uncertainties, we will remain open and transparent. At the same time, we will continue to leverage our technology to improve the way people live and help to build a more efficient society. Thank you.

Shaoke Li — Secretary to the Board of Directors

This concludes the remarks of our CEO, Mr. Zhang. Now, on behalf of our CFO, Mr. Hong Quanfu, I will provide an overview of our third quarter financial results. Before I start, please note that all numbers are in RMB terms, unless otherwise noted.

Total computing power sold in the third quarter was 2.9 million terahash, representing a year-over-year decrease of 20.7% from 3.7 million terahash in the same period of 2019 and a quarter-over-quarter increase of 13.4% from 2.6 million terahash in the second quarter of 2020. The total net revenue decreased by 75.5% year-over-year and 8.5% quarter-over-quarter to RMB163 million from RMB670.6 million in the same period of 2019 and RMB178.1 million in the second quarter of 2020. Cost of revenues in the third quarter of 2020 was RMB180 million, compared to RMB524.4 million in the same period of 2019 and RMB134.8 million in the second quarter of 2020. The year-over-year decrease in cost of revenue was in line with the changes in Company’s sales volume of terahash and cost per terahash. The quarter-over-quarter increase was primarily due to the investor — inventories write-down of RMB44.9 million and the increase of sales volume. As a result, we reported a gross loss of RMB17 million in the third quarter of 2020, compared to a gross profit of RMB146.2 million in the same period of 2019 and gross profit of RMB43.3 million in the second quarter of 2020.

Research and development expenses in the third quarter of 2020 was RMB32.1 million, compared to RMB38.1 million in the same period of 2019 and RMB26.1 million in the second quarter of 2020. The quarter-over-quarter increase was mainly due to the increase in materials used in the third quarter of 2020 in order to better perform in the coming bull market. As a percentage of total net revenues, research and development expenses in the third quarter of 2020 was 19.7%, compared to 5.7% in the same period of 2019 and a 14.6% in the second quarter of 2020.

Let’s now take a look at our operating expenses in the third quarter. Selling and marketing expenses in the third quarter of 2020 decreased by 49.4% year-over-year and 51.2% quarter-over-quarter to RMB3.2 million from RMB6.3 million in the same period of 2019 and RMB6.5 million in the second quarter of 2020. The reductions were mainly driven by the decreased salaries of the staff in the Company’s sales and marketing departments. As a percentage of total net revenues, sales and marketing expenses in the third quarter of 2020 was 2%, compared to 0.9% in the same period of 2019 and 3.7% in the second quarter of 2020. General and administrative expenses in the third quarter of 2020 totaled RMB40.6 million, compared to RMB28.2 million in the same period of 2019 and RMB29.6 million in the second quarter of 2020. Consequently, our total operating expenses in the third quarter of 2020 was RMB75.9 million, compared to RMB72.7 million in the same period of 2019 and RMB62.2 million in the second quarter of 2020.

Loss from operations in the third quarter of 2020 was RMB92.9 million compared to income from operations of RMB73.5 million in the same period of 2019 and our loss from operations of RMB18.9 million in the second quarter of 2020. Excluding share-based compensation expenses of RMB1.6 million, non-GAAP loss from operations in the third quarter of 2020 was RMB91.2 million. Net loss attributable to ordinary shareholders in the third quarter of 2020 was RMB86.4 million compared to a net income of RMB94.6 million in the same period of 2019 and a net loss of RMB16.8 million in the second quarter of 2020. Non-GAAP adjusted net loss in this quarter of 2020, which excluded share-based compensation expenses was RMB84.8 million. Basic and diluted net loss per ADS in the third quarter of 2020 was both RMB0.55. In comparison, basic and diluted net earnings per ADS in the same period of 2019 were both RMB0.65. Basic and diluted net loss per ADS in the second quarter of 2020 was both RMB0.11.

Turning to our balance sheet. As of September 30, 2020, we had cash and cash equivalents of RMB177.4 million compared to RMB516.6 million as of December 31, 2019. The decrease was mainly due to the higher short-term investments as Company had invested RMB204.6 million in short-term investments as of September 30, 2020 compared with RMB11 million in short-term investments of December 31, 2019. The Company purchased short-term financial products to receive higher returns, but at the same time, can withdraw at any time.

This concludes our prepared remarks for today. Operator, we are now ready to take questions.

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from the line of Zheng Jialiang from HashKey Capital. Please ask your question.

Zheng Jialiang — HashKey Capital — Analyst

[Foreign Speech] I would translate it myself. So, thanks for Zhang, Hong, and also for management. And I’d like to raise a question regarding the new business that [Indecipherable]. I’d like to know that for the mining business, this is for the self-operating business or just a mining pool for external clients? Thank you.

Nangeng Zhang — Chairman of the Board and Chief Executive Officer

[Foreign Speech] All right. So, let me translate. Our new business is still focused on operating our own mining business — Bitcoin mining business. So we will — we’re planning to use our Bitcoin mining machines to hold Bitcoin currencies, and for the long term, we are — so this is how we are planning to develop our business. And for — in terms of the mining pool, we’re still doing that through partnerships and we are not currently planning to operate our own mining pool, given its compliance problems and — but we will still keep monitoring that.

Zheng Jialiang — HashKey Capital — Analyst

[Foreign Speech] So my second question is how long does [Technical Issues] tariff on this new business and where this business will be going to expand? Thank you.

Nangeng Zhang — Chairman of the Board and Chief Executive Officer

[Foreign Speech] So we have actually been preparing for the business for quite a while and we’re actually finishing off the preparation process. Currently, we are looking at either late first quarter 2021 or early second quarter 2021. So — and the — in terms of location, we’re looking at the overseas market and currently we are preparing in Asia and the Europe as well as the North American market.

Zheng Jialiang — HashKey Capital — Analyst

[Foreign Speech] So my third question regarding how many resources that the Company will be I think invest into the — in the business, including how much the [Indecipherable] and also how much capital will be allocated for this? And also like to know what’s the size of the mining farm? Thank you.

Nangeng Zhang — Chairman of the Board and Chief Executive Officer

[Foreign Speech] So, in terms of our investments in new business, we’re actually adopting a more prudent approach. The — so when we develop, we’re looking at investments in locations and operations and human resources. So we’re leaning towards partnering with local partners and investing in certain local resources. So we’re not building facilities in local markets at the moment.

[Foreign Speech] So to elaborate on the investments or on the cash investments, we are actually — we’re going to leverage our partnerships, and so the — both in terms of equity investments or just investments in local resources, and in fact, we actually think the cash investment is going to be a small portion compared to our investments in mining machines. So, actually the mining machines will be a major part of our investment in our cash.

[Foreign Speech] So for the — for our mining business, the scale of our mining business is going to depend on the market dynamics. And so, if the market is fluctuating, we are going to focus on running — or expanding our mining business, so we would — we will be in a better place to streamline our supply chain and the production of our mining machines.

[Foreign Speech] Okay. So for the actual scale of our mining business, we are expecting between 10% to 20% of our mining machines to be used in the mining business. When the market is looking good and when it’s fluctuating, we are going to increase that presentation.

Zheng Jialiang — HashKey Capital — Analyst

Okay, thank you. [Foreign Speech] Sorry, I’ll translate myself. So my thinking is that our product will be prioritized our clients first and also when the market is in fluctuation period, our suppliers’ mining machines will be divided into our own mining farms, right?

Nangeng Zhang — Chairman of the Board and Chief Executive Officer

[Foreign Speech] Yeah. So when we’re — our sales are performing well, we only expect 10% to 20% [Phonetic] of our mining machines to go our mining business. But when the market isn’t doing so great, that’s going to be — we’re going to increase that.

Zheng Jialiang — HashKey Capital — Analyst

[Foreign Speech] So my following question is regarding the supply chain that we all know that industry [Indecipherable] supply for mining machine factory this period. But we know that our orders have been pushed into the next first quarter and those actually — we see that this is a common trend for the whole mining machine industry. So what is [Phonetic] management projections and what is [Phonetic] supply situation? Also, how this situation will be — affect our Canaan’s productive [Indecipherable]?

Nangeng Zhang — Chairman of the Board and Chief Executive Officer

[Foreign Speech] So to summarize our supply chain process, so for the first half of 2020, our production has actually been under pressure, mostly because issues in global trade, and for the first half of the year, Bitcoin — the Bitcoin is — actually the market — whole market isn’t very healthy and the inventory is pretty low.

[Foreign Speech] So, in the second half of the year, the market demand for semiconductors actually rebounded and Bitcoin price increased as well. So — but for the second half of the year, we still have problems in the production, which we actually saw coming in the first half of the year, which is why we’re going to be committed to upholding our strategy of partnering with more than one manufacturers.

[Foreign Speech] So, currently, for the first half of 2021, our production is still going to ramp up, and as we mentioned earlier, our pre-order — pre-sale orders are already scheduled for the second quarter of next year but that’s more because of the increasing market demand.

[Foreign Speech] Okay. So, one of the problems that we see, firstly, the — so currently, our — the production process for our machines is picking 90 to 120 base. So — but we’re ramping up the production and we expect to — our production capabilities to have to produce over, well, several thousands — several tens of thousands mining machines next year.

[Foreign Speech] And also, now we have the — we operate our own Bitcoin mining business, which will enable us to streamline our supply chain process given when the market is under — is facing turbulence and we should be able to just build our inventory regardless.

Zheng Jialiang — HashKey Capital — Analyst

All right. Thanks for your answers.

Operator

Thank you. I will now hand the conference back to the management team for their closing remarks.

Shaoke Li — Secretary to the Board of Directors

All right. Thank you all for joining us today and we look forward to talking to you guys next quarter.

Operator

[Operator Closing Remarks]