Canaan Inc. (CAN) Q2 2020 Earnings Call Transcript

Canaan Inc. (NASDAQ: CAN) Q2 2020 earnings call dated Aug. 31, 2020

Corporate Participants:

Shaoke Li — Secretary to the Board of Directors

Nangeng Zhang — Chairman of the Board and Chief Executive Officer

Quanfu Hong — Vice President of Finance

Presentation:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to Canaan Incorporated Second Quarter 2020 Earnings Call. [Operator Instructions] After the management’s prepared remarks, we will have a Q&A session. [Operator Instructions]

Now, I’d like to hand the conference over to your speaker for today Mr. Shaoke Li, Board Secretary of the Company. Please go ahead, sir.

Shaoke Li — Secretary to the Board of Directors

Thank you very much, and hello, everyone. Welcome to Canaan Inc. second quarter 2020 earnings conference call. The company’s financial and operational 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 and Mr. Wenjun Zhang, [Phonetic] our Executive Assistant will also be available during the question-and-answer session. Mr. Zhang will start with the call by providing an overview of the company and the performance highlights for the second quarter of 2020. Mr. Hong will then provide the details on the company’s operating and the 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 well — as we will be making forward-looking statements. Please also note that we will discuss non-GAAP measures today, which are mostly roughly explained and reconciled 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 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

[Foreign Speech] Hello, everyone. This is Nangeng Zhang, Chairman and the CEO of Canaan Inc. I will now provide a brief overview of our progress in second quarter of 2020.

[Foreign Speech] During the quarter, Bitcoins price volatility declined in comparison to the first quarter, as a result of the Bitcoin halving events in May 2020. As Bitcoins price began to recover in the post halving period during the second quarter, we recorded a meaningful improvements on a sequential basis in our financial and operating performances.

[Foreign Speech] Most notably, our total net revenues increased by 160.8% quarter-over-quarter to RMB178.1 million, driven by a 198.5% sequential increase in our total computing power sold and a 153.5% sequential increase as a number of Bitcoin mining machines sold during the quarter. In addition, we also improved our profitability as we grow our gross profit of — to RMB43.3 million in the second quarter from RMB2.4 million in the prior quarter while significantly narrowing our net loss to RMB16.8 million in the second quarter from RMB39.9 million in the prior quarter.

[Foreign Speech] This strong performance was a testimony to our ability to rejuvenate our business and the financial growth as Bitcoin prices stabilized in the post halving period. Additionally, China’s raining season brought an excess of hydropower in the second quarter, making electricity cheaper and the mining more profitable. As a result, the welcoming environment for Bitcoin and the Blockchain has accelerated with a rebound of market demand for mining machines.

In fact, during the second quarter, we came close to clearing out our entire inventory and our Bitcoin mining machines that are now currently under production in the third quarter have all been pre-ordered. To-date, we have already started accepting pre-orders for mining machine deliveries in the fourth quarter of 2020 and early [Indecipherable] 2021. These pre-orders will result in significant increases in customer advances and prepaid expenses in the third quarter. We are encouraged by the strong market demand.

[Foreign Speech] Meanwhile, we further strengthened our research and the development of capabilities to ensure that our products maintain the position at the cutting edge of technological innovation after mass production — after mass producing the first generation of the Samsung 8-nanometer chip in the first quarter. We completed the R&D process for the second-generation of the same chip in the second quarter. During our tests, the second-generation chip has displayed a 20% overall improvement in comparison to its predecessors [Phonetic]. We are planning to utilize the new generation of the Samsung 8-nanometer chip to begin our mass production of new Bitcoin mining machines on early September.

[Foreign Speech] In addition, during the second quarter, we completed the tape-out [Phonetic] process for the SMIC first-generation N+1 [Phonetic] chip which was one of the first N+1 chips to have a successful tape-out at SMIC. In late August, we have already received the N+1 chips from SMIC and its performance during the test has exceeded our expectations. Currently, we are expecting to start delivering mining machines with the N+1 chip in the middle of the fourth quarter.

[Foreign Speech] While, refining our product offerings, we also remain committed to the expansion of our overseas customer base. In Kazakhstan, for example, we have secured multiple large-scale purchase orders from local mining companies such as A2 [Phonetic] Group Limited and AMEC. Furthermore, we are currently in the process of tendering several international Bitcoin mining firms, each of which involves more than 10,000 machines. As of now, we are optimistic about our ability to secure these projects and we will continue to keep the market updated to our — on our progress.

[Foreign Speech] As the price of the Bitcoin stabilized in the post halving period, the market demand for higher quality mining machines is notable [Phonetic]. However, the global capacity for wafer fabrication and the dispersion has been impacted by a series of factors, such as a COVID-19 pandemic and geopolitical issues. To ensure that we can continue delivering our products to customers in the coming markets. We have made sure to place a sufficient number of orders with our production partners. Nonetheless, as a result of our efforts to diversify our supply sources since 2019, we are well prepared to fulfill our customers’ orders and drive our business expansion going forward.

[Foreign Speech] In terms of our AI products, we remain focused on expanding our AI partnership and accelerating the monetization of our AI products during the second quarter, as COVID-19 of which is gradually brought out under control in China, we believe that the social distancing practice people have developed during the epidemic will help to accelerate the digitization process for government agents, businesses and the individuals.

[Foreign Speech] In line with this strategic focus, we partnered with VergeSense, a US-based workplace management service provider, specializing in sensor hardware and SaaS solutions. Through this partnership, our K210 chips will be implemented in VergeSense new generation of motion sensors developed to analyze safe, social, distances and the pandemic. Mass production for this new generation of motion sensors began in July.

[Foreign Speech] On the previous earnings call, we mentioned that we had developed an intelligent door lock system capable of running facial recognition on people wearing masks. This system is now available in the markets and the system orders are ramping up.

[Foreign Speech] In addition, during the second quarter DJI Technology selected our K210 chips for one of its STEM education project. This product was launched in July and we expect it to start implementing our chips into DJI Technologies product in late 2020 or early 2021. Moreover, our AI products jointly developed with both the leading STEM learning solution provider, UBTECH and the leading developer of [Indecipherable] stabilize clearly intuition information have began production testing.

[Foreign Speech] We are also working around the clock to develop our next generation AI chip, the K510. The new chip has already received a large number of customer requests for testing and we expect to start mass production before the first quarter of 2021. At the same time, we have maintained our commitment to integrating our AI products into our open source community. Our strategic goal is to build an open source AI application platform.

[Foreign Speech] Recently, we also announced the changes to our organizational structure and the Board of Directors. The new additions to our executive team will help to ensure that we have an in-depth understanding of the future trends in the high-tech industry. Additionally, these executive change have also helped to ensure that our management team has extensive experience not only in the IC industry, but also in global market strategic planning at the corporate governance. We firmly believe that effective corporate governance, will enable us to generate the most value for both our company and our shareholders going forward.

[Foreign Speech] Although, the global economy is still facing uncertainties, we are confident that the technology transcends borders and the world becomes a vital tool for us to enhance society’s operational efficiencies and improve everyone’s way of life.

This concludes the remarks of our CEO, Mr. Zhang.

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

Total net revenue in the second quarter of 2020 decreased by 26.3% to RMB178.1 million, from RMB241.5 million in the same period of 2019. The year-over-year decline was primarily attributable to the outbreak of COVID-19 and as a Bitcoin halving event in the second quarter of 2020, both of which led to the decreases in our total computing power sold and our average selling price per terahash in the same period.

On a sequential basis, total net revenue grew by 160.9% from RMB68.3 million in the first quarter of 2020. Cost of revenue in the second quarter of 2020 was RMB133.8 million compared to RMB230.8 million in the same period of 2019 and RMB65.9 million in the first quarter of 2020. The year-over-year decrease and the quarter-over-quarter increase in the cost of revenues were in line with the change in both our terahash sales, sales volume and cost per terahash.

Gross profit in the second quarter of 2020 increased to RMB43.3 million, representing an increase of 302.5% from RMB10.8 million in the same period of 2019 and an increase of 1,711.5% from RMB2.4 million in the first quarter of 2020. Gross margin in the second quarter of 2020 expanded to 24.3% from 4.5% in the same period of 2019 and the 3.5% in the first quarter of 2020.

Research and development expenses in the second quarter of 2020 decreased to RMB26.1 million from RMB35.9 million in the same period of 2019, and RMB41.8 million in the first quarter of 2020. The reduction of R&D expenses was mainly due to the decrease in materials used for research and development purpose during the second quarter. As a percentage of total net revenues, R&D expenses in the second quarter of 2020 was 14.6% compared to 14.9% in the same period of 2019, and 61.2% in the first quarter of 2020.

Let’s now take a look at operating expenses in the second quarter. One, selling and marketing expenses in the second quarter of 2020 were RMB6.5 million compared to RMB5.6 million in the same period of 2019 and RMB4.1 million in the first quarter of 2020. The increase in selling and marketing expenses was mainly driven by higher salaries for our sales and the marketing department staff [Phonetic]. As a percentage of total net revenues, selling and marketing expenses in the second quarter of 2020 was 3.7% compared to 3.3% in the same period of 2019 and 6.1% in the first quarter of 2020.

Two, general and administrative expenses in the second quarter of 2020 were RMB29.6 million compared to RMB238.1 million in the same period of 2019, and RMB27.6 million in the first quarter for 2020. In the second quarter of 2019, a total of RMB213.1 million in share-based compensation allocated to general and administrative expenses, was caused by the excess of appraised fair value over the transfer price of ordinary shares transferred from the existing shareholders to other existing shareholders who were also employees.

Consequently, our total operating expenses in the second quarter of 2020 decreased to RMB60.4 million from RMB279.7 million in the same period of 2019 and RMB73.5 million in the first quarter of 2020. Loss from operations in the second quarter of 2020 decreased to RMB18.9 million from RMB268.9 million in the same period of 2019 and RMB71.1 million in the first quarter of 2020. Excluding share-based compensation expenses of RMB0.7 million, non-GAAP loss from operations in the second quarter of 2020 was RMB80.2 [Phonetic] million.

Net loss attributable to ordinary shareholders in the second quarter of 2020 decreased to RMB16.8 million from RMB263.1 million in the same period of 2019 and RMB39.9 million in the first quarter of 2020. Non-GAAP adjusted net loss in the second quarter of 2020, which excluded share-based compensation expenses was RMB16.8 million. Diluted net loss per ADS in the second quarter of 2020 was RMB0.11 compared to RMB1.88 in the same period of 2019 and RMB0.25 in the first quarter of 2020.

Turning to our balance sheet. As of June 30, 2020, we had cash and cash equivalents of RMB157 million compared to RMB516.6 million as of December 31, 2019. The decreases was mainly due to the higher short-term investments. As of June 30, 2020, we had invested RMB347.6 million in short-term investments compared to RMB11 million in the short — in short-term investments as of December 31, 2019. We purchased the short-term financial products to receive higher returns, but no withdraw restrictions.

So this concludes our prepared remarks for the — for today. Operator, we are now ready to take questions.

Questions and Answers:

Operator

Thank you so much. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] And our first question comes from the line of [Indecipherable] from Charles [Phonetic] Investments. Your line is now open.

Unidentified Participant — — Analyst

Yes. Thank you very much. I apologize. I don’t speak Chinese. So I have to ask the question in English. Is there, — can you make any comments on deposits made by customers for orders, for your mining equipment?

Nangeng Zhang — Chairman of the Board and Chief Executive Officer

[Foreign Speech] Okay. Our existing customer orders are mainly from the A10 series product and this is part of because the A10 product was more matured. And in the second quarter, our sales are mostly — our selling — based on selling on our inventory. And starting from the third quarter, our inventory was completely, [Phonetic] so the new orders are now future orders are booking that — our future new series of products. This is fairly a common practice in our industry, and especially for big orders they normally you have to wait for a certain period.

Now that our expected delivery time is between the third quarter, this year and first quarter next year. The delivery time, it’s bit longer is because of the processing and manufacturing of the foundry, it takes a longer time. Recently, our per quarter — number of orders are increasing, because of our new product series has better performance and better price cost efficiency.

Unidentified Participant — — Analyst

Okay. Thank you.

Operator

Thank you so much. [Operator Instructions] And your next question comes from the line of Michael Parker from TDF [Indecipherable] Limited. Michael, your line is now open.

Unidentified Participant — — Analyst

Thank you. Yes. My question is to the CFO. What international accounting standards, does the company worked within tools, [Phonetic] please?

Quanfu Hong — Vice President of Finance

[Foreign Speech] Hi. Our accounting principle is following the US GAAP standard.

Unidentified Participant — — Analyst

Okay. Thank you.

Shaoke Li — Secretary to the Board of Directors

Thank you.

Quanfu Hong — Vice President of Finance

Okay. Thank you.

Operator

Thank you so much. There were no further questions at this time. I hand back over to the management for closing remarks.

Shaoke Li — Secretary to the Board of Directors

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

Operator

[Operator Closing Remarks]