Canaan Inc. (NASDAQ:CAN) Q2 2020 Results Earnings Conference Call August 31, 2020 8:00 AM ET

Company Participants

Shaoke Li - Board Secretary
Nangeng Zhang - Chief Executive Officer
Quanfu Hong - Chief Financial Officer

Conference Call Participants

Operator

Ladies and gentlemen, thank you for standing by and welcome to Canaan Incorporated Second 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 Q&A session. Please note that this event is being recorded.

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

Thank you very much and hello everyone. Welcome to Cannan Inc. second 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 and Mr. Wenjun Zhang [ph] 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 the CEO, Mr. Nangeng Zhang. Mr. Zhang will deliver his remarks in Chinese and I will provide with corresponding English translation. Please go ahead, sir.

Nangeng Zhang

[Foreign Language] 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 Language] During the quarter Bitcoins price volatility declined in comparison to the first quarter as a result of the Bitcoin halving event 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 Language] 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 in the number of Bitcoin mining machines sold during the quarter.

In addition, we also improved our profitability as we grow our gross profit 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 Language] This strong performance was a testimony to our ability to rejuvenate our business and 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 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 2021. These pre-orders will result in significant increase in customer advances and prepaid expenses in the third quarter. We are encouraged by the strong market demand.

[Foreign Language] Meanwhile, we further strengthened our research and development capabilities to ensure that our products maintain the position at the cutting-edge of technology for 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 [ph]. 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 Language] In addition, during the second quarter we completed the tape-out [ph] process for the SMIC first generation N+1 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+1chip 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 Language] Before 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 [ph] Group Limited and AMEC. Furthermore, we are currently in the process of tendering several international Bitcoin mining firms, each of which involves more than ten thousand 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 Language] As the price of the Bitcoin stabilized in the post-halving period, the market demand for high quality mining machines is nobly [ph] 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 customer's orders and drive our business expansion going forward.

[Foreign Language] 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 outbreak 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 governments agents, businesses and individuals.

[Foreign Language] 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 [indiscernible] the pandemic, mass production for this new generation of motion sensors began in July.

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

[Foreign Language] 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 [indiscernible] to stabilize clearly intuition information have began production testing.

[Foreign Language] 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 Language] 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 IT industry, but also in global markets 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 Language] 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 in the Bitcoin having event in the second quarter of 2020, both of which led to decreases in our total computing power sold and our average selling price per Thash [ph] 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 quarter-over-quarter increase in the cost of revenues were in line with the change in both our Thash [ph] sales volume and cost per Thash.

Gross profit in the second quarter of 2020 increased to RMB43.3 million, representing an increase of by 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 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 reductions of R&D expenses were 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 marketing departments. As a percentage of total net revenues, selling and marketing expenses in the second quarter of 2020 was 3.7% compared to 2.3% 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 of 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, out 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 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 RMB60.8 [ph] 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 decrease was mainly due to higher short-term investments.

As of June 30, 2020, we had invested RMB347.6 million in short term investments compared to RMB11 million 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 today. Operator, we are now ready to take questions.

Question-and-Answer Session

Operator

Thank you so much. [Operator Instructions] And our first question comes from the line of [indiscernible] from Charles Investments. Your line is now open.

Unidentified Analyst

Yes. Thank you very much. I apologize I don't speak Chinese. So I have that - the question in English. Can you make any comments on deposits made by customers for orders for your mining equipment?

Nangeng Zhang

[Foreign Language] Okay. Our existing customer orders are mainly from the A10 series product, and this is part of because the A10 product was more mature. And in the second quarter our sales are mostly - are selling based on - selling on our inventory. And starting from the third quarter, our inventory was completely sold. So the new orders - are now - future orders are booking - our future new series of products.

This is fairly a common practice in our industry, and especially for big orders they normally - you'd 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, it's because of the processing and manufacturing of the foundry takes a longer time. Recently our number of orders are increasing because our new product series has better performance and better price - cost efficiency.

Unidentified Analyst

Okay, thank you.

Operator

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

Unidentified Analyst

Thank you. Yes. My question is to the CFO, what international accounting standards does the company worked with on tools [ph] lease?

Quanfu Hong

[Foreign Language] Hi. Our accounting principle is full [ph] on the US GAAP standard.

Unidentified Analyst

Okay. Thank you.

Quanfu Hong

Thank you.

Operator

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

Shaoke Li

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

Operator

And that concludes the conference for today. Thank you for participating. You may all now disconnect.