Canaan Inc. (NASDAQ:CAN) Q1 2020 Earnings Conference Call May 22, 2020 8:00 AM ET

Company Participants

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

Conference Call Participants

Zheng Jialiang – HashKey Capital

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

Thank you very much and hello everyone and welcome to Cannan 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 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 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 corresponding English translation. Please go ahead, sir.

Nangeng Zhang

[Foreign Language] Hello. I am Nangeng Zhang, Chairman and CEO of Canaan Inc. Please allow me to provide a brief overview of the company in the first quarter of this year. This call is just a month away from the last, but Bitcoin halving just happened on May 12th from the general market perspective after having the Bitcoin prices steady and rising. We haven't seen computing power volatility. The Bitcoin network is running stable. In general, to serve the halving in Bitcoin history has successfully completed.

Upon completion, the coming rainy season further rebalanced as a market demand of mining machines. In Q1 this year affected by the COVID-19, our total net revenue was RMB68.3 million reflects a 44.6% year-on-year increase. The company's total net revenue growth aligns with the computing power sales. The company's total sales grew from 700,000 terahash per second to 900,000 terahash per second in Q1 2020, represents 18.4% year-on-year increase and there was an increase to ASP. The company's first quarter gross profit was RMB2.38 million while operating loss was RMB71.1, which mainly includes RMB41.8 million R&D expense representing a 33% year-on-year increase. The drop of our gross profit margin is due to Q1 market conditions, including the influence of low Bitcoin price and the halving was about to come.

We have performed a series of retirements in management procedures and the product upgrades. We expect a sound increase in gross profit margin during the next coming windows to some market recovery. On behalf of the team, I would like to sincerely thank all of the medical and the community workers, who continuously fight on the front line against the COVID-19 to protect the safety of general public and the operation of the society. We are grateful to our safe working environment.

[Foreign Language] In terms of mining business, we started a mass production and shipments based on the Samsung 8-nanometer chip in Q1 this year. We had manufactured a several tens of thousands of such units. The 14-nanometer process based on miner developed with SMIC will begin mass production in Q2. Meanwhile, next-generation process development with Samsung and SMIC is ongoing. Also 5-nanometer process ASICs with TSMC are in progress and accelerating.

We continuously optimize the universality of hardware and the software design in our mining business. We believe the platform design of mining machines can reduce costs, shorten design cycles and they simplify customer development and maintenance. Avalon 1066 Pro is our first serialized product under such concept that which currently available to our clients. The Avalon 1146 Pro will be made available soon after.

To improve competitiveness in real-world operation, we are about to launch immersion cooling mining, the further improved thermal performance and reduced noise level, leading to improve the energy efficiency for longer miner lifecycle and increased fabrication scenarios. We further provide our customers SaaS platform to lower energy barrier and free our clients for maintenance work. It is always our relentless pursuit to provide the product of extreme performance, reliability, practicality and the accessibility.

As COVID-19 impact the issue individuals and the institutional investors, especially Wall Street investors are entering Bitcoin trading, mining market, that is seen in media reports that legendary trader, Paul Tudor Jones entering Bitcoin’s futures markets, Galaxy Digital’s positive attitude and the active participation and et cetera.

We also see more and more big players interesting in our product and the services. Market confidence is recovering. Furthermore, the May to October is raining season and that brings cheap hydroelectricity. That would pressure the price of thermal power, resulting in overall cost of reduction of mining. Both increased the trading and the cost of reduction should create a demand for miners and are favorable to payment.

[Foreign Language] We are also pleased to report that our AI chip K210 has received the hardware specialist certificate by Foresters IC chip industry report in Q2 2020 acknowledging its solid performance, low power consumption, suitable for various application scenarios and easy accessibility. In April, K210 support was added to Linux 5.7 kernel so that more developers can use a mainstream operating system to design with our AI chip for more applications, even beyond our design scope.

Furthermore, Linux provides a much standard development environment to reduce time-to-market and the user’s learning curve. For example, only two days after our announcement, our world’s largest technology community, GitHub, a team of three RISC-V developers has shared the support to K210 in Rust language. We improved the synergy between algorithm, hardware setup and the software design. We developed this with smart gate control further incorporated the mask detection, mask of the face recognition, and the liveness detection mode.

Our product satisfied many application scenarios at the banks, schools, communities and commercial and industrial parks and have received many customer inquiries. The positive feedback is a good starting point of our AI business, where I committed to open-source of K210. We find that the product menu and the open-source tool chain and attracting domestic and the foreign developers to build in active and the skillful developer community.

[Foreign Language] In corporate management, we have optimized the management procedures. We find the governance system and the organization structure linked to corporate culture. It was performance review in order to ensure product quality, control risks and the optimized capital allocation to benefit our shareholders on every front. With an average age of 32, and the work experience of eight years, our R&D team is passionate and experienced. Our management team has extensive experience in R&D corporate governance and a strategic planning in the IT industry, as well in international business execution. These are our core assets for future growth.

Super computing is what we do. Social enrichment is why we do it. Despite the growing macro economic uncertainty, we have maintained the strong growth momentum. So technological and the product innovation, we are to deliver better futures to everyone. Thank you.

Shaoke Li

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 super computing solutions, we remain committed to continuously enhancing our technology and refining our product offerings in the quarter. Consequently, our research and the 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 was 61.2%.

Let’s now take a look at our operating expenses in the first quarter. Sales and the 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 of company’s sales and the marketing department. As a percentage of total net revenues, S&M expenses in the first quarter of 2020 was 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, the increase was mainly due to higher issuance fee in the first quarter of 2020. Total operating expenses in the first quarter of 2020 was 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 a 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 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 only as a business and as a market in which it operates. 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 the financial forecast that could be materially different due to the rapidly changing market and the operational conditions.

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

Question-and-Answer Session

Operator

Yes. Thank you. We will now begin the question-and-answer session. [Operator Instructions] And the first question comes from Zheng Jialiang with HashKey Capital. Please go ahead.

Zheng Jialiang

Thank you. Zheng Jialiang. Am I heard?

Shaoke Li

Yes. We hear clearly.

Zheng Jialiang

[Foreign Language] So I’ll translate it myself. My first question is regarding per Thash revenue. I think the Thash revenue in the first quarter of 2020 has been dropped from the RMB160 million from the first quarter in the last year to I think 76 Thash per Renminbi. I know there’s some reason for new products to be reaching in this quarter. So I would like to know details regarding how this happened? Thank you.

Nangeng Zhang

[Foreign Language] Okay. This is Nangeng Zhang. I’m trying to translate Nangeng Zhang’s answers towards your questions. In fact, we understand in the last December, the overall ADS price is seeing a little bit dropping and the overall market is not performing so well. And it has been observed and the extension also in January of this year. That’s still under such kind of circumstances and also market situation. Canaan was able to do sales. Of course, the sales would see a small impact on the unit price per Thash.

Since February this year, we all understand that the outbreak of COVID-19 and which heavily impacted, significantly in China during that period, especially the logistic and cash rotations almost stopped. Between February and March, we see some BTC price rising, increasing, but still the COVID-19 outbreak, which is heavily impacted during this period. So we still see how our price dropping weaker, but we have confidence that in that coming months, especially in the quarter, in the last two quarters, the quarter three and quarter four, will have new products. And we are sure that in the second semester we’ll have a sales increase and also a very good unit price per Thash. Thank you.

Zheng Jialiang

[Foreign Language] I would like to ask about the second quarter as the company will not issue business outlook for the next quarter. So [indiscernible] on the second quarter revenue of Canaan? Thank you.

Nangeng Zhang

[Foreign Language] Okay. We know that in the Chinese selling will start from May 22, normally. It’s almost the next week sometime. And the sales is coming even after the halving happened last – happened a few days ago. We see many inquiries and demand on the – on our products, more and more – more and more demand and inquiries in the coming – in those weeks. After – even after the halving, we see more and more inquiries and would be in large, the amount is in large, order – potential order inquiries. And these informations honestly cannot be precisely quoted today in our CFO’s statement, but I'm sure I can disclose this good news and also I'm sure that in the second quarter we will see much better performance from Canaan. Thank you.

Zheng Jialiang

[Foreign Language] My third question regarding the [indiscernible] remember that in the last fourth quarter coming as a write-down of inventory and prepayment about RMB329 million, so that’s in this quarter or may be in next quarter we’ll be write-back to your balance sheet or when can be – this repayment will be write back, given that [indiscernible] from the last year same period?

Quanfu Hong

[Foreign Language] Please allow me to translate for Mr. Hong. Our annual report is very close to today’s call. So the market hasn't changed much within this short-time window. We will see future market conditions and sales conditions and decide whether and when we are going to write back that impairment. We believe if sales goes better we will surely do that.

Unidentified Analyst

[Foreign Language] I would like to know that the new product regarding Canaan’s [indiscernible] 5-nanometers ASIC 9-nanometer power machine. I would like to know that is there any concrete timeline for the new product? Thank you.

Nangeng Zhang

[Foreign Language] Okay. This is Nangeng Zhang and I will take your questions. Regarding the new product, yes we – in fact, we haven't stopped ourselves in quarter one, quarter two on R&D even within the COVID-19 outbreak, but we believe with 5-nanometers, which is a more advanced technology, which takes longer cycle to be mass products. So we believe in next year probably this kind of product will be involved in the mass production.

And today if you're looking at our products, the power efficiency will be around 40 joules or below 40 joules, it will be a mainstream product. In coming second semesters, our stock price will be [indiscernible], which is about 42 joules high and this is the product that we will have in the second semester. And if we are looking at further more new product developments in the second semester, we will have mainstream products all those still below 30 joules in terms of power consumptions. And we are working with today all the three foundries: SMIC, Samsung and TSMC as well. Thank you.

Unidentified Analyst

[Foreign Language] So my next question also I would like to know how the management like to see the markets going to especially on miners generation – especially new generation of miners come to market especially to situation based Bitcoin halving also the fall season at this point. So how do you see the old generation miners fall out of market and new generation miners demand in recent maybe just half years? Thank you.

Nangeng Zhang

[Foreign Language] Okay. Steve, this is Nangeng Zhang. And I'll take the question. Regarding the old generation miners, which will be to go out of the market, those miners are in average, we have power consumption around 100 watts. So these are natural – these miners are actually unable to perform. And looking at the current situation with many deals coming and also having – has happened already.

We started to receive a huge power demand. So in the market there is a strong demand for miners, but of course, they're locked into this pool of second-hand miners and they are competing on the price broadly. It worked in short-time effect, the new miners price, average unit sales price in the short-term. But I will see in the long-term, the demands from the market for new miners will come and the new miners should take the lead in the mining industries. Thank you.

Unidentified Analyst

[Foreign Language] I like to know about the policy changes and certain province requirement, the mining industry because it has any effect on our miner sales? Thank you.

Nangeng Zhang

[Foreign Language] Thank you. I’ll take the question. Steve, this is Nangeng Zhang. Well, you mentioned the government policies regarding miners. In fact, we have noticed the news today or yesterday regarding the mining industries but still it is a newly released news. We didn't see any impact so far in these industries. But of course, we know that the hydroelectricity supporting mining provinces mainly in China and Vietnam province, Guizhou province and Sichuan province.

And we've been seeing these governments are developing or releasing new policies, encouraging those hydroelectricity mining industries. By doing that we see in those provinces or areas, the mining are values more and more in a well managed ways. So we are happy to see this happening and still we are evaluating these kind of policies if we will see new policies coming or releasing these days. Thank you.

Unidentified Analyst

[Foreign Language] I'd like to know the new SaaS platform that we released this April, called Canaan Cloud. I'd like to know – you mentioned sales and marketing strategy comment of this SaaS solutions platform also like to know about the programs, also you mentioned, also clients mentioned? Thank you.

Nangeng Zhang

[Foreign Language] And we see the miner sales are more and more using key clients or Bitcoins. So demand or the requirements from the key clients are a little bit different, more and more we see best top service or current solution is becoming their new client. So from this year, we started to improve our software and adding to our software into a sort of platform SaaS management system to support these kind of needs or demand.

And in fact, it's like Amazon Cloud, Canaan Cloud, that the customers asking for hash rate not the product or mining itself. And finally they wanted hash rate not a mining itself. So this product in terms product itself is trying to giving a lower entry level to our customers to avoid that they involving their mining operations but still they can be benefited from those mining industries by using our SaaS platform. Thank you.

Unidentified Analyst

Thank you.

Operator

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