Canaan Inc. (NASDAQ:CAN) Q4 2020 Results Conference Call April 12, 2021 8:00 AM ET

Company Participants

Shaoke Li - Board Secretary

Nangeng Zhang - Chairman and CEO

Tong He - CFO

Conference Call Participants

Operator

Ladies and gentlemen, thank you for standing by, and welcome to Canaan Inc.’s Fourth Quarter and Full Year 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.

I would like to hand the conference over to your speaker today, Mr. Shaoke Li, Board Secretary of the Company. Please go ahead, Mr. Li.

Shaoke Li

Thank you very much. Hello, everyone, and welcome to our 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. Tong He. In addition, Mr. Xiaoming Lu, [Ph] our SVP, 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. He will then provide 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 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 more roughly explained and reconciled to the most comparable measures reported under Generally Accepted Accounting Principles in our earnings release and the filings with 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 corresponding English translation. Please go ahead, sir.

Nangeng Zhang

[Foreign Language]

Shaoke Li

Hello, everyone. This is Nangeng Zhang, Chairman and the CEO of Canaan Inc. I will now provide a brief overview of our progress in the fourth quarter and the full year of 2020.

During the fourth quarter, Bitcoin prices continued to rise, which helped to grow the market demand for mining machines. Our visionary approach has already enabled us to establish a presence in the market in previous quarters. In the fourth quarter, we further optimized the composition of our customer base and secured a large number of orders from our long-term partners, which helped to safeguard our abundant cash flows. As of December 31, 2020, our total contracted orders amounted to $174 million, with $66 million in advances from our customers, representing a sequential increase of $54 million from the third quarter of 2020.

We also successfully started our mass production and delivered the next-generation of A12 series mining machines in the period, and we have already begun delivering this new product service at a large scale in the fourth quarter of 2021.

During the fourth quarter, we further strengthened the core competencies of our mining machine business by expanding our operations in the market, investing in our R&D capabilities and refining our supply chain management. In addition, our increased investment in our AI chips business segment have enabled us to achieve meaningful progress in developing best-in-class AI chips and facilitating their commercial applications.

In particular, the total number of orders we received for our mining machines in 2020 reached 172,000 machines. In the second half of 2020, we were able to significantly grow the number of orders for our mining machines, reaching 92,000 machines in the fourth quarter alone. Among these orders, we continued to secure orders from prominent institutions, including the investment for Blue Energy Invest, [ph] which has ordered 13,000 machines and Octo Credit [ph] which has ordered 1,350 machines. In addition, we have also started collaborations with several well-regarded mining machine customers in Northern Europe.

As of the end of the first quarter of 2021, we have already recorded orders for more than 156,000 in mining machines with over $238 million in advances from our customers. These orders included 6,400 from highest blockchain technology, Canada listed a crypto miner and the 6,000 from Core Scientific, a leading U.S.-based crypto miner.

Meanwhile, in order to provide our global customer base with the best services possible, we have been building up our global customer service network and established our first international customer service center in Kazakhstan in the fourth quarter. Going forward, we plan to build additional customer service centers in North America and other regions, which will enable us to provide a timely and effective and after-sale service to our local customers around the world.

We have always prioritized our investments in product and R&D, and our total R&D investments reached $21 million in 2020. We have a team of seasoned engineers as well as complete designing flow. We continuously recruit talented people with competitive compensation scheme and working conditions.

We also continued to refine our supply chain during the quarter. Since starting to work closely with our new IC manufacturing partner, which we began more than one year ago, we have been continuously improving the yield of the chips, the power consumption and the computing performance of which have basically reached the expected level in the product test. In 2021, we will continue to develop several new generations of our chips.

In addition to advancing our core mining -- in our AI business segment, for example, the usage of AI chips grew significantly across both domestic and international markets in 2020. In fact, our numbers of AI chips delivered tripled on a year-over-year base in 2020. And we currently expect that our AI segment revenue will maintain its relatively high year-over-year growth rate in 2021.

Following our research, we have identified significant market opportunities for customer growth products with AI chips, in particular, the wide adoption of AI vision chips is currently creating a large addressable market. In fact, in 2020, the total production output of China’s smartphone sector has exceeded RMB 1 trillion and the potential market size is expected to be as high as RMB 5.8 trillion.

In light of these market opportunities, we have formed a three-tier product plan. First, we will prioritize the development of low-cost customer product solutions with customers -- with consumer chips. For the second tier, we have vision chips with medium computing power for smart homes, smart education and other applications. The third tier will be vision chips with high computing power for new retail, assisted driving, robotics and other applications.

For the roadmap of AI chips, we have analyzed a specific application, use cases and the corresponding market demand for computing power. As a result, we have designed multiple product lines.

We completed the tape-out process for the K510 series in the fourth quarter last year and finished the series chip back process in early March. The K510 series chips, which carry a variety of digital and analog IPs that we have developed over the past two years, are undergoing commissioning as partially customized chips for the mid to high-end AIoT market, the K510 series chips have already generated significantly high interest in the market and received several small preorders.

Currently, we expect to start the mass production of the K510 series in the second half of 2021. On the other hand, the K230 series under development is an upgraded version of our K210 series. Using customer feedback from the K210 series, we further optimized the K230 series computing power and the power consumption field. In addition, we also made this next-generation chip more flexible for developers and the refined to transport, laying the foundation for the K230 service to better support the needs of future enterprise development.

For the first half of 2021, we continue to expect that future contract sales for our mining machines will contribute around 70% to 80% of our total revenues. However, for the second half of the year, we will adjust such percentage based on the market situation and the production capacity.

Our current mining machine production capacity for the first half [Technical Difficulty] been fully presold through future contracts. As a result, starting from the second quarter of 2021, we plan to dedicate several thousand mining machines to our own vehicle mining business. These machines were primarily consisted of our A12 and A11 series miners for an additional combined computing power between 350 Thash to 450 Thash.

Starting from the second half of 2021, we plan to allocate no less than 10% of our total monthly production capacity of mining machines to our own Bitcoin mining business every month. The actual number of mining machines will be adjusted based on the development of our partners, mining farms, the price of a Bitcoin and our production capacities. In the case that there are no significant change to the price of a Bitcoin and our production capacity, we expect that the total consulting power dedicated to our Bitcoin mining business will reach between 2 EH to 4 EH by the end of the year.

2020 was an extremely important year for Canaan. We overcame external challenges such as COVID-19 pandemic, and there’s obstacles that are into place throughout our supply chain. We also continued to optimize our management structure while adding personnel and independent directors to our Board in order to further strengthen our corporate governance.

Finally, I would like to take this opportunity to thank all of our employees for your hard work as well as our business partners and investors for their ongoing trust and support during the challenging year.

In 2021, we will remain as committed as ever towards our mission of improving the efficiency of our society and the way of our life. Thank you.

Tong He

This concludes the remarks for our CEO, Mr. Zhang. I will provide an overview of our fourth quarter and full year financial results.

Before I start, please note that all numbers are in RMB terms unless otherwise noted. Total net revenue decreased to RMB 38.2 million from RMB 463.2 million in the same period of 2019 and RMB 163 million in the previous quarter. The decrease was due to a few factors. First, we started mass production of our new product series during the first quarter, which only began to ramp up in sales in the period. Meanwhile, we have almost sold out our inventory of our older production in the third quarter of 2020.

Cost of revenue decreased to RMB 29.2 million from RMB 1.14 billion in the same period of 2019, and RMB 180 million in the third quarter of 2020. The fluctuation in our cost of revenues was in line with the changes in our sales volume of Thash and cost per Thash.

As a result, we reported a gross revenue of RMB 9.1 million in fourth quarter of 2020 compared to the to a gross loss of RMB 673.4 million in the same period of 2019 and a gross loss of RMB 17 million in the previous quarter.

Research and development expenses were RMB 40.1 million compared to RMB 63.6 million in the same period of 2019 and RMB 32.1 million in previous quarter. The year-over-year reduction was mainly due to the changes in materials that we used for R&D purposes. The sequential increase was driven by the higher salary and welfare benefits for R&D personnel.

Let’s now take a look first at other operating expense in the fourth quarter.

First, selling and marketing expenses were RMB 6.1 million compared to RMB 7.7 million in the same period of 2019 and RMB 3.2 million in the previous quarter. The changes in our selling and marketing expense were primarily due to travel expenses and salary changes in our sales and marketing department.

Secondly, G&A expenses decreased to RMB 33.9 million from RMB 56.4 million in the same period of 2019, and decreased RMB 40.6 million in the previous quarter. The reduction was mainly driven by lower share-based compensation during the fourth quarter of 2020.

Consequently, our total operating expense in the fourth quarter of 2020 were RMB 80.1 million compared to RMB 127.7 million in the same period of 2019 and RMB 75.9 million in the previous quarter.

Loss from operations to RMB 71 million from RMB 801.2 million in the same period of 2019 and RMB 92.9 million in the previous third quarter.

Net loss attributable to ordinary shareholders was RMB 72 million compared to RMB 798.2 million in the same period of 2019 and RMB 86.4 million in the previous quarter.

Non-GAAP adjusted net loss, which excludes share-based compensation expense was RMB 73.1 million. In comparison, non-GAAP adjusted net loss was RMB 750.5 million in the same period of 2019 and RMB 84.8 million in the previous quarter.

Diluted net loss per ADS was RMB 0.46 compared to RMB 5.3 the same period of 2019 and RMB 0.55 in the previous quarter.

Now, turning to our results in full year of 2020. Total computing power sold in the full year of 2020 decreased by 37.1% to 6.6 million Thash/s from RMB 10.5 million Thash/s in 2019, as a result of increased relative [indiscernible] of Bitcoin price and our product, [ph] which is unclear of our older product series inventory during the first nine months of 2020. Consequently, total net value in 2020 decreased to RMB 447.7 billion from RMB 1.42 billion in 2019.

Cost of revenues in 2020 decreased by 78.9% to RMB 409.9 million from RMB 1.94 billion in 2019. As a result, our gross profit in 2020 was RMB 37.8 million compared to a gross loss of RMB 516 million in 2019.

Total operating expense in 2020 decreased by 45.8% to RMB 291.6 million from RMB 538.5 million in 2019.

Loss from operations in 2020 narrowed to RMB 253.9 million from RMB 1.05 billion in 2019.

Net loss attribute to ordinary shareholders into 2020 was RMB 215.1 million compared to RMB 1.03 billion in 2019.

On a non-GAAP basis, our adjusted net loss in 2019, which excluded share-based compensation of RMB 3 million was 212.1 million.

Net loss per ADS in 2020 was RMB 1.38 compared to RMB 7.21 in 2019.

Turning to our balance sheet. Contract liabilities as of December 31, 2020, increased to RMB 430.4 million from RMB 8.3 million as of December 31, 2019. The increase was driven by increased down payment for the sales order of our Bitcoin mining machine, which are scheduled for delivering in 2021 and beyond.

As of December 31, 2020, we had cash and cash equivalents of RMB 391.3 million compared to RMB 516.6 million as of December 31, 2019. The decrease was mainly due to higher short-term investments as we had invested RMB 62.4 million in short-term investments as of December 31, 2020, compared with RMB 11 million in short-term investments as of December 31, 2019. Notably, we purchased short-term financial products to receive higher returns and can withdraw at any time.

Looking forward, we are convinced our expense in 2020 will enable us to improve our financial performance significantly in 2021. As the price of Bitcoin started to resume its upward trajectory since the fourth quarter of 2020, consequently, we expect our total net revenue in first quarter of 2021 to exceed RMB 400 million. Please note that the forecast only reflects our current expectations and preliminary views on the market and operational conditions, which are subject to changes, particularly in regarding to the potential fluctuations in the price of Bitcoin as well as the impact of COVID-19 on the global economy. This concludes our prepared remarks for today.

Operator, we are now ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] We have the first question from the line of [indiscernible]. Please go ahead.

Unidentified Analyst

[Foreign Language]

My first question is about our new generation Bitcoin mining machine that CEO, Zhang mentioned. And I would like to know which foundry partner are we cooperating with and which technology node are we using? And any launch schedule for this new machine?

Nangeng Zhang

[Foreign Language]

Shaoke Li

Okay. Let me add a translation. So, we are one of the few in our industry to have multiple foundry partners. And we are actually working with them to -- for our new generation chips. And so, every year, we have roughly two to three product introductions, and this year will be no exception. We will evaluate our selection of foundry partners around variety of factors such as technology, the market as well as the capacity. So, the work is currently in progress. But at this point, we cannot really disclose any additional information on the schedule of launches.

Unidentified Analyst

[Foreign Language]

My second question is about our capacity. We know that current capacity is very tight. And how much wafer capacity can we procure each month? And do we have any improvement about our wafer capacity?

Nangeng Zhang

[Foreign Language]

Shaoke Li

Okay. So, let me translate. We believe a series of inherent issues in the Bitcoin mining industry resulted in the shortage of chip supply. So, mining machine manufacturers generally use Bitcoin prices as reference points to estimate future market demand for their mining machines, which in turn, will determine the production volume of their mining machines. Due to the low Bitcoin prices in the second half of 2020, most mining machine manufacturers reduced their investment in fabrication during the period. As a result, when the Bitcoin price bounced back in the second half of 2020, we saw a severe supply shortage in the industry. In addition to the limited supplies across the semiconductor manufacturing sector recently also has played a role in building the shortage of chips in 2021, further accelerating the problem of chip supply.

We cannot really disclose the exact number of chips that we have under production right now. But one of the strategies we’ve adopted to address this problem is to maintain our partnerships with multiple foundry partners and keep expanding our collaborations, which has helped us achieve outstanding results in terms of keeping up.

On the other hand, we are also actively incorporating with large mining companies worldwide, including both publicly traded companies and professional institutions with long-term purchase orders for mining machines in place. We can effectively secure the delivery of our chips from our foundry partners. This, in turn, would enable us to alleviate the technical shortages of chip supply caused by the fluctuations in Bitcoin prices.

Unidentified Analyst

[Foreign Language]

My follow-up up is that we have good relationship with Mainland China advanced foundry partners, and we got a lot of wafer capacity from them? And do we see any competitor to compete with this capacity in 2021 and what’s our strategy to protect the capacity?

Nangeng Zhang

[Foreign Language]

Shaoke Li

Okay. So first, there will, of course, be competitors, especially given the high Bitcoin prices. But we have already established a strong competitive mode with our extensive experience, our collaborations with multiple foundry partners, our integrated supply chain, as well as our large global client base. This is why we actually let the industry market share of mining machine [Technical Difficulty] in new markets during the first half of 2021 so far. And we actually see supply chain in a similar fashion as design, where the good design requires continuous and higher investments in R&D.

In terms of screening production capacity, which is -- which actually has similar requirements too, we need to increase our investments in supply chain, technology and engineering in the current market environment in 2021 today. We are working to see the marketing opportunities to enhance our cash positions and strengthen our product development capabilities. Our work on product designs on multiple nodes at the same time works for us with additional flexibility when we negotiate or coordinate with these partners to ensure capacity.

Unidentified Analyst

[Foreign Language]

My next question is our current yield rate. CEO already mentioned that our yield rate already achieved some milestones, and how do we expect the improvement in Q2 or second half and the contribution of the improvement to our machine shipment?

Nangeng Zhang

[Foreign Language]

Shaoke Li

So, yield rate can easily be affected by a variety of factors and it is also an important and confidential trade secret. But generally, when introducing new product, especially when starting corporation with a new partner, it takes a bit of time for the production capacity and the yield rate to ramp up. And we are working around the clock to minimize this so-called break-in period as much as possible. Through the hard work of our employees, our colleagues and our partners, we can -- we have effectively completed this difficult break-in period -- break-in process in the second quarter of 2021.

Unidentified Analyst

[Foreign Language]

And my last question is about our Ethernet mining machine. Do we have any plan to launch our ETH machine in 2021 or 2022?

Nangeng Zhang

[Foreign Language]

Shaoke Li

So, what I can say right now is that our R&D is currently in progress. But, at this point, we can’t really disclose any more information than that.

Operator

Next question is from the line of [indiscernible].

Unidentified Analyst

[Foreign Language]

We know that selling price on mining machines and Bitcoin price are highly related, but Bitcoin price has increased significantly since fourth quarter last year. Why it didn’t reflect on our fourth quarter financial report and the fourth quarter guidance?

Nangeng Zhang

[Foreign Language]

Shaoke Li

Okay. So yes, to answer your question, the price of mining machines actually moves with the Bitcoin prices only for the mining machines that are ready for delivery. So, since the second half of last year and the first half of this year, most of the mining machines we sold were actually sold as futures contracts, which had a fixed price. And the prices were actually lower than our existing machines.

Unidentified Analyst

[Foreign Language]

According to the news, a company called Integrated Ventures purchased 600 mining machines from our company with the total cost of around $2.70 million and the calculated price is around $4,500 for mining machine. May I ask how much was Bitcoin price when the deal made? And were those 600 mining machines all prepaid orders, how much is the price on mining machines under credit sales at this kind of price generally?

Nangeng Zhang

[Foreign Language]

Shaoke Li

To answer that question, the order -- the deal was made in February. And for the mining machines that we sold, we actually sold them at different prices and which may be compared to actually more complicated. And generally speaking, for mining machines that we sell at a given time, future’s could be much lower than the price of the existing, the existing machines could be similar or instances could have higher prices. And so, it kind of depends on the timing of when we sign those contracts and the timing of when we deliver them, as well as a bunch of other factors. Well, generally speaking, the future’s contracts should have around 60% to 80% of the price of the existing machine.

Unidentified Analyst

[Foreign Language]

My question is, how do we expect the sales volume in 2021, how much prepaid orders we have currently? I mean, what is the average selling price of mining machine under current Bitcoin price?

Nangeng Zhang

[Foreign Language]

Shaoke Li

So, we actually mentioned this number earlier in my prepared remarks. So, as I said before, we have already recorded orders for more than 156,000 mining machines with over at RMB 238 million in advances from our customers for -- as of the end of the first quarter of 2021.

Nangeng Zhang

[Foreign Language]

Shaoke Li

And to add to my previous answer, the current timing of existing machines -- the current timing of delivery of existing machines is -- actually spans a pretty longer time, some of them were scheduled to mid of next year actually. And the prices of the existing machines actually remained pretty high as well. Some of them are in the range of $50 to $100. And most of them are going out as well.

Unidentified Analyst

[Foreign Language]

Nangeng Zhang

[Foreign Language]

Shaoke Li

Just to add translation. So, that $50 to $100 is priced for each Thash.

Unidentified Analyst

[Foreign Language]

My question is, you have mentioned that our Company is planning to involve in Bitcoin mining activity. What is the current progress? How many mining exchanges do you plan to use for mining by the end of the year? And how much does our Company account for the network computing power? Compared with other mining companies, what is your expectation for computing power at the end of the year?

Nangeng Zhang

[Foreign Language]

Shaoke Li

We are advancing our mining business. We have actually already set up an operation center in Singapore to run the operation. And Kazakhstan is also going to be on the top of our considerations as well as North America. And we have always prioritized compliance for our mining business, which is why we are in constant communication with our lawyers, auditors as well as other independent agencies to ensure our compliance and reduce our operation risk.

Nangeng Zhang

[Foreign Language]

Shaoke Li

So, given that our production of mining machines have been pretty much fully booked for the first half of 2021, we actually expect that the deployment of mining machines for our own mining business for the second quarter of the year to be in the thousands [ph] with a total computing power between 350 Thash to 450 Thash. So, for the second half of the year of 2021, we will adjust that number, that figure based on the market environment as well as our production capacity. So, for the second half of the year, we plan to deploy more than 10% of our total production capacity every month for our own mining business. The actual number will be -- we will monitor the progress of mining -- other mining companies with -- that we’re partnering with as well as the Bitcoin to make real-time adjustments. Provided that we don’t see any huge changes in the Bitcoin prices and our production capacity, we expect to deploy around 2 extra -- 4 extra hash [ph] of total computing power for our mining business by the end of the year.

Unidentified Analyst

[Foreign Language]

My last question is, what’s the plan for the mine Bitcoin, are you going to hold or exchange for U.S. dollars or any other kind of consideration?

Nangeng Zhang

[Foreign Language]

Shaoke Li

So, as I said earlier, we’re definitely going to make sure that all of our operations are compliant. And under guidance, we will aim to hold our Bitcoin as long as for the long term. At the same time, it is also possible for us to sell the Bitcoin. So, we’re doing this so that we can have the benefit or the dividend of the growing industry.

Operator

Thank you. There are no more questions at this moment. I will hand the call back to the management for closing remarks. Thank you.

Shaoke Li

Okay. Thank you all for joining us today. We look forward to talking to you next quarter. Thank you.

Operator

Thank you. Ladies and gentlemen, that does conclude your conference for today. Thank you for participating. You may all disconnect now. Thank you.