Canaan Inc. (NASDAQ:CAN) Q3 2020 Results Earnings Conference Call November 30, 2020 7:00 AM ET

Company Participants

Shaoke Li - Secretary to the Board of Directors

Nangeng Zhang - Chairman and Chief Executive Officer

Quanfu Hong - Chief Financial Officer

Jingjie Wu - Vice President

Conference Call Participants

Zheng Jialiang - HashKey Capital

Operator

Ladies and gentlemen, thank you for standing by, and welcome to Canaan’s Inc. 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'll 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

Thank you very much. Hello, everyone. And welcome to Canaan Inc. 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 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 with the call by providing an overview of the company and the performance highlights for the quarter. Mr. Hong will then provide the 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 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 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

[Foreign Language] [Interpreted] 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 third quarter of 2020.

Our total net revenue in the quarter decreased by 8.5% quarter-over-quarter to US$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 has re-bounced. 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 any significant revenue contribution to our third quarter results.

At the beginning of the third quarter of 2020, the price of a Bitcoin maintained its upsides momentum, reaching US$12,400 in the period and, in fact, hitting US$19,000 during the fourth quarter of this year. As such, the blockchain market recovered - market recovery trend continue to boost the demand for our products. By the end of the third quarter, our advanced receipts totaled US$11.14 million, representing an increase of US$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 US$4.73 million, further demonstrating our confidence in the long-term development of the company.

On September 8, we announced the share repurchase program of up to US$10 million worth of our shares outstanding. As of December - as of October 30, we had already bought back 1,225,000 shares, which represented a total transaction value of US2.43 million under the program and thus continued to illustrate our confidence in Canaan's long-term business prospects and the growth potential.

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 per terahash, a total computing power of 90 terahash per machine and the lowest unit cost 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 joule per terahash to 40 joule per terahash. Looking ahead, we believe that the enhanced performance of our new products will continue to boost our competitive advantages, especially in terms of cost management, which will serve further - expand our industry leadership.

A number of factors impacted the product - production capacity of the global IT industry in 2020. Nevertheless, we have remained committed to both our fabulous model and the maintenance of our collaboration with multiple established IT manufacturers, enabling us to ensure the sufficient supply of IT products going forward to better meet customer needs.

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 a 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 US$45 million.

During the third quarter, we experienced the significant changes in our revenue’s geographic competition. 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 medium-sized clients.

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 workplace 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 the 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.c

Currently through our partnership with both UBTECH Robotics and the 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 use to participate in programming 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 production costs.

At the same time, we're actively involved in smart city projects. So our collaboration with [indiscernible] IoT technology, and its Smart Door - Smart Door Lock project. For example, we have won a number of tender processes for government contracts of Smart Door Locks. Additionally, through our partnership with Hangzhou [ph] smart city, we have successfully integrated our K210 chips, as well as successor products of our K210 chips into the smart city operations of Beijing, Haidian District.

Currently, our monthly shipment of AI chips have 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 at more than 50,000 per month.

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 utilize our brand new and independently developed gene [ph] 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 tickets [ph] through which we will enter into new markets. With its low production costs and industry-leading performance, the K510 is capable of powering products with the potential to disrupt multiple markets such as high end IPs [ph] smart home products, smart retail products, and the smart security system.

In the past six months, we focused on monetizing and analyzing both market dynamics and the marketer policies in domestic and international markets. Meanwhile, we also continue to accumulate industry resources and experiences for the development of our new business initiative. 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.

In fact, we expected 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 industries in its growth potential.

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 sized 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 industries growth.

In the face 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

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.

Quanfu Hong

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 RMB180million 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 change in the 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 in 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 a 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 [ph] 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 14.6% in the second quarter of 2020.

Let's now take a look at - take a look at the other 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% from 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 department.

As a percentage of total net revenues, sales and marketing expense 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 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 net loss of RMB16.8 million in the second quarter of 2020.

Non-GAAP adjusted net loss in the third 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 were 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 were 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 decreases was mainly due to the higher short-term investments as the Company had invested RMB204.6 million in short-term investments as of September 30, 2020, compared with RMB11 million in short-term investments as 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.

Question-and-Answer Session

Operator

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

Zheng Jialiang

[Foreign Language] And I will translate it myself. So thank you, Zhang and Hong [ph] and also for management. And I like to raise a question regarding the new business that I don’t know just – I wish how to say. I would like to know that for the mining business, it's for the self-operating business or just a mining pool for the external client? Thank you.

Nangeng Zhang

[Foreign Language] [Interpreted] All right, so let me translate. Our new business 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 – 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're not currently planning to operate our own mining pool, given its compliance problems and – but we will still keep monitoring that.

Zheng Jialiang

[Foreign Language] So, my second is, how long does the [Technical Difficulty] the tariff on this new business and where this new business will be going to expand? Thank you.

Nangeng Zhang

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

Zheng Jialiang

[Foreign Language] So my third question regarding how many resources that the company will be, I think, to invest into this new business, including how much the team and also how much capital will be allocated to this new act? And also like to know what's the size of the mining farm? Thank you.

Nangeng Zhang

[Interpreted] 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 new 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.

So to elaborate on the investments or on the cash investments, we are actually - we're going to leverage our partnerships. And so the important 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 machine - mining machines. So actually, the mining machines will be a major part of our investment, not cash.

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 - we're expanding our mining business. So we will be in a better place to streamline our supply chain and the production of our mining machines.

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

[Foreign Language] Okay, thank you. [Foreign Language] So my by 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

[Foreign Language] [Interpreted] Yes. So when we're – our sales are performing well, we only expect 10% to 20% of our mining machines to go over to our mining business. But when the market isn't doing so great, that's going to be - we're going increase that.

Zheng Jialiang

[Foreign Language] So my following question is regarding the supply chain that we all know that [indiscernible] supply chain that the foundry may have cut a supply for the mining machine factory disappeared. 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 season management quote projection for next year's supply chain situation, also how this evolution will be – impact our Canaan’s productive in the next year? Thank you.

Nangeng Zhang

[Foreign Language] [Interpreted] 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 isn't actually the market - home market isn't very healthy and the inventory is pretty low.

So in the second-half of the year, the market demand for semiconductors actually rebounded and Bitcoin price increased as well. So for the second-half of the year, we still have problems in the production, which we actually thought 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.

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 delivery for the second quarter of next year, but that's more because of the increasing market demand.

Okay. So one of the problems that we see - so currently, our - the production process for our machines is taking 90 to 120 days. So - but we are - we're running out to production and we expect to - our production capabilities to have to produce over, well, multiple of – several thousand - several tens of thousands of mining machines next year.

And also, now we have the - we operate our own Bitcoin mining business, which would enable us to streamline our supply chain process, even when the market is under – is facing turbulence. And we should be able to just build our inventory regardless.

Operator

All right. Thank you. I’ll now hand the conference back to the management team for their closing remarks.

Shaoke Li

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

Operator

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