Canaan Inc. (NASDAQ:CAN) Q3 2021 Earnings Conference Call November 16, 2021 7:00 AM ET

Company Participants

Nangeng Zhang – Chairman and CEO

G. Zhang – Investor Relations

James Cheng – CFO

Jingjie Wu – SVP

Shaoke Li – Secretary of the Board

Neshi Zhang – Interpreter

Conference Call Participants

Martin Chen – Tencent

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Canaan Inc. Third Quarter 2021, Earnings Conference Call. At this time, all participants are in listen-only mode. After the management's prepared remarks, we will have a question-and-answer session. Please note that this event is being recorded. Now, I would like to hand the conference over to your speaker host today, Nangeng Zhang Investor Relations Manager of the Company. Please go ahead, Ms. Zhang.

Neshi Zhang

Thank you. Hello, everyone. 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. James Cheng. In addition, Mr. Jingjie Wu, our SVP, Mr. Shaoke Li, our Secretary of the Board, Mr. [Indiscernible] IR Senior Director will be available during the question-and-answer session. Mr. Zhang will start the call by providing an overview of the Company and performance highlights for the quarter.

Mr. Cheng 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 thoroughly explained as [Indiscernible] most comparable measures reported under general accepted accounting principles in our earnings release and [Indiscernible] with the SEC. With that, I will now turn the call over to our Chairman and CEO, Mr. Nangeng Zhang, please go ahead, sir.

Nangeng Zhang

Thank you. [Indiscernible] [Indiscernible]

Neshi Zhang

Okay. Let me translate. In the third quarter, powered by our team's efforts we have achieved [Indiscernible] structural results on multiple fronts. We generated 1,317.6 million RMB in total [Indiscernible] revenues up 708.2% year-over-year, and up 21.8% over quarter-over-quarter, reaching a new historical high. At the same time, our profitability further improved with our gross margin expanding to 56.3% during the quarter. Non-revenue totals [Indiscernible] 467.2 million, setting a new record of IPO. To achieve this performance, both our business and operations have overcome significant challenges as the recent-related regulatory and policy changes negatively impacted the mining machine sales market. Besides the market factors, we attribute our accomplishment against the challenges to the visionary and preemptive strategies that our management team have been implementing.

Following our IPO in 2019, we have been continuously expanding our business locally and diversifying the geographic presence of our business, while upholding our business philosophy of operating in compliance. Moreover, we have deepened our collaboration with some of our key clients from purity in mining machine sales through joint mining, further expanding the breadth and form of our corporation. On the supply front, we maintained healthy relationships with our suppliers, enhancing our discussion on communication, securing capacity from waiver production to packaging and testing, so as we ensure the supply to our own production. As such, we were able to overcome the semiconductor supply instability, as well as the constraints on electricity and international logistics toward the end of the quarter. Importantly, we remain steadfast in bolstering our R&D efforts, and attracting [Indiscernible] talent to build our product development team, thereby strengthening our technological capability and consequently, our growth.

Nangeng Zhang

[Indiscernible] [Indiscernible]

Neshi Zhang

In terms of our mining machine sales, we believe our 6.7 million terahash per second of computing power to our clients during the third quarter of 2021, this [Indiscernible] our increase of 128.4% year-over-year, and 12.9% quarter-over-quarter marking a new historical high for quarterly sales performance. In the first 9 months of 2021, we delivered of our mining machines directly to 26 countries and regions where we are building a geographically diversified business. We also strengthened our foothold in several overseas markets where market amount is more concentrated, such as the U.S. and [Indiscernible]. We have received repeat orders from several large scale mining companies in these overseas markets and established a long-term corporation with them. In the third quarter, 24 million terahash per second of computing power sold was ordered by repeat customers, demonstrating their continued recognition of our product performance, delivery capabilities, and service quality. At the same time, we are in discussion with these clients regarding potential partnerships to expand deeper into the industry value chain to drive mining operations, and advocating for renewable energy mining in all of this market.

Nangeng Zhang

[Indiscernible]

Neshi Zhang

The average selling price or ASP of our computing power slowed in the third quarter. Although [Indiscernible] our previous quarter, we currently expect of our ASP to continue to serve as a growth driver for our top-line performance in the fourth quarter [Indiscernible] in the third quarter.

Nangeng Zhang

[Indiscernible]

Neshi Zhang

In terms of our supply chain, we continue to strengthen our cooperation with stronger partners and secure their capacity through upfront payments. Our adequate cash position, which was a result of the past and future sales of our mining machines has enabled us to secure a sufficient supply of resources and production capacity for chips.

Nangeng Zhang

[Indiscernible]

Neshi Zhang

For our Bitcoin Mining business, we uphold our business philosophy of operating in compliance with relevant laws and regulations, and choose to work with large-scale compliant and solid partners in overseas markets. We're able to leverage our advantages in the supply chain to allocate machines to those facilities of strategic partners with lower electricity cost. Given the industry dynamics, we will adjust our business operations from time to time to implement the [Indiscernible] development strategy, and seize market opportunities. To do so, we will constantly adjust the allocation of mining machines between sales and the mining business.

Nangeng Zhang

[Indiscernible]

Neshi Zhang

We are currently operating mining machines with a total computing power of approximately 32,000 terahash per second. We have also delivered mining machines with 850,000 terahash per second computing power for our [Indiscernible] mining firm, and gradually put them into operation. In addition, we have filed contracts with partners for approximately 1million terahash per second of additional computing power. And we are preparing to ship-out this machines to the mining firms by January's end in 2022. Furthermore, we are negotiating with a number of this partners for [Indiscernible] mining projects with a total capacity of about 200 megawatts.

Nangeng Zhang

[Indiscernible]

Neshi Zhang

For our AI business, we have seen a rapid growth momentum in terms of total sales of AI shift, which includes the buyer 451% in the first 9 months of 2021 from the same period of last year. We have also made solid progress in the research and development of our true -- 230 AI shift.

Nangeng Zhang

[Indiscernible]

Neshi Zhang

Our R&D expenses, which the RMB 92.76 million in the third quarter, increasing by 188.8% year-over-year. We have continued to expand our R&D team by recruiting more elite talent to our unit -- through our initiative to enhance our employer branding efforts directly as experienced fellows and campus hires. During the third quarter, we recruited 33 technical staff, accounting for 19% of the total headcounts in our R&D team as of September 30th, 2021. Our total number of R&D staff as of the end of the third quarter increased by 70% from a year-ago. As effect -- at the same time, we have made steady progress in the research and developments of the new generation of [Indiscernible] mining machines.

Nangeng Zhang

[Indiscernible]

Neshi Zhang

After the completion of our previous announced share repurchase program, in September 2021, our Board of Directors approved a new share repurchase program of up to $20 million. As of today, we have repurchased about 0.6 million ADS in a total amount of over $4.6 million. We have strong faith in Canaan's growth potential and will remain committed to creating value for our shareholders.

Nangeng Zhang

[Indiscernible] [Indiscernible]

Neshi Zhang

During the quarter, we experienced the regulatory changes continuous supply constraints in the global semiconductor industry and other challenges posted by the market environment. However, despite those challenges, we leveraged our team's collective efforts, as well as our effective network of customers and supply partners to navigate the difficult market dynamics. As such, we delivered a historically best quarterly performance in the third quarter based on the foundation of our success in the previous quarter. I will like to take this opportunity to express my gratitude towards everyone at Canaan for their hard work and dedication, as well as our partners, clients and investors for their continued support and vote of confidence.

Nangeng Zhang

[Indiscernible]

Neshi Zhang

Going forward through our pathway endeavors, we aim to sustain our gross trajectory to create increasing value for all of our shareholders. We now expect us -- our revenue in the fourth quarter of 2021 will increase by 35% to 50% on a sequential basis. Please note that this forecast reflects our current and preliminary views on the market and operational conditions, which are subject to change.

Nangeng Zhang

[Indiscernible]

Neshi Zhang

This concludes my prepared remarks. I will now turn the call over to our CFO, James.

James Cheng

Thank you, Mr. Zhang And hello, everyone, this is James speaking. Q3 was not an easy quarter, however, we still delivered a solid performance in this quarter with record highs in multiple operating and financial metrics. I'm glad to share the results to all of you. In the third quarter, we achieved another record high top-line result and further expanded our profits level [Indiscernible], we delivered a total net revenues of RMB 1317.6 million and a [Indiscernible] gross profit of RMB 741.7 million with a gross margin of 56.3%. We also reached a new high in our bottom line with non-GAAP adjusted net income of RMB 587.5 million. From top line perspective, we delivered our record high computing power sold 6.7 million terahash while at the same time, our average selling price per terahash improved by 7% sequentially, both volume and the price increased, which drove revenue to a new level. Looking at our sales pipeline, our pre -orders have retained our contract liability at a high level of RMB1026.7 million as of the quarter-end, compared with RMB 430.4 million as of December 31, 2020.

Gross profit was RMB 741.7 million compared to a gross loss in the same period of 2020, representing a sequential growth of 73.3%. Here I do want to note that the demand for an ESPO, our computing power are meaningfully influenced the -- by the Bitcoin price and its trend outlook, which are difficult to project. On the other hand, we also [Indiscernible] the pressure from [Indiscernible] cost to increase from our suppliers, which could affect our margin to a certain extent. As such, our gross margin rates is always subject to a combined effect over the volatile sector. As we previously disclosed, we have kicked off our mining business and now we have 32,000 tera-hashes is in the mining operation. As all -- the third quarters end, we were holding 23.86 Bitcoin s. Please be advised that our mining income and the crypto currencies are initially recorded at the price when we generate some through our mining operation. Our digital assets are recorded on the balance sheet net of any impairment losses incurred of things initial recognition.

Gains are not recorded until realized upon disposal of such digital assets. Therefore, the digital assets value on our balance sheet does not reflect its value appreciation in case of an increase of Bitcoin price. Regarding the plan of our mining business, as Ms. Zhang just shared. We also have 850,000 terahashes computing power under deployment that recovered the trend. We are under discussion with a few partners to secure additional power and operating capacity. Looking forward, we will continue to allocate Bitcoin mining machines to our mining business sector and we will continuously disclosed the progress. Research and development expenses were RMB 92.8 million increasing by 188.8% year-over-year. The increase was primarily attributable to the increased staff costs in technology-related departments, as well as the incremental development costs for new products.

We will continue to invest in R&D with respect to our expense managements, we will closely monitor [Indiscernible] on different projects. We have incurred minimal income tax expense in the third quarter. I'd like to note since we're going to use up the deferred tax assets generated by accumulated operating losses from previous quarters, we expect to incur substantial income tax expenses for our profitable quarters going forward. Overall, while we delivered solid results for the quarter, we're not resting on our laurels. We do note the risks and the volatilities of our normal life in this rapid [Indiscernible] developing industry. We endeavor to proactively manage the risks with our agile operating strategies. Now, I would like to briefly walk you through our financial results for the quarter.

Total net revenues increased by 708.2% year-over-year, and increased by 21.8% quarter-over-quarter to RMB 1,317.6 million. 6 million. Gross profit was RMB 741.7 million up 73.3% sequentially. Total operating expenses in the third quarter or RMB 278.4 million compared to RMB 75.9 million in the same period of 2020, and RMB 262.4 million in the second quarter of 2021. Income from operation was RMB 463.3 million up 179.9% sequentially. Net income attributable to ordinary shareholders was RMB 467.2 million, up 179.3% sequentially. Non-GAAP adjusted net income was RMB 587.5 million, up 83.6% sequentially. Non-GAAP adjusted net income or loss excludes share-based compensation expenses. Basic and diluted net earnings per ADS for the quarter were RMB 2.68 and RMB 2.64, respectively. As of September 30th, 2021, the Company had cash and cash equivalents of RMB 1,698.5 million up, 334% compared to RMB 391.3 million as of December 31, 2020. This concludes our prepared remarks. We are now open for questions.

Question-and-Answer Session

Operator

Operator Instructions] ask your question. The first question comes from the line of Martin Chen from Tencent. Please go ahead.

Martin Chen

[Indiscernible] First congratulations for the very strong Q3 earnings in the Q4 guidance, and the CEO already mentioned that the Chinese government tightened regulation in the [Indiscernible] for the shutdown of mining operation in Mainland China. In your view, what's the impact on the cryptocurrency mining industry and how it impacted tenants sales in Q3 and can this [Indiscernible] -- can be transferred to the oversee customers?

Nangeng Zhang

[Indiscernible]

Neshi Zhang

If we will kind of computing power statistics of the Bitcoin network. By the end of the third quarter, basically all of the computing power from mining firms in Mainland China have been removed. Afterwards, most of the continuous mining farm, along with the computing power has relocated to over Phase markets. However, as of now, the Bitcoin network's total computing power still has not recovered to highest level in the industry.

Nangeng Zhang

TK - [Indiscernible]

Neshi Zhang

There will be some market developments regarding the short-term volatilities in the price of Bitcoin. However, we can see that Bitcoin price has fully recovered from the temporary losses as of now.

Nangeng Zhang

[Indiscernible]

Neshi Zhang

Typically, although with this regulatory changes created a further level of negative impact for the sale of mining machines in the short-term, the market had already reacted and adjusted in a timely manner during the quarter. As industry players we allocated this continued computing power to the overseas market. The overall global demand for mining machines resumed its upwards trajectory. We have also observe that the financing environment for miners in the overseas market is improving. A lot of large sale overseas [Indiscernible] are actively investing in mining [Indiscernible]. So overall the demand for the computing power is relatively stable.

Nangeng Zhang

[Indiscernible]

Neshi Zhang

Additionally, our financial performance maintained a robust growth momentum in the quarter as you can see. And we anticipate even higher sequential growth in the fourth quarter. As such, we believe our -- the active measures to expand our business footprint in overseas market has enabled us to offset the impact of the [Indiscernible] regulatory changes. I hope I answered your questions. Thank you.

Martin Chen

[Indiscernible] CEO already mentioned that cannot already lock some [Indiscernible] and could you elaborate more on your collaboration with your [Indiscernible] partner in 2022, and in terms of the cost operations, and you're [Indiscernible] And do you further increase of the price of [Indiscernible] in the next year due to sub-10 supply comps trend?

Nangeng Zhang

[Indiscernible]

Neshi Zhang

So we have implemented a multipronged growth strategy, and we established a long-term partnership with multiple major foundries. Our smooth cooperation with these foundry partners in term has secured a stable waiver supplies for our production. As our yield, we continue to improve in 2021, we are able to reassure the performance of our mining machines, while improving our production capacity. We have also been approximately seeking additional production capacity to meet the increasing demands from our clients. With one of our foundry partners [Indiscernible], we have secured waiver supplies through prepayments Q2 in 2022.

Nangeng Zhang

[Indiscernible]

Neshi Zhang

On top of that, we continue to refine the fabrication process and the improvements in our yield rate has been encouraging. Nobody -- we have achieved slightly higher [Indiscernible] in all processes throughout the fabrication line, such as packaging, associate or impacting. As a result, we were able to improve the overall product yield, and thus our gross margins in the third quarter.

Nangeng Zhang

[Indiscernible]

Neshi Zhang

While we have to recognize that the continuing industry-wide supply and supply constraint is creating a seller's market, consequently increases the labor price on natural uninhabitable from our founding partners for our position in upper stream of the industry value chain. Again, the backdrop of our unstable waivers supply. We are discussing a series of flexible strategy with our founding partners to secure our wafer supply. This strategies also include accepting price increases under certain conditions to ensure our supply. Our supplies of wafer increases throughout the semiconductor industry. We will continue to negotiate future labor prices with [Indiscernible] partners. And we believe that a reasonable range of price increases will further solidify our [Indiscernible]. In 2022, we will continue to upgrade our fabrication process and improve the performance and cost efficiency of our products. I hope I answered your questions.

Nangeng Zhang

[Indiscernible]

Neshi Zhang

Thank you.

Martin Chen

[Indiscernible] And we have hear the [Indiscernible] 10 is turning to release regulations on cryptocurrency mining, do you [Indiscernible] material impact on your mining business?

Nangeng Zhang

[Indiscernible]

Neshi Zhang

Yes, we did notice the recent policies in [Indiscernible] and believe these policies will promote a sustainable development of the cryptocurrency mining in the country. Under the new guidelines, mining companies need to obtain approval from the [Indiscernible] government in order to secure electricity supply. We have learned from out recent communications with our customers in the country, that large companies [Indiscernible] relate with us in technology capabilities and sufficient funding will benefit from this policy. Our current top 3 customers in Kazakhstan, also large-scale companies will have obtained the necessary approvals from the Kazakhstan Ministry of Energy to conduct mining business. Therefore, ensuring our business development in the country. From another perspective, the formulation of this policy will effectively prevent unqualified and small mining companies from conducting speculative and market disturbing activities, and in turn benefit our largest development in the Kazakhstan market.

Nangeng Zhang

[Indiscernible]

Neshi Zhang

So I would like to point out that our global operations reach far beyond [Indiscernible], as we have already established a foothold in Central Asia, Southeast Asia, Europe, and North America. Most notably, North America is accounting for approximately 30% of our overseas market, with the majority of the long term, [Indiscernible] public [Indiscernible] companies. This Company include Molson, Iris Energy, and Highest Block Chain.

Nangeng Zhang

[Indiscernible]

Neshi Zhang

Hope I answered your question. Thank you.

Martin Chen

[Indiscernible] And could you elaborate more on your incoming and profit your mining business, and how you're holding and trading of Bitcoin strategy to influence your financial spending in future?

Nangeng Zhang

[Indiscernible]

Neshi Zhang

So it is worth reiterating that compliance with level and loss on regulation is the foundation on which we explored our mining business in overseas market with extreme caution at the early stage. We are currently operating mining machines with a total computing power of approximately 32,000 terahash per second. After the initial file on testing [Indiscernible] for six months, we can now effectively execute many aspects of the business, such as legal, tax, and operations. In addition, we have delivered mining machines with 857 terahash computing power to our partners mining farms, which have been set up for operation. We have also signed contracts with mining partners for approximately 1 million TH/s of additional computing power, and scheduled the shipment of these mining machines by the end of January of next year. Furthermore, we are negotiating with a number of North American business partners to join mining projects in North America, with a photo electricity consumption capacity of 400 megawatt.

Nangeng Zhang

[Indiscernible]

Neshi Zhang

As of September 30, we hold 23.86 Bitcoin, our current strategy is to hold our Bitcoin and we will not free them in the short-term. However, we do not rule out the possibility of trading them in the future.

Nangeng Zhang

[Indiscernible]

Neshi Zhang

So according to the [Indiscernible], the value of Bitcoin we hold is recognized at [Indiscernible] costs and we [Indiscernible] acquire the asset on the Balance Sheet. For subsequent valuation, we recognize impairment losses it'd be assessed, the value is lower than the initial costs. If the value goes up in the [Indiscernible] all our segments, we do not record any gains on the Balance Sheet. Only when the Bitcoin are sold, will we recognize the actual [Indiscernible] real life?.

Nangeng Zhang

[Indiscernible]

Neshi Zhang

Thank you.

Martin Chen

[Indiscernible] Thank you. [Indiscernible]. And my last question is about the tenants mining cost in the third quarter.

Nangeng Zhang

[Indiscernible]

Neshi Zhang

The costs of mining in finalized stage in the third quarter was about 39% of mining revenue, and the gross margin was 61% which is slightly higher than the gross margin of our sales of mining machines. However, going forward for different collaboration, the gross margin will continue to be subject to change in the price of Bitcoin where it is harvest [Indiscernible] and this different ways of collaborating with mining partners.

Martin Chen

[Indiscernible]

Operator

Thank you. Once again, [Operator Instructions]. Thank you. As there are no further questions, I would now like to turn the call back to the management for any closing remarks.

Neshi Zhang

Thank you. Once again, for joining us today. If you have further questions, please feel free to reach out through the contact information provided on our website.

Operator

Thank you. That concludes the call today. Thank you, everyone for attending. You may now disconnect. Thank you all.