Canaan Inc. (CAN) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Canaan Inc. First Quarter 2021 Earnings Conference Call. [Operator Instructions] Please note that this event is being recorded. Now I'd like to hand the conference over to your speaker host today, Mr. Shaoke Li, Board Secretary of the company. Please go ahead, Mr. 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; [ Mr. Matthew Lee ] from ICR, our IR consulting firm, will conduct the English translation throughout the call. In addition, Mr. Xiaoming Lu, our SVP, will also 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 the 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 and reconciled at the -- to the most comparable measures reported under 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. Please go ahead, sir.

[Interpreted] Hello, everyone. This is Nangeng Zhang, Chairman and CEO of Canaan Inc. I will now provide a brief overview of our progress in the first quarter of 2021. During the quarter, we significantly improved our financial performance as a result of the Bitcoin price rally, increasing customer demand and a substantial ramp-up of our mining production and delivery. As such, we reported total net revenues of USD 61.5 million and a non-GAAP adjusted net income of USD 21.9 million in the first quarter of 2021, a significant improvement from a non-GAAP adjusted net loss of USD 31.4 million in the full year of 2020. With the mass production of new-generation mining machines, our product yield continued to improve. Through the close collaboration with our foundry partners, we have further enhanced our chip manufacturing process. As of today, such advances have led to industry-leading performances in our chip speed and yield. In the second quarter-to-date, in addition to our delivery of mining machines, we have also secured a number of large purchase orders of future contracts. Furthermore, we have locked in the fab capacities of our foundry partners for the next 12 months to fulfill this future contracts. Although the Bitcoin price volatility in Q1 created some challenges in sales of mining machines, we expect our Q2 total shipments to either maintain or surpass our current growth rate. Due to the Bitcoin price volatility caused by recent policy and market uncertainties, we're not able to project the total net revenues for the second quarter in a precise manner. Hence, we expect our total net revenue for the second quarter to be in the range of USD 150 million to USD 200 million. In terms of mining machines' sales strategy, we have reprioritized our sales focus to our long-term and large-scale customers. As of May 31, 2021, we have had total order volume of over 149,000 mining machines with over USD 190 million of total customer transactions. In regards to our future contracts, we have signed purchase orders of more than 10,000 mining machines with both Molson, the U.S. liquor company; and Genesis, an international Bitcoin mining giant. In aggregate, we have had 29 different customers, each with purchase orders of more than 1,000 mining machines accounted for 94% of our total orders this quarter. Our partnerships with such large-scale customers generally involve multi-batch mining machine purchases over a long period of time. These characteristics have helped us to reduce the impact of short-term fluctuations in cryptocurrency prices and to ensure the stability of our production and delivery schedules. Since the second half of 2020, we have had our focus on overseas customers. As of May 31, 2021, our overseas revenues accounted for more than 70% of our total net revenues with purchase orders from overseas markets accounting for more than 70% of our total outstanding purchase orders. Since the second half of last year, capacity shortages in the global semiconductor supply chain have become a common challenge for chipmakers around the world. In order to secure the production and supply of our products, we have initiated negotiations with our suppliers, opting to provide them with a higher unit price and longer upfront payments. As of now, we have paid our suppliers a total of approximately USD 200 million in upfront payment. Additionally, in April of this year, we completed a direct offering of 13,492,065 of our ADS at USD 12.6 per ADS for a total amount raised of USD 170 million. The financial impact through our latest series and through our recent large purchase orders will considerably enhance our cash position, aid us in supply chain improvements and enable us to secure sufficient production capacity for future deliveries. Going forward, we will continue to invest in our R&D capabilities to improve the quality and performance of our mining machines. We will also utilize our cash reserves to enhance our customer service capacity and expand our business segment and models. In anticipation of self-operated Bitcoin mining, we have already set up a wholly-owned subsidiary in Singapore and deployed an operational team in Kazhakstan. In the latter part of May of this year, we have also deployed the first batch of mining machines in Kazakhstan for our Bitcoin mining-related operations. We believe that our self-operated Bitcoin mining business will help us improve our financial performance as well as expand our business growth and customer base. As we integrate more industry resources into our operations, we believe this business segment will enable us to revitalize our mining machines inventory, shield us from Bitcoin volatility and ensure our inventory sufficiency during a market upturn. As a technology company, we have always prioritized our investments in R&D as the driver of our core competitiveness. As such, our total R&D investments reached USD 8.9 million in the first quarter of 2021, with the majority of our R&D investments allocated to develop new products, improve capacity and yield, expand product lines and supply chains as well as invest in our R&D team. Beyond our core mining machine business, we also achieved steady progress in advancing our other business initiatives during the period. The AI industry is still in the early stage of market cultivation. Since launching our first-generation for AI chip K210 series in 2018, we have made outstanding progress and continue to gain traction in the market for robotics, education and smart homes. We have cumulatively delivered 479,000 of the K210 series AI chips to our customers to date. In March 2021, we finished the [ chip back process ] for our second-generation for AI chip, the K510 series. We have also completed the main function testing for all functional modules of this series and expect to launch in the second half of this year. As such, we plan to expand our K510 series in multiple application scenarios with a promising outlook that include high-end cameras, edge computing, video conferencing and more. Furthermore, we maintain and emphasize education sponsorship with the establishment of a developer ecosystem. We recently became the sole technical support provider for the 2021 National Student OS Design Competition, an event organized by China's Ministry of Education. Using development board equipped with our K210 chips, students from over 120 colleges and universities across China participated in the competition. And currently, our Kendryte K210 chip also became the chip of choice for developers in many interesting application scenarios such as smart meter, eye-tracking VR applications, programmable robot dogs, et cetera. In summary, we have established the in-depth partnerships to the various segments of the semiconductors industry value chain. These relationships will play an essential role in supporting our steady business expansion in the future. As we continue to accelerate our growth, we will generate increasing returns for our customers and investors going forward. Now I will turn the call over to Mr. Tong He, our Chief Financial Officer, to go through financial details.

Hello, everyone. This is [ Matthew Lee ] with ICR. I will now speak in English on behalf of Mr. Tong He. [Interpreted] Thank you, Nangeng. Now I will provide an overview of our first quarter financial results. Before I start, please note that all numbers are in RMB terms, unless otherwise noted. Total net revenues increased to CNY 402.8 million from CNY 68.3 million in the same period of 2020 and CNY 38.2 million in the previous quarter. The increases were due to the increase in our total computing power sold as we delivered more Bitcoin mining machines in the period. Cost of revenues increased to CNY 208.6 million from CNY 65.9 million in the same period of 2020 and CNY 29.2 million in the previous quarter. The increase in our cost of revenues were in line with the changes in our sales volumes of Thash and cost of our Thash. As a result, we reported a gross profit of CNY 194.2 million in the first quarter of 2021 compared to CNY 2.4 million in the same period of 2020 and CNY 9.1 million in the previous quarter. Gross margin further expanded to 48.2% from 3.5% in the same period of 2020 and 23.8% in the previous quarter. Research and development expenses were CNY 58.2 million compared to CNY 41.8 million in the same period of 2020 and CNY 40.1 million in the previous quarter. The increases were mainly due to higher share-based compensation expenses, which increased to CNY 24.1 million in the first quarter of 2021 as part of our amended 2018 shares incentive plan. The increases were partially offset by the decrease in contractor expenses and other expenses related to our R&D activities during the first quarter of 2021. Let's now take a look at our other operating expenses in the first quarter. Selling and marketing expenses were CNY 6.3 million compared to CNY 4.1 million in the same period of 2020 and CNY 6.1 million in the previous quarter. The increases were mainly driven by higher share-based compensation expenses in the first quarter of 2021, partially offset by lower advertising expenses. Our selling and marketing expenses in the quarter included CNY 3.0 million share-based compensation expenses. General and administrative expenses increased to CNY 143.4 million from CNY 27.6 million in the same period of 2020 and CNY 33.9 million in the previous quarter. General and administrative expenses in the quarter included CNY 114.8 million share-based compensation expenses. Consequently, our loss from operations in the first quarter of 2021 narrowed to CNY 13.7 million from CNY 71.1 million in the same period of 2020 and CNY 71.0 million in the previous quarter. Net income attributable to ordinary shareholders was CNY 1.2 million compared to a loss of CNY 39.9 million in the same period of 2020 and CNY 72.0 million in the previous quarter. Non-GAAP adjusted net income, which excluded share-based compensation expenses, was CNY 143.2 million. In comparison, non-GAAP adjusted net loss was CNY 38.2 million in the same period of 2020 and CNY 73.1 million in the previous quarter. Diluted net earnings per ADS was RMB 0.01 compared to a loss of RMB 0.25 in the same period of 2020 and a loss of RMB 0.46 in the previous quarter. Turning to our balance sheet. Contract liabilities as of March 31, 2021, increased to CNY 1,210.6 million from CNY 430.4 million as of December 31, 2020. The increase was driven by the increased downpayment for the sales order of our Bitcoin mining machines, which are scheduled for delivery in the following quarter of 2021. As of March 31, 2021, we had cash and cash equivalents CNY 1,337.8 million compared to CNY 391.3 million as of December 31, 2020. Short-term investments as of March 31, 2021, decreased to CNY 8.5 million from CNY 62.4 million as of December 31, 2020, as we redeemed a portion of our short-term financial products during the period. We purchased the short-term financial products to receive higher returns, but at the same time, can withdraw at any time. Looking ahead into the second quarter of 2021. As we have begun mass producing our new generation of Bitcoin mining machines, we believe that our product yields and deliveries will substantially increase on a year-over-year basis. However, the volatility in Bitcoin pricing in late May of this year has made it difficult to reduce the future trends in Bitcoin prices. As a result, we will not provide financial guidance for the coming quarter. This concludes our prepared remarks for today. Operator, we're now ready to take questions.

[Operator Instructions] The first question is coming from the line of [ Akita Elkin ] from China Securities.

[Foreign Language] I'm going translate myself quickly. My first question is about how do you consider the impact of financial regulation on the Bitcoin mining industry in companies like Canaan?

[Interpreted] In terms of policy environment, I believe every new and emerging industry is subjected to the testing for market evolution and regulatory compliance. Since 2020, cryptocurrency represented by the Bitcoin is increasingly accepted by the market. The Bitcoin has gone through a long process for being valued to being recognized by the market. Similarly, in terms of regulatory supervision, I believe the Bitcoin and the mining industry also needs to go through a process of regulatory compliance. The particularity of the cryptocurrency mining industry is the combination of technology-driven and strong financial future. As the Vice President of the PBOC, Mr. Li Bo expressed at the Boao Forum for Asia recently, "If we consider Bitcoin as an investment instrument, we need to develop regulatory policies to efficiently manage potential financial risks, which mainly refer to: one, activities to cause market disorders, such as financial fraud; and two, preventing individual investment risks from extending into the overall financial system. As such, we believe regulatory supervision is constructive to the development of the Bitcoin mining industry, not destructive. In the long run, regulatory provision is positive for the healthy and early development of the industry." From the market perspective, currently, majority of our customers are overseas companies, including public companies, well-established mining companies and professional financial institutions. Policy changes in China might cause some domestic mining companies or vendors to undersell Bitcoin mining machines to medium and small miners abroad, which will cause price volatility of mining machines in international markets. Majority of our customers are large-scale institutions and professional mining companies. The large amount of upfront payments received from these customers will enable us to smoothen the price volatility caused by the underselling of mining machines.

[Foreign Language] My second question is, what is the attitude of overseas government towards cryptocurrency currently? Will Bitcoin and Bitcoin mining save pricing regulation globally?

[Interpreted] The supervision on Bitcoin from world's major economy has long been insisted. Most economies from a developmental perspective, according to the statistics of [indiscernible] among 257 economies in the world, over 52% or 132 economies currently recommends Bitcoin as legal currency and do not impose restrictions on it. Only 14 economies consider Bitcoin illegal and restricted. In terms of the nature of Bitcoin, more than 60% of the economies believe that it has monetary properties, which means it could be used as a means of payment. Nearly 30% of the economies regard it as a commodity. More than 10% of economies treat it as property. And recently, many countries such as Turkey and India contended that they may join the list of economies who will strip or prohibit Bitcoin since the pandemic has worsened the growth of their economies. Their domestic inflation has clearly risen. The attitude towards Bitcoin and regulation of these economies varies over time.

[Foreign Language] My third question is, so recently opinion leaders, both domestically and also internationally, have raised their concerns about the high energy consumption of Bitcoin mining. So what do you think of this kind of sale? And also will be closing down of Bitcoin mining firms in Inner Mongolia cause a chain reaction in other premises in China?

[Interpreted] The establishment of a whistleblower platform for digital currency mining companies in Inner Mongolia is not a new move. India has issued similar policies before. At present, the development of the Bitcoin mining industry relies on low-cost power resources. There are 2 main types of resources, thermal power and hydro power. The Northern Western region is dominated by thermal power, which is against the inherent environmental protection principle of carbon neutrality. This is one of the fundamental reasons for the withdrawal of local mining in Inner Mongolia. Secondly, many mining companies engage in mining activities pertaining to the data centers enjoying policy subsidies granted by the country, but failing to fulfill their corresponding social responsibility. A withdrawal of these companies will help standardize the operations of domestic mining companies. Although the mining industry consumes electricity, it uses waste electricity to a large extent. Miners prefer to choose areas with low electricity prices to engage in mining activities out of profit-making purposes. The low electricity price indicates that the local power supply is greater than the actual demand, and there is a waste of energy. Before the emergence effective means to displace with the electricity, Bitcoin mining is a solution to transform with the electricity and restore value. At present, certain degree of power abandonment exist in many mining areas in China, such as the Northwest and Southwest regions. Bitcoin mining has contributed a lot to the finances, employment and income of residents in property areas. It also helps new energy facilities to generate income and further expand their scale. Hope that answers your question.

The next question is coming from [ Martin Chen ] from [indiscernible] Assets.

[Foreign Language] We still poor revenue growth in the second quarter. Maybe you can give us some color of the second quarter mining machine output and the price compared to the first quarter of 2021.

[Interpreted] As we discussed last quarter, we still expect 70% to 80% of our Q2 orders to the future contracts. Driven by our optimizing supply chain, continuous ramp-up of our capacity and the improvement of product yield, our product throughput has been considerably elevated. As a result, we expect shipment of mining machines in Q2 to be more than tripled from that in Q1.

[Foreign Language] Do we see any impact on the Bitcoin price fluctuation in the second quarter or second half 2021?

[Interpreted] Recently, we have observed considerable fluctuation and retreatment of the Bitcoin price and also heard different voices on the market. The overall return for Bitcoin miners remains at a relatively high level. Under most circumstances, the cost of mining machines does not exceed 1/3 of a miners' income. In addition, total computing power of the Bitcoin network declined recently due to policy change in China and the transition between dry and wet business. There is a minor decline of overall return for miners, but the change is significantly less than the retreatment of Bitcoin prices. And the price of mining machines depends on multiple factors. Without considering the impact of policy change, we see a strong correlation between the price of mining machines and return of mining. However, the recent policy uncertainties and the volatility of Bitcoin prices have cultivated an overwhelming watching atmosphere in our domestic market. As domestic miners consider going abroad, overseas demand for secondhand mining machines boomed, which caused the short-term turbulence in market supply and demand. From our experience and current market situation, we believe the major impact from policy uncertainty and fluctuating Bitcoin price is not the price of mining machine itself, but the timing of placing purchase orders. While domestic customers wait for a clearer policy environment, overseas customers inclined to a more stable Bitcoin price. Currently, most of our overseas customers have resumed ordering for spot sales of futures contracts. And the impact on overall price is not material, especially miner on the price of futures contracts. Depending largely on the Bitcoin price, current price of mining machines for spot sales is 20% to 30% lower compared with that when Bitcoin price was USD 60,000.

[Foreign Language] About our shipment, we already tripled our shipment in the second quarter compared to first quarter. Can we continue to increase shipments in the second half?

[Interpreted] In terms of our total shipments in this year, we currently expect it to be around 300,000 Bitcoin mining machines delivered to our customers in this year. However, in terms of revenue and profit, we are not able to give you a clear guidance at this point. I think they are closely related to the price of Bitcoin.

[Foreign Language] I also want to know, do we have any strategy to get rid of the Bitcoin cycle and maintain a profitability for a long time?

[Interpreted] This is a very good question. Firstly, as we are in a fast-developing, emerging new industry, we believe stable profitability is not the top priority of our business operation. We are working on maximizing our profit and managing the risks of losses at the same time. Our operating performance used to be significantly affected by the change of Bitcoin price. The impact was sometimes even magnified on our operating performance. This is natural due to the simplicity of our business model and product line. As a result, we have carried out the following initiatives to increase and stabilize our profitability. The first initiative is the selection of customers and sales models. We enter into long-term supply agreements with select customers and suppliers to stabilize our supply chain, sales and profit. And we also reserved a small portion of the mining machines for spot sales in market upturn to increase our profitability. Our second initiative is to expand into new business segments, such as self-operated mining business to diversify our business model. This is a critical segment for a hardware manufacturer to share the development dividend of the blockchain industry. In addition, as a disruptive business model of the blockchain industry, it is the fundamentals for computing power using cloud computing sales and even computing power contracts. As the industry evolves, the entry barriers for cryptocurrency mining has become too high for most participants on our call today to build and operate a tens of millions of dollars large-scale mining facility. This entry barrier has essentially discouraged investments in this field. The business model of pure hardware manufacturing is out of date. We should promote the hardware plus service model or even pure service model, Mining as a Service, or MaaS, to become the mainstream model. And the third point is diversification. Essentially, we are a chip company. Our core competence is the capability of designing chips and the massive production of it. It will be too narrow if we limit our technological advantage and a strong balance sheet only in the development end of mining chips. As such, we are developing homologous technologies to be applied to completely different AI devices and edge AI chip. Although this new business segment is still in the early stage of market cultivation, it is generally acknowledged that AI chip is an important industry in the future with huge market potential. We hope to be prepared for potential business opportunities in the future. Thank you. Hope this helped.

[Foreign Language] We would like to know how is our current next-generation machine progress? Which country are we profiting -- cooperating with? And which node are we using? And any roughly status of publication?

[Interpreted] In order to avoid causing confusions for the market, we normally don't separately launch a single new chip due to the simultaneous iteration of technologies and massive production by multiple foundry partners. Uncertainty is always associated with any R&D project. As such, there might be change to our following discussions and expectations. The next-generation chip is the second iteration of our existing technology. We expect to gradually adopt the next-generation chip in the second half of this year. Compared with current products, we expect the overall improvement to be 10% to 15% in terms of performance, cost and power consumption. In terms of the R&D process of the next-generation chip by our foundry partners, the full function testing chips have been put into production, and mass production is up to the foundry partner's schedule. Current expectation is next year. Compared with current products, we expect overall improvement to be in the range of 20% to 30%. In addition, we're also in the process of developing the 5-nanometer chip. We expect to launch the M5 products in next year. Instead of the challenges of the R&D itself, the long process and capacity constraints are the major obstacles for its launch. In terms of our cooperation with Samsung, the manufacturing of mining chip requires large volume wafers. Under the current supply shortages of wafers, we're only able to utilize foundry's surplus capacity from time to time. As such, our demand is not prioritized by the foundry partners. Foundries who have multiple cutting-edge fabrication production lines are important potential partners for us. The performance and cost of our 8 nanometers chip produced by Samsung was very good. Limited by Samsung capacity constraint, we suspended our cooperation for several months in this year. We plan to resume our cooperation with Samsung for the production of our new chip in later this year or next year. As far as strategic plan of developing our mining machines, currently, the mainstream Bitcoin included only the Bitcoin, Ethereum and Litecoin. In addition to our existing Bitcoin mining machines, we are developing mining machines for Ethereum or ETH. We hope to improve the performance of the new machine by 1 to 2 orders of magnitude compared with the current mainstream GPU. As a result, the R&D of new ETH mining machines is complicated and difficult. So we expect to launch our ETH mining machine next year. In light of the current supply shortages on the market, we think it's difficult for anyone in the industry to put ETH mining machines into mass production in this year since due to the severe short of supply for logic wafers, DRAM wafers and package.