Canaan (NASDAQ:CAN) Q3 2020 Earnings Call

0:00 Ladies and gentlemen, thank you for standing by and welcome to Canon Inc.'s 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'd now like to hand over the conference to your speaker host today, Mr. Shao Curley. Board Secretary of the company. Please go ahead, Mr. Li. Thank you very much. Hello, everyone, and welcome to Canaan Inc.'s 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 are our Chairman and CEO, Mr.

0:52 Nangeng Zhang, and our CFO, Mr. Quanfu Hong. In addition, Mr. Xiaoming Lu, our VP, 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. Hong 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 sharply explained and reconciled 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 the CEO, Mr.

1:58 Nangeng Zhang. Mr. Zhang will deliver his remarks in Chinese and I will provide the corresponding English translations. Please go ahead, sir. Hello, everyone. Hello, everyone. Hello everyone, this is Nangeng Zhang, Chairman and CEO of Canon Inc. I will now provide a brief overview of our progress in the third quarter of 2020. The total revenue of the company in the third quarter is $2,401 million, which fell by 8.5% in the second quarter. The company's second quarter sales are mainly based on stock. By the beginning of the third quarter, the stock has basically been sold out.

2:47 After the end of the second quarter, the market became clear. Our mass production and investment is gradually starting in the third quarter. However, the capital of these three quarters will basically be handed over to customers in the fourth quarter to the first quarter of next year. Therefore, these capital contributions to the three quarters themselves are not large. From the beginning of the third quarter, the price of Bitcoin continues to rise to a maximum of $12,400. The fourth quarter has broken through $19,000. The entire blockchain market continues to rise. The company's pre-order has increased significantly. By the end of the third quarter, the company's pre-order was $11,114 million. By the end of the second quarter, it increased to $1,098 million. The company continued to increase its investment in R&D in the third quarter.

3:35 The total R&D cost of the third quarter was $473 million, which increased by 23.2% in the second quarter, showing the company's long-term development confidence. Our total net revenue in the quarter decreased by 8.5% quarter-over-quarter to $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 had rebounded. and as such, we continued to ramp up our production and the take-out 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.

4:34 Consequently, these waivers did not make a significant revenue contribution to our third quarter results. At the beginning of the third quarter of 2020, The price of Bitcoin maintained its upside momentum, reaching $12,400 in the period and in fact hitting $19,000 during the fourth quarter of this year. As such, the blockchain market recovery trend continued to boost the demand for our products. By the end of the third quarter, Our advance receipts totaled $11.14 million, representing an increase of $10.98 million from the end of the previous quarter.

5:24 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 $4.73 million. further demonstrating our confidence in the long-term development of the company. On September 8, the company announced a total of more than $10 million in stock repurchase plans. Until October 30, the company completed a total of 122.5 million stocks of repurchase. The transaction amount is $243 million. This also reflects the company's potential for long-term business and growth potential. On September 8th, we announced a share repurchase program of up to $10 million worth of our shares outstanding.

6:18 As of October 30th, we had already bought back 1,225,000 shares, which represented a total transaction value of $2.43 million under the program, and thus continued to illustrate our confidence in Cayman's long-term business process and the growth potential. Thanks to the company's strong research capability, the company has launched a series of products based on A1246 in the third quarter. The product design efficiency ratio is 38 joules per TH. The total computing power of the single machine is 90 TH, and it has the lowest unit cost in the industry. This series of products greatly improves the computing power and efficiency ratio, which satisfies the market for large computing power, low efficiency, The company will continue to launch energy-saving products in 30G to 40G per THS in 2021.

7:13 At the same time as improving performance, the advantages of new products in terms of cost and competitors will increase further. This year, due to the shortage of production capacity in the global chip industry due to many reasons, the company will continue to adopt the strategy of cooperation with multi-expo plants and maintain close cooperation with mainstream expo plants. On the mining machine front, we continue to leverage our leading R&D capabilities in the third quarter to launch our A12 product series. This new generation of products has achieved an energy efficiency ratio of 38 joule per terahash, a total computing power of 90 terahash per machine, and has the lowest unit costs in the industry.

8:05 by significantly improving the computing power and optimizing the energy efficiency ratio of our new products. We have successfully filled the market demand for mining machines with high computing power and a 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 further expand our industry leadership. A number of factors impacted the production capacity of the global IC industry in 2020.

9:00 Nevertheless, we have remained committed to both our fabulous model and the maintenance of our collaboration with multiple established IC manufacturers, enabling us to ensure the sufficient supply of IC products going forward to better meet customer needs. 如剛剛提到,公司在第三季度獲得大量預售訂單, 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 its 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 first quarter of 2020 and the first quarter of 2021 had already exceeded 45 million U.S. dollars.

10:26 From the sales area, the proportion of independent countries has increased significantly. The traditional overseas market, such as the United States, has significantly decreased due to the impact of the epidemic and other factors. It is expected that it will gradually recover in the second quarter of next year. From customer type analysis, we can see that the mining market is developing into a professional company. More than 90% of customers are middle-sized customers with a purchase volume of more than 1,000 units. And in these two quarters, we have a lot of new middle-sized customers. During the third quarter, we experienced significant changes in our revenue's geographic composition. In particular, revenue contributions from the Commonwealth of Independent States markets increased significantly during the period.

11:14 Meanwhile, as a result of the 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. More than 90% of our clients are large and medium-sized corporations that have made the purchase of more than 1,000 units.

12:00 Over the last two quarters, we have also been active in addition of many new large and medium-sized clients. The company has applied K210 to the new generation of sensor hardware and software companies, WorldSynth, to meet the needs of the social safety and distance detection function caused by the COVID-19 pandemic. Currently, they have mass-produced more than 4,000 pieces of chips from the company. As a result, the company's international product development is the first in the US market. Now turning to our progress on the AI front. In 2020, we have accelerated the monetization of our AI business.

12:48 Moreover, earlier in this year, we established a partnership with VergeSense, which is a US-based workspace management service provider specializing in sensor hardware and SaaS solutions. After establishing this partnership, we implemented our K210 chips in VergeSense's 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 orders for more than 4,000 of our AI chips, the delivery of which will represent our first international delivery of AI chips to the U.S. market.

13:36 Currently, our partnership with both UBTECH Robotics and 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 the products jointly developed with UB Tech, 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 the production costs.

14:51 At the same time, the company also actively participated in the smart city project. The company successfully targeted several government-led network recruitment projects through cooperation with the Jiuchan Intellectual Property Office. At the same time, we are actively involved in smart city projects. So our collaboration with Ningbo JoyChina, IoT technology, and its 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 Zhongguanchun Smart City, we have successfully integrated our K210 chips as well as the successor products of our K210 chips into the smart city operations of Beijing Haidian District.

15:53 Currently, the monthly supply of AI chips has stabilized at 20 to 30K. 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 shipment to stabilize at more than 50,000 per month. In addition to K210, the K510, which the company has been producing for a long time, has also been released. It is expected to be officially released in the first quarter of next year. K510 uses a new self-proclaimed GNE architecture.

16:38 It is a new AI specialized processor designed on the basis of KPU. K510 will be a more reasonable configuration, lower power consumption, more external shooting, more durable, and more suitable for the market's actual demand. K510 is divided into two target markets for replacement and increase. Beyond our K210 chips, we have also completed the takeout process of our K510 series, and we expect 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 utilizes our brand new and independently developed gene structure.

17:33 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 KE510 as both a replacement of our previous generation of AI chips and the tickets through which we will enter into new markets. With its low production costs and industry-leading performance, the KE510 is capable of powering products with the potential to disrupt the multiple markets such as high-end IPCs, smart home products, smart retail products, and smart security systems.

18:29 In the past six months, the company has fully identified and verified domestic and foreign markets and political environments, because the development of new business has accumulated sufficient industry experience and resources. In the past six months, we focused on monetizing and analyzing both market dynamics and market policies in domestic and international markets. Meanwhile, we also continued to accumulate industry resources and experiences for the development of our new business initiatives. Looking ahead, We believe that we are fully prepared to develop our Bitcoin mining business and hold digital currencies in a manner that is both legal and compliant.

19:21 The company is expected to successfully develop mining related business in the next six months. This business can make the company's supply chain stable production, improve the company's sales and storage situation, and make the company gain more profits and enjoy the prosperity of the blockchain industry. In fact, we expect 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 take and tap into the blockchain industry's in-muse growth potential.

20:12 According to the business development plan after the listing, the company is not only a hardware and equipment manufacturer. In the future, the company will develop with mining as a base and become a company with a complete blockchain ecosystem and can provide a complete, convenient, efficient and reliable one-stop solution for investors who are willing to join the industry. Our mining machines are a 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-size 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 industry's 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.

21:31 Thank you. This concludes the remarks of our CEO, Mr. Zhang. Now, on behalf of our CFO, Mr. Hong Chengfu, I will provide an overview of our third quarter financial results. 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.

22:23 The total net revenue decreased by 75.5% year-over-year and 8.5% quarter-over-quarter to RMB 163 million from RMB 670.6 million in the same period of 2019. and RMB 178.1 million in the second quarter of 2020. Cost of revenues in the third quarter of 2020 was RMB 180 million compared to RMB 524.4 million in the same period of 2019 and RMB 134.8 million in the second quarter of 2020. The year-over-year decrease in cost of revenue was in line with changes in companies' sales volume of TeraHash and the cost per TeraHash.

23:16 The quarter-over-quarter increase was primarily due to the investor inventory's write-down of RMB $44.9 million and the increase of sales volume. As a result, we reported a gross loss of $17 million in the third quarter of 2020 compared to a gross profit of $146.2 million in the same period of 2019, and a gross profit of 43.3 million in the second quarter of 2020. Research and development expenses in the third quarter of 2020 were 32.1 million compared to 38.1 million in the same period of 2019, and 26.1 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 market.

24:16 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 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% quarter over quarter to $3.2 million from $6.3 million in the same period of 2019. and 6.5 million in the second quarter of 2020.

25:05 The reductions were mainly driven by the decreased salaries of the staff in the company's sales and marketing departments. As a percentage of total net revenues, sales and marketing expenses 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 $40.6 million compared to $28.2 million in the same period of 2019 and $29.6 million in the second quarter of 2020. Consequently, our total operating expenses in the third quarter of 2020 was to 75.9 million compared to 72.7 million in the same period of 2019 and 62.2 million in the second quarter of 2020.

26:08 Loss from operations in the third quarter of 2020 was 92.9 million compared to income from operations of 73.5 million in the same period of 2019 and a loss from operations of 18.9 million in the second quarter of 2020, excluding share-based compensation expenses of 1.6 million. Non-GAAP loss from operations in the third quarter of 2020 was 91.2 million. Net loss attributable to ordinary shareholders in the third quarter of 2020 was 86.4 million. compared to a net income of $94.6 million in the same period of 2019 and a net loss of $16.8 million in the second quarter of 2020. Nangeng Zhang adjusted the net loss in the third quarter of 2020, which excluded the share-based compensation expenses worth $84.8 million.

27:09 Basic and diluted net loss per ADS in the third quarter of 2020 were both RMB 0.55. In comparison, basic and diluted net earnings per ADS in the same period of 2019 were both RMB 0.65. Basic and diluted net loss per ADS in the second quarter of 2020 were both RMB 0.11. Turning to our balance sheet, as of September 30, 2020, we had a cash and a cash equivalent of $177.4 million compared to $516.6 million as of December 31, 2019. The decrease was mainly due to the higher short-term investments.

28:07 as the company had invested RMB 204.6 million in short-term investments as of September 30, 2020, compared with RMB 11 million in short-term investments 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. Operators, we are now ready to take questions. Thank you. Ladies and gentlemen, we will now begin the question and answer session. If you wish to ask a question now, please press star 1 on your telephone and white for your name to be announced. If you wish to cancel your request, please press the pound or hash key. Once again, ladies and gentlemen, if you wish to ask a question now, please press star 1.

29:26 Thank you. Your first question comes from the line of Jia Liang from Hashkey Capital. Please ask your question. Good evening, Mr. Zhang. Good evening, Mr. Guan. I would translate it for myself. So, thanks for Zhang Zong and also to management. And I'd like to Hello. Let me explain. Our new business is mainly based on self-sufficiency mining.

30:37 That is to say, the company will use the method of deployment of miners to get digital currency through mining. And there is also a plan to use the method of sale of interest to develop a new business model. As for the mining pool you mentioned, the company is still focusing on cooperation. It will not develop a mining pool like Sui Jialan by itself for the time being. It will not do this at the moment. Let me translate. Our new business still focused on operating our own mining business, Bitcoin mining business. We're planning to use our Bitcoin mining machines to hold Bitcoin currencies.

31:40 This is how we are planning to develop our business. In terms of the mining pool, we're still doing that through partnerships. We're not currently planning to operate our own mining pool. Given its compliance problems, we will still keep monitoring that. Within six months, I would like to ask how long this preparation period will take. So my second question is how long does the company will be prepared for this new business and where this new business will be going to expand?

32:34 Thank you. Okay, that's it. Actually, we have been preparing for this business for a long time. I think the actual deployment will be in the first half of next year, in the end of the first quarter or the beginning of the second quarter. We need to see the actual operation efficiency. As for the location, currently we will choose overseas. It will be in Central Asia or the European and American countries to carry out our first step of work. So we have actually been preparing for the business for quite a while, and we're actually finishing up the preparation process. Currently, we're looking at either late first quarter 2021 or early second quarter 2021.

33:44 So in terms of location, we're looking at the overseas market, and currently we are preparing in Asia and the Europe as well as the North American market. Okay. The third question is about the new business. How much resources are we going to invest in the new business? On the one hand, how big will the team be? On the other hand, how much funds will we invest? So my third question regarding how many resources that the company will be going to invest into this new business, including how much the size of the team and also how much capital will be allocated to this new app.

34:49 I'd also like to know what's the size of the mining farm. Thank you. Hello. Regarding the investment in new business, we mainly focus on control. Because mining requires a lot of manpower, resources, and a lot of local resources. So we will do a deeper cooperation with the current hosting. In addition, Jia Nan will also consider investing in some sites.

35:34 But Jia Nan will not do site construction or direct operation. So in terms of our investments in new business, we're actually adopting a more prudent approach. So when we develop, we're looking at investments in locations and operations and human resources. So we're leaning towards partnering with local partners. Investing in certain local resources, so we're not building facilities in local markets at the moment.

36:28 The second is about investment. In fact, if we use cooperation to develop mining business, we need to invest a small amount of money. If you are using a place of investment or a company that invests in a place of investment or buying some shares in this way to cooperate, in fact, the amount of capital required is about the same as the cost of the machine, the mining machine itself. It is also a relatively small proportion. So you can think that our main investment is actually mining the resources, not the cash. So to elaborate on the investment or on the cash investments, we are actually, we're going to leverage our partnerships and so both in terms of equity investment or just investment in local resources. And in fact, we actually think the cash investment is going to be a small portion compared to our investment in mining machines.

37:49 So actually, the mining machines will be a major part of our investment, not cash. 然后继续刚才的这个问题,您提到了这个mining的这个业务的话,规模先做到多大? 这个规模的话,实际上是和当时的市场的这个 The situation is related. For example, when the product is announced, we will definitely reduce the scale of self-mining. When there is a fluctuation in the market, and the audience is relatively heavy, we will increase the scale of our own mining. In fact, this approach can also balance our own supply chain, and it is a relatively beneficial approach to our own production and stock. So for our mining business, the scale of our mining business is going to depend on the market dynamics.

38:52 And so if the market is fluctuating, we are going to focus on expanding our mining business so we will be in a better place to streamline our buy chain and the production of our mining machines. Okay, so for 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.

39:45 When the market is looking good and when it's fluctuating, we are going to increase that percentage. Does that answer your question? OK. Thank you. My thinking is that our product will be Yes, when the market is in fluctuation period, our surplus mining machine will be devoted into our own mining farms. Yes, when the market is in fluctuation period, our surplus mining machine will be devoted into our own mining farms.

40:45 Yes, when the market is in fluctuation period, our surplus mining machine will be devoted into our own mining farms. But as you said, if the market fluctuates, our self-sufficiency will absorb a part of our own machines and achieve a smooth fluctuation effect. Yes, so when our sales are performing well, we only expect 10% to 20% of our mining machines to go to our mining business. But when the market isn't doing so great, we're going to increase that. Okay, thank you. And then, about our mining supply chain, now everyone knows that the upstream supply will be tighter.

41:44 And then, we just mentioned that it will be in the first quarter of next year. I think some of our friends may also be in the middle of next year. I just want to ask about next year's So my following question is regarding the supply chain that we all know that industry has been in a squeeze in the upper supply chain that the founder may have cut the supply for the money machine factory at this period. So we know that our orders have been pushed into the next first quarter. And also we see that this is a common trend for the whole mining machine industry. So what is the management projection for next year's supply chain situation? Also how this situation will affect our cannons' productivity in the next year's S&P 500?

42:59 Hello. Finally, someone asked about the supply chain. I will make a summary of the supply chain situation this year. In fact, in the first half of this year, the overall production capacity has been relatively tense, mainly due to some problems of international trade friction. However, in the first half of this year, because the Bitcoin market To summarize our supply chain process, for the first half of 2020, our production has actually been under pressure, mostly because of issues in global trade. and for the first half of the year, the whole market isn't very healthy and the inventory is pretty low.

44:09 In the second half of this year, because the demand for semiconductors has suddenly recovered, so at the end of this year, as the price of coins rises, our entire industry will start to In the second half of the year, the market Demands for semiconductors actually rebounded, and Bitcoin price increased as well.

45:02 But for the second half of the year, we still had problems in the production, which we actually saw 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 manufacturer So, I think for the next half of the year, the production capacity of J&J is relatively large. Although we just heard that our orders have reached the second quarter, but in fact, I think this is because of the higher demand. So currently for the first half of 2021, our production is still going to run pubs. And as we mentioned earlier, our pre-order, pre-order, pre-sell orders are already scheduled for delivery for the second quarter of next year.

46:13 But that's more because of the increasing market demand. The main problem now is that we are already at a relatively advanced technical node. Therefore, the entire manufacturing time of Jingyuan should be in the range of 90 to 120 days in the industry. Therefore, the production cycle is relatively long. From the production capacity we are currently preparing, we can supply hundreds of thousands of mining machines next year. Okay, so one of the problems that we see is that the, so currently our, the production process for our machines is taking 90 to 120 days.

47:04 So, but we are, we're running out of production and we expect to, our production capabilities to have, to produce over Well, several thousands, several tens of thousands mining machines next year. In addition, we need to emphasize a point. In fact, because we now have a plan for self-sufficiency mining, when we face market fluctuations, the supply chain pressure will be lower than before. And also now we operate our own Bitcoin mining business, which would enable us to streamline our supply chain process, even when the market is facing turbulence. and we should be able to just build our inventory regardless.

48:25 Thank you. I'll now hand the conference back to the management team for their closing remarks. Thank you all for joining us today and we look forward to talking to you guys next quarter. Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.