Canaan Inc. (CAN) Q1 2022 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to Canaan Inc.'s First Quarter 2022 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, Ms. Xi Zhang, Investor Relations Manager of the Company. Please go ahead, Ms. Zhang.

Thank you, operator. 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. James Jin Cheng. In addition, our -- Mr. Xiaoming Lu, our SVP, Mr. Leo Wang, IR Senior Director, Mr. Clark Soucy, IR Director, will also 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. Today's call will include forward-looking statements. These statements include, but not limited to, our outlook for the company, and statements that estimate, or project future results of operations, or the performance of the company. These statements speak only as of the date hereof and the company assumes no obligation to revise any forward-looking statements that may be made in today's press release, call or webcast, except as required by law. These statements do not guarantee future performance and are subject to risks, uncertainties, and assumptions. Please refer to the press release and the risk factors and documents we file with the SEC, including our most recent annual report on Form 20-F for information on risks uncertainties and assumptions that may cause actual results to differ materially from those set forth in such statements. In addition, during today's call and webcast, we will discuss both GAAP financial measures and certain non-GAAP financial measures, which we believe are useful as supplemental measures of the company's performance. These non-GAAP measures should be considered in addition to and not as a substitute for or in isolation from GAAP measures -- from GAAP measure results. You can find additional disclosure regarding these non-GAAP measures including reconciliations with comparable GAAP measures -- GAAP results in our earnings press release, which is posted on the company's website. With that, I will now turn the call over to our Chairman and CEO, Mr. Nangeng Zhang. Please go ahead, sir.

[Foreign Language] Against the backdrop of the expected increase in U.S. interest rates, the first quarter of 2022 saw a continued trend for both lower and more volatile bitcoin prices that began in late 2021. At the same time, in the context of an increase in the bitcoin network's total computing power and relatively sharp energy price increases resulting from geopolitical conflicts, ROI per terahash of computing power decreased to a certain extent. In addition, the resurgence of the COVID-19 pandemic in multiple cities across China, along with the implementation of corresponding pandemic prevention and escalating control measures, negatively impacted our supply chain, production, and logistics. Despite these challenges, our team achieved encouraging results on multiple fronts. We are resolutely committed to our globalization strategy, deepening customer relationships and services, maintaining a steady operation of our supply chain, and pushing forward our research and development work for new products. This quarter, we in total, sold 4.3 million terahash per second in computing power, and achieved revenues of RMB1.36 billion and a net income of RMB442 million. Our revenues of RMB1.36 billion for the first quarter of 2022 were mainly driven by the 4.3 million terahash per second of computing power we delivered. As mentioned in our earlier press release, the local government implemented a nearly three week lockdown for all residents and businesses in the city where our mining machine factory and warehouses are located. We were therefore not able to deliver orders during this period, and this created a backlog running into the second quarter. Unexpected logistical disruptions resulted in revenues for the quarter underperforming our expectations. Nevertheless, we still made positive strides in sales of our mining machines. We also continued to win international orders, and demand from energy-abundant areas such as Central Asia, North America, and Australia remained solid. During the quarter of 2022, for the first quarter, we obtained customer orders from Laos. While we kept engaging new clients, we also achieved a large portion of orders from existing clients. To optimize our market exploration and better serve our customers, we have established an international headquarters in Singapore, which has recently earned recognition and support from the Singapore Economic Development Board. This sets a milestone for our globalization strategy, as we evolve into an increasingly globalized and culturally diverse technology company over the long run. Furthermore, we are building a team of local talents to drive our business expansion in Singapore and Southeast Asia. As we gradually build up our after-sales service system overseas, we are getting closer to our customers and making headway in our globalization push. In addition, we recently broadened our sales channels by launching an online store for overseas retail customers, providing them convenient access to our products. Turning to our pre-sales of computing power. Due to delivery delays during the first quarter of 2022, we have a total of 9.96 million terahash of computing power to be delivered and RMB1.77 billion of advances from customers as of the first quarter's end. Our production and logistics have gradually resumed throughout the second quarter of 2022 to-date following the local government's adjustment and guidelines for resumption of production. As of today, we have delivered most of the orders that were backlogged from the first quarter of this year. During the first quarter of 2022, our overseas mining operations were impacted by the COVID-19 pandemic, logistics congestion, and inadequate power supplies. By the end of the first quarter, our deployed computing power in Kazakhstan exceeded 2.4 million terahash per second, but there was volatility in the number of active machines which resulted in mining capacity during the period varying between 0 and 0.8 million terahash per second. In the quarter, we mined a total of 113.94 bitcoins. By the end of the first quarter, we held a total of 166.96 bitcoins. In addition to closely monitoring the status of local energy supplies, we are also proactively liaising with our partners to evaluate alternatives in order to optimize resource allocation. Despite the headwinds mentioned above, bitcoin mining is still a significant component of our business development strategy. This business segment allows us to balance computing power allocation, engage more deeply in the bitcoin mining industry value chain, and helps us better understand customers' needs. Overall, we believe that the long-term development of our mining business will diversify our revenue sources and optimize our operations. Therefore, we will continue executing on our strategy, and will be more prudent and agile in developing our mining business, while mitigating risk by deploying machines to multiple localities. In terms of research and development, as you may have noticed already, we recently launched our new mining machine model, the Avalon 1266. With process optimization based on our existing fabrication node, this new model outperforms previous models and has a computing power of 100 terahash per second. Meanwhile, research and development for the next generation of bitcoin mining machines is progressing smoothly. We have completed the design work for some of the programs, and we are in the critical stage of progressing towards mass production. Due to various uncertainties throughout the research and development and mass production progress, we will disclose the specific performance parameters of our new generation of mining machines and commence pre-sales only after we complete the full testing process for the machine. Turning to our AI chip business. We insist on open-source philosophy and recently made our Kendryte K510's software development kit and documentation publicly available on the Internet. We carefully selected and provided dozens of AI model applications in the software development kit storage. Developers can add their own data and train on the K510 to acquire different user experiences based on real-world scenarios. As we overcame challenges and endeavored to expand our business and propel our research and development in new products, we are also aware that uncertainties arising from reoccurrences of the COVID-19 pandemic, and macro headwinds in the capital market have had an adverse impact on our stock price. Given our solid fundamentals and cash position, we recently announced another share repurchase program under which we may repurchase up to $100 million worth of outstanding ADS over the next 24 months. The share repurchase program will commence execution in the coming window period. As previously announced, we completed the share repurchase plan authorized in September of 2021 ahead of schedule. This new share repurchase program demonstrates our confidence in the company's long-term outlook. We will provide updates on the program in our future earnings releases. By the end of the first quarter, the company had cash and cash equivalents of RMB2.64 billion, demonstrating sufficient cash liquidity for operations. Considering the inherent need for capital in our business operation, we have been exploring access to long-term financing to mitigate our potential operating risks. As such, we entered into an at-the-market offering agreement, providing for an ATM equity offering program with H.C. Wainwright. The program is yet to be executed, but we have set up the relevant financial instruments that extend us the flexibility to raise capital with relatively lower costs in the open market when market conditions improve in the future. We will provide updates on its use in our future earnings releases. The company will also prioritize shareholder interests and the general market when considering the execution of financing facilities, and will make proactive adjustments to accommodate market conditions. Taking a wider view, we have been monitoring the challenges that Chinese ADR companies are facing under the Holding Foreign Companies Accountable Act. On May 4 of this year, we were provisionally identified under the Holding Foreign Companies Accountable Act and are likely to be conclusively identified at some time in the future. This was raised some -- has raised some shareholder concerns over the possible delisting of our company. We have proactively responded to our inclusion on the SEC's list on the following date, and we will continue to comply with all relevant laws and regulations in both China and the United States. We have seen progress in discussions between the Chinese and U.S. governments, and we hope that the two parties can reach an agreement in the near future regarding inspections and investigations of auditors' work. As a company generating the majority of revenues overseas, we will maintain and improve our strong corporate governance and compliance with local laws and regulations. We will continue to communicate with the capital markets and actively explore possible solutions to protect the interests of our stakeholders. To conclude, we overcame many unexpected challenges and volatilities during the first quarter of 2022. Despite our topline results being negatively impacted due to pandemic-related delivery delays, our business performed steadily and achieved promising results. These were achieved as we implemented initiatives to support our business's long-term development and continued to expand our market and strengthen collaboration with our customers. Facing foreseeable headwinds or unexpected challenges in the future, we will continue to execute on our agile and flexible operating strategy and endeavor to maintain sustainable supplies to respond to market fluctuations and bitcoin volatility. We will aim to maximize shareholder returns by maintaining healthy operational cash flows, prudently allocating our mining machines between sales and our mining business, and actively promoting the development of our AI chip business. Meanwhile, we will continue to advance our business's globalization while better serving our customers by fostering a more client-centric after-sales service system. Looking forward to the second quarter of 2022, we see that significant uncertainties in the market environment still remain. Based on our current view, we expect our total net revenue in the second quarter of 2022 will be in the range of RMB1.6 billion to RMB1.8 billion, representing an increase of 48% to 67% compared with the second quarter of 2021. Please note that this forecast reflects our current and preliminary views on the market and operational conditions, which are subject to change. This concludes my prepared remarks. I will now turn the call over to our CFO, James.

Thank you, Mr. Zhang, and good day everyone, this is James. As Mr. Zhang mentioned, the first quarter of 2022 was a challenging one for our company, and facing various unexpected obstacles, we still managed to deliver solid results for our investors. In the first quarter of 2022, we recorded 4.3 million terahash in total computing power sold, representing a year-over-year increase of 119%. Our revenues were RMB1,356 million, increased by 237% compared with the same period of last year. As we expected, our topline results were not able to meet the previous guidance we projected in our fourth quarter financial report, due to the postponement of order deliveries from our warehouses. This is because of the unfortunate resurgence of COVID-19 pandemic since mid-March and subsequent overall lock-down measures in the city where our mining machine factory and warehouses are located. Since the end of March, although we swiftly prepared to resume production and delivery under the guidelines of the local government, our delivery schedule for the first quarter has been materially delayed due to the nearly three weeks of halted operations. Amongst the backdrop of these difficulties, we maintained our international business development and dynamic pricing strategy. Therefore, we continued to engage new and existing clients, and managed to sustain a relatively high average selling price in the first quarter of 2022. With our relentless efforts to resume normal operations as of today, we have delivered most of the delayed machine orders from the first quarter. Our mining business is gradually ramping up, but still facing headwinds from the power supply shortage. This resulted in a considerable portion of our deployed mining machines not being online in the first quarter of 2022. During the quarter, our mining computing power online varied in a rough range of 0 to 0.8 million terahash. During the first quarter of 2022, we generated 113.94 bitcoins and held 166.96 bitcoins as of the quarter's end. As winter has ended, the power shortage situation is improving. Since the second quarter of this year, more and more machines are gradually coming online. Our gross profit for the quarter grew 327% year-over-year to RMB830 million. As mentioned in previous quarters, due to the continued wafer shortage across the semiconductor industry, the inevitable increase in wafer price further weighed on our profit margin, which narrowed to 61% in the first quarter of 2022, still higher than the average level of 57% in the full year 2021, but declining from 68% in the fourth quarter of 2021. To further strengthen our supply chain, we have made prepayments to our foundry partners to secure their production capacity throughout the year 2022. We are also grateful for all of our foundry, testing and packaging partners' great efforts, as they strived to continue the supply for us despite the serious resurgence of COVID-19 in their cities during the first quarter of 2022. In the face of challenging supply environment and recent bitcoin price downward fluctuations, we expect our gross margin may further come under pressure in the coming quarters. We reported a net income of RMB442 million in the first quarter of 2022, a healthy bottom line result, considering the impacted topline performance and increased production costs. Please also note that, as we have utilized part of deferred tax assets as of the first quarter of 2022, we incurred higher income tax expenses. We also expect an increasing tax burden for our profitable quarters going forward. I would now like to comment briefly on our share repurchase programs. During the first quarter of 2022, we repurchased a total of 2.1 million ADSs with an aggregate value of US$10.3 million, representing an average repurchase price of US$4.81 per ADS. Earlier on March 16, we announced an up to US$100 million share repurchase program effective over the next 24 months. This new program follows on the heels of our recently completed US$20 million buyback that we authorized in September of 2021 and completed ahead of schedule. Recently in the capital markets, we have been under pressure from both crypto-currency price fluctuations and de-listing suspicions. We consider it's a good timing to focus on repurchasing shares, which helps to protect value for our shareholders. We are committed to delivering value to our investors, and this enhanced buyback program indicates the confidence that both the management team and the Board of Directors have in the company over the long run. Last month we also entered into an at-the-market offering agreement, providing for an at-the-market equity offering program to access to capital in the public market, with H.C. Wainwright. Please note that as of now, we do not currently expect to sell any ADS under the ATM program at this point in time. In light of the recent industry fluctuations and negative market sentiment, we are focused on executing our aforementioned buyback program to drive value for our shareholders. As of the end of the first quarter, we had cash and cash equivalents of RMB2,643 million, demonstrating a solid cash position that enables us to sustain our operations and business resilience. We will be cautious and prudent with any use of the ATM facility. Any share sales executed by the ATM facility will be disclosed in future quarterly earnings reports regularly. While Mr. Zhang has already discussed the potential delisting issue, we sincerely hope a detente will be reached on the audit matter by the respective regulatory authorities. Please be assured that we are carefully monitoring the situation and exploring potential practical measures to protect the interests of our investors. Now, I would like to briefly walk you through our financial results for the quarter. Revenues were RMB1,356.1 million equals to US$213.9 million, representing an increase of 236.7% from RMB402.8 million in the same period of 2021. Gross profit was RMB829.8 million, which equals to US$130.9 million, representing an increase of 327.2% from US$194.2 million in the same period of 2021. Total operating expenses in the first quarter of 2022 were US$251.5 million, which equals to US$39.7 million, representing an increase of 21.0% from RMB207.9 million in the same period of 2021. Income from operations in the first quarter of 2022 was RMB578.3 million, which equals to US$91.2 million, compared to a loss from operations of RMB13.7 million in the same period of 2021. Net income attributable to ordinary shareholders in the first quarter of 2022 was RMB441.6 million, which equals to US$69.7 million, compared to a net income of RMB1.2 million in the same period of 2021. Non-GAAP adjusted net income in the first quarter of 2022 was RMB543.4 million, which equals to US$85.7 million, representing an increase of 279.5% from RMB143.2 million in the same period of 2021. Basic and diluted net earnings per ADS for the quarter were RMB2.57, which equals to US$0.41. Contract liabilities as of March 31, 2022, were RMB1,769.9 million, which equals to US$279.2 million, increasing from RMB1,340.7 million as of December 31, 2021. This concludes our prepared remarks. We are now open for questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Hans Chung from D.A. Davidson. Please ask the question.

Hi, management and team. Thank you for taking my questions. So I'll ask several questions, and I'll ask in English first, and then I'll translate too in Mandarin by myself. So first, what would be revenue have been if there were no impact from the COVID-19 control measure for the March quarter, and have the production or delivery fully recovered at this moment? And I mean -- and going forward, given China's zero policy on COVID, does the company have any backup plan to mitigate the related risk from a similar lockdown or supply disruption. [Foreign Language] Thank you.

[Foreign Language] So let me translate. Since the beginning of March this year, the pandemic has resurged in multiple cities across China. In response, local governments have taken pandemic prevention and control measures. On March 14 of this year, we received notice from the local government of the area where our factory is located that it would be implementing a five day quarantine lockdown for all residents and businesses in the city. We fully expect that our business performance will be affected. Later, the quarantine policy was extended until the end of March. During the quarantine period, local logistics and our deliveries were suspended. These delays to inventory delivery negatively impacted our revenue recognition in the first quarter of 2022. Since the end of March, the local government has switched to differing level of control measures based on the severity of the COVID-19 outbreak, while encouraging businesses to return to normal operations. During this period, we have been closely communicating with the local government and have tried our best to resume normal production and inventory delivery. So far, we have basically completed the deliveries that have been delayed from the first quarter of 2022. Okay. Let me first translate. We are also making new efforts on many operational fronts, such as warehouse, logistics, and supply chain. For example, we have established an international headquarters as well as warehouses in Singapore to handle parts of our global business, which is also beneficial for the stability of our supply chain. This not only acts as a countermeasure to the uncertainty brought by the COVID-19 pandemic, but is also an important step forward in our globalization strategy. As we also mentioned, I think, excluding the impact of the COVID-19 control measures, I think we can meet our guidance previously projected in our fourth quarter.

Okay. Thank you. It's helpful. And my second question. Can you provide color on the mix and pricing trends of the past achievements versus the future contract. And I think, I guess, this seems like we may have higher mix on spot treatment given the gross margins, I think, better than expected. And how will that -- and going forward, in a same quarter how is that trend involving, especially, we are in a bearish environment of the bitcoin market. And longer -- what would be the trend for longer term in terms of the mix? [Foreign Language]

[Foreign Language] Due to our dynamic and flexible operating methods, the proportions of spot sales and future contract sales vary from quarter to quarter. Because of the tight energy supply in the northern hemisphere in winter and the number of holidays, the first quarter is typically traditionally a low season. In addition, considering the recent market volatility, we expect a smaller proportion of spot sales in the second quarter of 2022. If the bitcoin price continues to be under pressure, we may allocate more of our computing power to our mining business. As we have said in previous quarters, we are not trying to fix the proportion of spot sales and future contract sales. Instead, we will maximize shareholder returns by dynamically adjusting the proportion of mining machines allocated to spot sales, future contract sales, and our mining business based on the bitcoin price and market volatility.

Thank you. [Foreign Language] So, can you share with us your overseas market development, particularly, the business in North America? What have you been done, have you achieved? And what challenges have you seen so far? And then when will we expect the meaningful ramp up in the market? Thank you.

[Foreign Language] As we have mentioned before, we set up an international headquarters in Singapore to handle operations such as research and development, warehousing, and supply chain. This has been approved by the Singapore Economic Development Board, which has supported us with preferential policies. Meanwhile, of our overseas businesses, we pay especially high attention to our development in North America. We have seen that abundant energy supplies, especially the rapid development of clean energy, and wide acceptance of crypto currencies in the region, are attracting more and more miners to invest in and develop mines. In early April this year, we participated in Bitcoin 2022, a conference held in Miami, and held in-depth dialogs and established connections with many mining companies and industry partners. We are building our local teams in North America, and already have some team members on Board. They are helping to expand our business in a number of ways, for example, in the field of sales and developing partnerships for mining business. More importantly, we are improving our after-sales services to provide continuous services closer to our customers. Overall, we attach great importance to the North American market and are proactively expanding our business. Yet, we expect to encounter many different kinds of challenges during this second start-up. Hopefully, our continuous efforts will deliver solid results. We will disclose more details about our progress to our shareholders when appropriate. Thank you.

Okay. Thank you. I'll pass here, and jump back in queue.

Thank you. Our next question comes from Mike Legg from The Benchmark Company. Please ask your question.

Thank you. With Bitcoin being weaker in the second quarter, could you talk about how that impacts your mining machine sales and the average selling price?

Okay. Let me translate for Mr. Zhang. [Foreign Language]

As we have mentioned earlier, we expect our total net revenues for the second quarter of 2022 to be between RMB1.6 billion to RMB1.8 billion. This forecast reflects our current and preliminary view on the market and operational conditions. Considering that there are still significant uncertainties in the market environment, this forecast is subject to change. We have noticed that the bitcoin price has continued to fluctuate and fall from its previous highs. In particular, since we entered May, the bitcoin price has been further affected by macroeconomic factors such as the Fed increasing rates. We have dynamically adjusted our mining machine pricing to share the pressures created by downward bitcoin prices with our customers. By expanding our business in the global market and providing better after-sales services, we continued to strengthen our current customer relationships, fortify our mining machines sales business, and attract new customers orders. As of the end of the first quarter of 2022, our advances from customers had reached RMB1.77 billion. Even excluding the orders that are delayed due to the effects of the COVID-19 pandemic, advances from customers are still at a relatively high level, setting a strong foundation for our second quarter revenue this year. Based on past experience, mining revenues, demand for mining machines and mining machine price are all affected by bitcoin price volatility, which has always been a challenge we have faced within this industry. With over nine years of operations and management, we have accumulated good experience to deal with this challenge. We will continue to react to market volatility and unexpected situations throughout agile -- through our agile and prudent operations, and our stable supplies. We expect that the trend of bitcoin price volatility will continue within this Fed interest rate hike cycle for U.S. dollars. We remain optimistic on the long-term prospects for bitcoin and its associated super-computing technology. Hope I answered your question. Thank you.

Excellent. That's great. Thank you. And then just one follow-up. You mentioned the supply chain was impacted in multiple Chinese cities. Can you talk -- I know you also set up some warehouses and stuff for logistics. Can you talk about your expectations for future supplies?

Okay. Thank you. Let me translate. [Foreign Language]

Our partners, including foundry, testing and packing partners located in the greater Yangtze River and Pearl River Deltas, were fully prepared and had backup plans for the resurgence of the COVID-19 pandemic. They did not suspend their business operations and continued to supply for us. I would like to express our gratitude for the great support from our partners. Okay. On the other hand, we have secured production capacity this year through upfront prepayments to our foundry suppliers. As announced in the earnings press release, our prepayments were RMB1.89 billion as of the end of the first quarter this year, reaching a new historical high. In the severe market environment brought by the COVID-19 pandemic, we and our supply chain partners are supporting each other to navigate through the tough time. We have a stable and solid relationship with our suppliers, and we remain cautiously optimistic for maintaining a stable supply. We are also in progress towards exploring and acquiring the technology and production capacity for more advanced nodes. Hope that answers your question. Thank you.

Yes. Thank you very much.

Thank you. Our next question comes from Song Jiaji from Guosheng Securities.

Can you hear me?

Yes.

Okay. So my question is, most of your customers are institutional buyers, so why have you built up your online store targeting retail customers? [Foreign Language]

As a matter of fact, customers can always buy mining machines from us regardless of the quantity, even just one machine. Putting customers as our priority and reducing friction in the transaction process and related costs is a very important aspect of our sales system. Now, small and micro scale customers and those who would like to purchase a sample machine can make a purchase in our online store. They can even settle with bitcoin in the region where such settlement is legally permitted, enjoying a quick and very convenient experience. In addition, our online store is important for raising the transparency of machine models and prices for our customers. Going forward, we will further develop our sales channels, and gradually improve after-sales services in the global market. Whether customers are small or micro scale, or mid and large scale, they can all enjoy an upgrade to every aspect of our service. Hope that answers your question. Thank you.

[Foreign Language] You launched a new generation of mining machines, the Avalon 1266, at the beginning of April. When will you start its mass production and sales?

We presented a new mining machine model, the Avalon 1266, to miners during the Bitcoin 2022 Miami Conference. Our model 1266 is an upgrade on the current design and fabrication node, with about 10% improvements in the power efficiency and performance. As a result, this new mining machine produces overall computing power of 100 terahash per second. Additionally, we will keep propelling forward the upgrades in our processing and design, and expedite the progress of introducing more advanced nodes, thus bringing more competitive products to the market. Hope I answered your question. Thank you. Operator, I think we can conclude the call. Thank you.

Right. Thank you very much. So this is all the time we have for questions. I will now turn the call back to the management for closing remarks.

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

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