Canaan Inc. (NASDAQ:CAN) Q2 2022 Earnings Conference Call August 18, 2022 8:00 AM ET
Clark Soucy - IR, Director of the Company
Nangeng Zhang - Chairman and CEO
James Cheng - CFO
Conference Call Participants
Jiaer Zhu - China Renaissance Securities
Michael Legg - The Benchmark Company
Kevin Dede - H.C. Wainwright
Ladies and gentlemen, thank you for standing by and welcome to Canaan Inc.'s Second 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, Mr. Clark Soucy, Investor Relations Director of the Company. Please go ahead, Clark.
Thank you. 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. Jin Cheng James. In addition, Mr. Edward Lu, our SVP; Mr. Leo Wang, IR Senior Director; and Ms. Xi Zhang, IR Manager, 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 up the call 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 are 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 Securities and Exchange Commission, 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 results. You can find additional disclosure regarding these non-GAAP measures including reconciliations with comparable 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.
[Foreign Language] During the second quarter of 2022, under the combined influence of two rounds of interest hikes by the Federal Reserve, the bitcoin price continued its downward trajectory declining to about US$20,000 from US$45,000, a surge in energy prices caused by geopolitical conflicts further impacted both mining income and demand for mining machines. The situation thus led the bitcoin network's total computing power to decline slightly.
At the same time, the cities where our main offices are located experienced a resurgence of the COVID-19 pandemic with accompanying large scale lockdowns and pandemic control measures. This combination of factors negatively impacted our operations during the quarter.
Despite this unfavorable backdrop, our team successfully navigated through the difficulties posed by the challenging environment, as well as ensuring that our employees remained healthy and more supplied with daily necessities, we continue to fulfill our clients' orders achieving 5.5 million terahash per second in total computing power sold. Coupled with the contribution from our steadily developing mining business, we generated total revenues of RMB1.65 billion for the quarter, meeting our previous expectations. Notably, we achieved a net profit of RMB609 million in the second quarter.
In regard to the sale of mining machines, we continued to work closely with our customers during the quarter. We delivered a total of 5.5 million terahash per second computing power generating revenues of RMB1.6 billion. Sales of mining machines continued to drive the growth of total revenues, which grew 48.6% year-over-year and up 21% quarter-over-quarter. We strove diligently to fill the demands of all of our customers.
Following the launch of our online store for overseas retail customers in late May, we have received orders from all over the world. As our customer base shifts to overseas markets, we worked tirelessly to build and expand supporting systems. Our overseas headquarters in Singapore has already established R&D, finance and other operational teams and launched a supply chain system that encompasses assembly, warehousing and logistics in this quarter. With comprehensive operational functions, our Singapore headquarters has become a second general office and will provide valuable support for our overseas operations.
As of the end of the second quarter of 2022, we had a total of 4.75 million terahash per second of computing power to be delivered and customer advances of RMB1.02 billion on hand. Although contract sales orders set a considerable foundation for upcoming short term revenue, we are also fully aware that the bitcoin price remains under pressure, while energy prices are increasing. As such, mining company's revenues and financials are expected to come under significant pressure.
Considering these factors, we expect that demand for computing power will weaken over the next one to two quarters, which will negatively affect our sales revenue in the second half of 2022.
Although our industry is experiencing a challenging period, we still retain our confidence in the long term prospect of bitcoin and its underlying blockchain and supercomputing technology. We continue to invest in research and development, improve our supply chain capability and work diligently to deliver superior products with high quality and advanced performance to the market and our customers. Our research and development for the next generation of mining machines is progressing smoothly.
Currently, we have reached the critical stage of progressing towards mass production. Due to various uncertainties throughout the research and development and mass production process, it is necessary for us to wait until we have the testing results before we disclose the specific performance parameters. of our new generation of mining machines.
In retrospect, no matter the upside or the downside cycle of the bitcoin price, we have always insisted on investing in research and development. Although the bitcoin price is currently experiencing turbulence, we still believe that bitcoin will present more value in the future. At the current stage, launching the next generation of mining machines and delivering through mass production are paramount for our innovation and R&D efforts. Our new products will help clients further enhance mining efficiency, better prepare future challenges, and obtain more returns.
Given the current environment characterized by downward fluctuations in the bitcoin price, it's particularly important to insist on flexibility and nimbly developing our business -- our mining business overseas. During the quarter, thanks to our improved electricity supply, we mined 245.11 bitcoins and we have a total of 346.84 bitcoins on hold by the end of the quarter.
Although the bitcoin price continued to decline during the quarter, we still generated mining revenue of RMB52.1 million representing quarter-over-quarter growth of 60.9%. Faced with such an unfavorable market environment we are currently exploring more opportunities for regional diversification of our mining business. We are forging partnerships in North America, Southeast Asia and other regions, so as to expand our business scale and lower costs.
Let's now turn to our AI chip business. As a result of the COVID-19 control measures implemented in major cities during the quarter, downstream manufacturers had slower inventory turnover for consumer products, which negatively impacted our AI chips business revenue in the second quarter. As the pandemic control measures are gradually eased in the third quarter, downstream clients have enjoyed better sales and started to build up their inventories again.
Simultaneously, we have further strengthened the sales efforts for our AI chips and our sales have now begun to recover. Recently, our K510 CRB Customer Reference Board Development Kit obtained Amazon's AWS IoT Core Certification. Through our technology reference support, it became easier for our clients to integrate AWS IoT service software on the K510 chip platform and develop products based on the AWS IoT service. At the same time, obtaining the certification allowed our product to be displayed on the AWS website, further increasing our brand recognition.
This quarter, we also made decisive progress on our share buyback program approved in March, under which we may repurchase up to $100 million worth of our outstanding ADS over the next 24 months. As of August 12, 2022, we have repurchased over 2.0 million ADS for a total of US$10.3 million with an average price of US$3.63 per share which is lower than the current stock price. Our execution of this repurchase program demonstrates our strong determination to continually increase shareholder value and our confidence in the company's long term outlook.
On June 23, 2022 we announced the repurchase agreement with certain warrant holders to repurchase all outstanding warrants for an aggregate price of approximately US$6.61 million. We have made the payments in full. Upon the completion of warrant certificate cancellation, our outstanding ADS will be reduced by US$4.72 million. We will discuss in due time when the cancellation process completes.
We didn't execute any financing activity during the quarter considering the current market environment and our stock price that is under pressure, we will be focusing on the repurchase program as the core of our capital market operations.
I would also like to acknowledge that investors have raised concerns over the delisting risk of our company under the Holding Foreign Companies Accountable Act. We have been actively exploring possible solutions to protect the interest of our shareholders and other stakeholders. We are taking every step to maintain our listing status and the advantage in compliance as a listed company to promote the long term development of our firm. As a public company with the majority of revenues generated overseas, we will further strengthen our governance and operations capabilities to comply with applicable laws and regulations in different locations and maintain active communications with capital markets.
During the second quarter, our business faced several concurrent headwinds, including further outbreaks of COVID-19, a volatile geopolitical and economic environment and a downward trend in the bitcoin price. Against this uncertain backdrop, we relentlessly maintained our communication and collaboration with upstream and downstream partners and performed steadily despite these challenges. However, we are aware that macro adversities, particularly the decline of the bitcoin price and rising energy costs, have pressured the entire bitcoin mining industry, seriously impacting miners demand for computing power for some time in the future.
Therefore, we expect our performance to come under further pressure during the upcoming one to two quarters. Based on our current view, we expect our total revenues in the third quarter of 2022 to be in the range of RMB900 million to RMB1.1 billion, representing a decrease of 17% to 32% compared with the third 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.
It has been nine years since our inception. And during that time, we have been through multiple bitcoin price cycles. Our management team has a good amount of experience operating in market environments where the bitcoin price is declining. As a responsible company, we always keep respect for the market. Even in bullish times, we didn't expand at the expense of balance sheet health. As such, now we do not have interest bearing debt and our mining machines and cryptocurrencies are not collateralized. These financial advantages along with our current cash position allow us to steadily push forward our mining, our business strategies despite unfavorable market environments and protect our employees and partners, while continuously improving our products and services.
When the market enters a downswing, it also provides a good time for us to sharpen our new products, steadily develop our markets and grow and optimize our supply chain and logistics. At the same time, we continue to expand our business internationally and strengthen our aftersales service system to better serve our customers. Furthermore, we will retain the agile and flexible operating strategy when prudently developing our mining business, while enhancing synergies between our machine sales and mining business.
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.
In the second quarter of 2022, we reported total revenues of RMB1,652.7 million, representing 21.9% quarter-over-quarter increase and a 52.8% a year-over-year growth, meeting our guidance range.
During the quarter, the bitcoin price further sank to below US$20,000 from about US$45,000 in late March. Despite this soft market sentiment, we strive to achieve this top line performance primarily due to the delivery of 5.5 million terahash per second of computing power for our clients. The relatively high average selling price was secured with contract sales in previous quarters also contributed to the top line results.
Our AI chip business recorded revenue of RMB1.6 million for the quarter due to softer demand from integrated product providers [indiscernible] customers. This is because the stock to app electronic product inventory that will embed our chipsets during the quarter when the pandemic related lockdowns negatively impacted their supply chains and the consumption of these retail electronic products.
As the pandemic quarantine control measures gradually eased and the retail started to recover, we are having more progress in our AI chip sales in July and early August. Our mining business with an improved power supply generated 245.11 bitcoins in the second quarter, which contributed RMB52.1 million in revenue representing a sequential revenue increase of 60.9%. We had 346.84 bitcoins on hold as of the quarter's end compared with 166.96 bitcoins as of March 31, 2022.
Due to the ongoing energy instability, a portion of our deployed mining machines have not been consistently online and we are facing increasing energy costs for our operations. Under the evolving marketing environment, we are prudently exploring other geographical regions with favorable mining conditions to diversify our operations.
Above all, our gross profit for the quarter increased by 12% sequentially and 117.3% year-over-year to RMB929.7 million. As a result of the complex effect of slightly decreased average selling price and increased product cost due to wafer price rise, our gross margin for the quarter narrowed to 56.3% from 61.2% in the first quarter of 2022.
In the second quarter, we continued our efficient expense management with consistent investments in research and development. Notably, we have built an R&D team at our Singapore overseas headquarters by leveraging the advantage of low curtailment. From profit and loss perspective, we have several material non-operating items related to accounting treatment for the quarter. First, we incurred a RMB30 million impairment for our cryptocurrency assets in the quarter due to the bitcoin price decrease compared with the first quarter's end.
I would like to reiterate that bitcoins are initially recorded at the price when we generate them, our digital assets are recorded on the balance sheet, net of any impairment losses incurred since initial recognition. Hence are not recorded until realized upon disposal of such digital assets.
Secondly, during this quarter due to the depreciation of RMB against the U.S. dollars, we also recorded a foreign exchange gain of RMB114.3 million, as almost all of our revenues were generated from overseas markets in U.S. dollars. Should the RMB appreciate against the U.S. dollars in the future, we expect to incur corresponding foreign exchange losses.
Last but not least, the change in fair value of warrant liability brought us a gain of RMB25 million in the second quarter, as we completed the repurchase of all outstanding warrants in late June, we don't expect any gains or losses from such fair value change in the foreseeable future. As a result of foregoing, we realized a solid net income of RMB608.9 million for the second quarter, achieving 37.9% increase quarter-over-quarter and 148.6% growth year-over-year.
Turning to our balance sheet. As of the end of the second quarter, we have customer advantage of RMB1,017.5 million together with our cash generated from product sales we have an aggregate of RMB2,640.7 million in cash and cash equivalent as of June 30, 2022 maintaining relatively flat compared with the end of the first quarter.
Our cash level provides us with a solid position to navigate challenging market environment, enables us to carry out prudent exploration in expanding our global presence and continues our share repurchase program. As of August 12, 2022, we have repurchased a total of US$2.8 million ADS with an aggregate value of US$10.3 million and an average repurchase price of US$3.63 per ADS under our current stock repurchase program approved in March 2022. This stock buyback demonstrates our firm confidence in the company's long term growth prospects.
Moreover, as mentioned earlier, we reached an agreement with our warrant holder to repurchase all 4.72 million outstanding warrants in late June for an aggregate of US$6.61 million. The repurchase of outstanding warrants enables us to capitalize on the current valuation and it grants us more financing flexibility in the capital markets in the future. Under the current marketing environment, we will continue our conservative approach in the capital market and prioritize the share repurchase program to drive value for our shareholders.
Looking forward, we see that to continue with a lower bitcoin price level coupled with increasing energy costs and the logistics expenses has significantly jeopardized our clients' demand and their cash flow. But we expect a considerable decrease in both product orders and average selling price.
Taking into account the relatively high level of production costs, we expect an average gross margin decrease in the second half of this year. Subsequently, we expect our bottom line performance to experience a substantial decrease or even loss making in certain scenarios if the bitcoin price continues to fluctuate at a low price level.
Maintaining respect for the market, we will continue our prudent and agile operating strategy to navigate the current market dynamics and strengthen our supply chains and develop and advance new product for future opportunities.
Now I would like briefly walk you through our financial results for the quarter. Revenues in the second quarter of 2022 were RMB1,652.7 million, US$246.7 million representing an increase of 21.9% compared to the first quarter and an increase of 52.8% from RMB1,081.8 million in the same period of 2021.
Gross profit in the second quarter of 2022 was RMB929.7 million, which means US$138.8 representing an increase of 12% from US$829.8 million in the first quarter of 2022 and an increase of 117.3% from RMB427.9 million in the same period of 2021.
Total operating expenses in the second quarter of 2022 were RMB270.5 million, which means that US$40.4 million representing an increase of 7.7% from RMB251.2 million in the first quarter of 2022, and an increase of 3.1% from RMB262.4 million in the same period of 2021.
Income from operations in the second quarter of 2022 was RMB659.3 million, which was US$98.4 million representing an increase of 13.9% from RMB578.6 million in the first quarter of 2022 and an increase of 298.4% from RMB165.5 million in the same period of 2021.
Net income attributable to ordinary shareholders in the second quarter of 2022 was RMB608.9 million which means US$90.9 million, representing an increase of 37.9% from RMB441.6 million in the first quarter of 2022 and an increase of 148.6% from RMB245 million in the same period of 2021.
Non-GAAP adjusted net income in the second quarter of 2022 was RMB688.2 million, US$102.7 million, representing an increase of 26.6% from RMB543.4 million in the first quarter and an increase of 115% from RMB320.1 million in the same period of 2021.
Basic and diluted net earnings per ADS for the quarter were RMB3.53 which is US$0.53. Contract liabilities as of June 30, 2022, were RMB1,017.5 million US$151.9 million, decreasing from RMB1,340.7 million as of December 31, 2021.
This concludes our prepared remarks. We are now open for questions.
[Operator Instructions] Thank you. We will now take our first question. Please standby. First question is from the line of Jiaer Zhu from China Renaissance Securities. Please go ahead.
[Foreign Language] We see a significant decline in the - we comprised during the first quarter of this year. And I want to know, are there any large customers build cap orders? And what is the impact on the outlook of the demand - the gross profit margin and ASP for the second half of this year? And how do we react to this down cycle and further expand our oversea market? Thank you
[Foreign Language] Our future contract sales require our clients to prepay at least 50% of the total payment to secure mining machines. By the end of the second quarter, our customer advances reached RMB1.017 billion. So far, we have seen very limited cases of payment defaults.
Future contract sales have always been a part of our business model. We negotiate contract sales with clients to lock in prices for orders to be delivered in the future. The business model has been acknowledged by both our clients and us. Even when the Bitcoin price sores, we will still deliver mining machines at predetermined prices.
Our current prepaid orders on hand set a considerable foundation for our third quarter revenue. However, we have noticed a significant decrease in demand from miners' deployment of computing power due to factors such as the declining Bitcoin price and surge in energy prices. We have adjusted our prices in response.
As you may have seen on our online shop, the average selling price for retail has been adjusted down to US$30 per terahash. Therefore, we expect a downward trend in sales and price of computing power in the second half of this year. As disclosed in the earnings release, we estimate the third quarter's revenues to be between RMB900 million and RMB1.1 billion.
So meanwhile, we've observed that for some of our experienced clients, their businesses haven't been particularly impacted in terms of operations and cash. They have the intention to deploy more computing power at the low point of the bitcoin and mining machine prices. We are currently in active communication with these clients.
We'll also continue to closely monitor market conditions and prudently explore opportunities for mining collaborations at the appropriate time. We will also flexibly adjust our operations in response to bitcoin price and market changes. Computing power will be dynamically adjusted in its allocation to spot sales, future contract sales and our mining business.
During the past few years, we've experienced multiple dramatic fluctuations of bitcoin price as well as bear market cycles. Although the market's not in an ideal condition right now, we are faced in our long-term growth.
No, if we have - still further plan to expand our oversea markets on the self-mining business?
[Foreign Language] So to answer your question, we continue to closely communicate and collaborate with overseas clients. As energy prices soar globally, we have seen stronger demand in places where energy resources are abundant and have price advantages. Our team, are also actively participating in bitcoin and mining industry conferences held in North America and other regions to enhance communications and product promotions with business partners and clients in the industry.
So during the quarter, our overseas headquarters in Singapore has already established R&D, finance and other operational teams and launched a supply chain system that encompasses assembly, warehousing, logistics. It is expected to provide more support and convenience for the development of our business overseas.
Our online store that targets overseas retail markets has already received many orders and prepayments from North America, Europe, Australia, Southeast Asia and other regions since its launch more than a month ago. Even though total sales volume is still very small, we've seen interest in Bitcoin mining from clients globally. The online store also opens up a channel for us to extend our reach to customers and expand our brand promotion.
Thank you. That's very clear.
Thank you. We'll now take our next question. Please standby. It is from the line of Michael Legg from The Benchmark Company. Please go ahead.
Thanks and congratulations on weathering this tough environment. Can you talk a little bit about your build out in the U. S. and how that's going, please?
[Foreign Language] Thank you for your question. So we highly value the North American market and notice the increasing demand for investing in and building mining farms by bitcoin miners in North America. This is due to the wide acceptance of cryptocurrency and the abundant energy resources there, especially the rapid development of clean energy.
So this year, we actively participated in many bitcoin industry conferences in United States. We had valuable dialogues and built connections with mining companies and business partners in North America. We now have colleagues based in North America towards expand our business, including sales and exploring mining business opportunities.
We are also building local warehousing and logistics there to support our business development. We also set up repair centers and provided continuous and improved - our local and after sales services for clients.
So currently in North America, we're in dialogue with multiple mining farm partners, maintaining a prudent strategy. We have initially booked mining site resources that can host 5,000 units of mining machines through typical deposit prepayment to explore mining operations in this new region in the future.
The mining business serving as the critical supplement for our mining machine sales enables us to dynamically allocate our mining machine inventories among sales and mining operations, so as to maximize our returns through our agile operations.
Great, thank you very much. I appreciate it.
Thank you. We'll now take our next question. Please standby. It is from the line of Kevin Dede from H.C. Wainwright. Please go ahead.
I would - I understand a strong interest in continuing to develop new machines and new technology would be continued spending on R&D. What I would like to understand is how you see semiconductor development and machine technology improving such that efficiency improves and your opinion on the inclusion of immersion capability? Thank you.
[Foreign Language] So for us in the mining machine business and important task in the future is to integrate products and solutions vertically, penetrating the whole product system from chip to site and mining computing power throughout the industry value chain. Currently in this process, the product front only includes mining machine hardware.
There is limited penetration into providing solutions for mining site deployment, operations and maintenance of mining machines. Based on our recent observations, the entire industry still lacks standardized products, simplified deployment for improved operations and lower costs and better use of waste and clean energy. For us, products and services will continue to be integrated and developed vertically.
So semiconductor technology is at the crossroads of transitioning from FinFET to GAA or nanosheet types of 4D technology. This application for mining machines is still the vanguard of helping stabilize advanced fabrication technology. Actually, our industry is currently doing this. Thank you.
Thank you very much.
Thank you. That's all the time we have for questions. I will now turn the call back over to management for closing remarks.
So thank you everyone very much for attending our earnings conference call today. Please feel free to reach out to our IR team. Thank you.
Thank you. That concludes the call today. Thank you, everyone, for attending. You may now disconnect.