Ladies and gentlemen, thank you for standing by, and welcome to the Canaan Inc., First Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation -- after the management’s prepared remarks, we will have a question-and-answer session. Please note this event is being recorded. Now, I'd like to hand the conference over to your speaker host today, Mr. Shaoke Li, Board Secretary of the Company. Please go ahead, Mr. Li.

Thank you very much. Hello, everyone, and welcome to our earnings conference call. The Company's financial and operating results were released by our news source services earlier today and are currently available online. Joining us today are our Chairman and CEO, Mr. Nangeng Zhang; and our CFO, Mr. Tong He; Mr. Maso Lee from ICR, our IR consulting firm, will conduct the English translation throughout the call. In addition, Mr. Xiaoming Lu, our SVP, will also available during the question-and-answer session. Mr. Zhang will start the call by providing an overview of the Company and the performance highlights for the quarter. Mr. He will then provide the details on the Company's operating and the 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 applied today's call as we will be making forward-looking statements. Please also note that we will discuss non-GAAP measures today, which are more thoroughly explained and reconciled at the -- to the most comparable measures reported under Generally Accepted Accounting Principles in our earnings release and the filings with the SEC. With that, I will now turn the call over to our Chairman and CEO, Mr. Nangeng Zhang. Please go ahead, sir.

Hello, everyone. This is Nangeng Zhang, Chairman and CEO of Canaan Inc. I will now provide a brief overview of our progress in the first quarter of 2021. During the quarter, we significantly improved our financial performance as a result of the Bitcoin price rally, increasing customer demand and the substantial ramp-up of our mining production and delivery. As such, we reported total net revenues of $61.5 million and a non-GAAP adjusted net income of $21.9 million in the first quarter of 2021, a significant improvement from a non-GAAP adjusted net loss of $31.4 million in the full year of 2020. With the mass production the new generation mining machines, our product yield continues to improve. Through the close collaboration with our foundry partners, we have further enhanced our chip manufacturing process. As of today, such advances have led to industry-leading performances in our chip speed and yield. In the second quarter-to-date, in addition to our delivery of mining machines, we have also secured a number of large purchase orders of future contracts. Furthermore, we have locked in the fab capacities of our foundry partners for the next 12 months to fulfill these future contracts. Although the Bitcoin price volatility in Q1 created some challenges in sales of mining machines, we expect our Q2 total shipments to either maintain or surpass our current growth rate. Due to the Bitcoin coin price volatility caused by recent policy and market uncertainties, we are not able to project the total net revenues for the second quarter in a precise manner. Hence, we expect our total net revenue for the second quarter to be in a range of $150 million to $200 million. In terms of mining machine sales strategy, we have reprioritized our sales focus to our long-term and large-scale customers. As of…

Hello, everyone. This is Maso Lee with ICR. I will now speak in English on behalf of Mr. Tong He.

Thank you, Nangeng. Now I will provide an overview of our first quarter financial results. Before I start, please note that all numbers are in RMB terms unless otherwise noted. Total net revenues increased to RMB402.8 million from RMB68.3 million in the same period of 2020 and RMB38.2 million in the previous quarter. The increases were due to the increase in our total computing power sold as we delivered more Bitcoin mining machines in the period. Cost of revenues increased to RMB208.6 million from RMB65.9 million in the same period of 2020 and RMB29.2 million in the previous quarter. The increase in our, cost of revenues were in line with the changes in our sales volumes of Thash and cost of our Thash. As a result, we reported a gross profit of RMB194.2 million in the first quarter of 2021 compared to RMB2.4 million in the same period of 2020 and a RMB9.1 million in the previous quarter. Gross margin further expanded to 48.2% from 3.5% in the same period of 2020 and 23.8% in the previous quarter. Research and development expenses were RMB58.2 million compared to RMB41.8 million in the same period of 2020 and RMB40.1 million in the previous quarter. The increases were mainly due to higher share-based compensation expenses, which increased to RMB24.1 million in the first quarter of 2021 as part of our amended 2018 Shares Incentive Plan. The increases were partially offset by the decrease in contracted expenses and other expenses related to our R&D activities during the first quarter of 2021. Let's now take a look at our other operating expenses in the first quarter. Selling and marketing expenses were RMB6.3 million compared to RMB4.1 million in the same period of 2020 and RMB6.1 million in the previous quarter. The increases were mainly driven…

Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] We have the first question. This is coming from the line of Akida Erkin from Chinese Securities. Please go ahead.

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

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

My second question is. What is the attribute of overseas government towards cryptocurrency currently? Will be pointing to commodities based positive regulation globally?

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

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

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

Thank you. We have the next question. This is coming from Martin Shen from [indiscernible]. Please go ahead.

We still have good revenue growth in the second quarter. Maybe you can give us some color of the second quarter mining machine output and the price compared to the first quarter of 2021?

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

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

Recently, we have observed considerable fluctuation and retreatment of the Bitcoin price and also heard different voices on the market. The overall return for Bitcoin miners remains at a relatively high level. Under most circumstances, the cost of mining machines does not exceed one-third of the miners' income. In addition, total computing power of the Bitcoin network declined recently due to policy change in China and the transition between dry and wet business. There is a minor decline of overall return for miners, but the change is significantly less than the replacement of 3.5 million. The price of mining machines depends on multiple factors. Without considering the impact of policy change, we see a strong correlation between the price of mining machines and return of mining. However, the recent policy uncertainties and the volatility of Bitcoin prices have cultivated an overwhelming watching atmosphere in our domestic market. As domestic miners consider going abroad, overseas demand for secondhand mining machines boom, which caused the short-term turbulence in market supply and demand. From our experience and current market situation, we believe the major impact from policy uncertainty and fluctuating Bitcoin price is not the price of mining machine itself, but the timing of placing purchase orders. While domestic customers wait for a clearer policy environment, overseas customers inclined to a more stable Bitcoin price. Currently, most of our overseas customers have resumed ordering for spot sales or futures contracts. And the impact on overall price is not material, especially miner not futures contracts. Depending largely on the Bitcoin price, current price of mining machines for spot sales is 20% to 30% lower compared with that when Bitcoin price was $60,000.

About our shipment, we already treat our shipment in the second quarter compared to first quarter. Can we continue to increase shipments in the second half?

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

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

Yes. This is a very good question. Firstly, as we are in a fast-developing, emerging, new industry, we believe stable profitability is not the top priority of our business operation. We are working on maximizing our profit and managing the risks of losses at the same time. Our operating performance used to be significantly affected by the change of Bitcoin price. The impact was sometimes even magnified on our operating performance. This is natural due to the simplicity of our business model and product line. As a result, we have carried out the following initiatives to increase and stabilize our profitability. The first initiative is the selection of customers and models. We enter into long-term supply agreements with select customers and suppliers to stabilize our supply chain sales and profits, and we also reserve a small portion of the mining machine for spot sales in market upfront to increase our profitability. Our second initiative is to expand into new business segments, such as self-operated and mining business to diversify our business model. This is a critical segment for a hardware manufacturer to share the development dividend of the blockchain industry. In addition, as a directive business model of the blockchain industry, it is the fundamentals for computing power easing, cloud computing sales and even computing power contracts. As the industry evolves, the entry barriers for cryptocurrency mining has become too high for most participants on our call today to build and operate a 10s of millions of dollars large-scale mining facility. This entry barrier has essentially discouraged investment in this field. The business model of pure hardware manufacturing is out of date. We should promote the hardware plus service model or even pure service model, Mining as a Service or MaaS, to become the mainstream model. And the third point is diversification. Essentially, we are a chip company. Our core confidence is the capability of defining chips and the massive production of it. It will be too narrow if we limit our technological advantage and a strong balance sheet only in the development of mining chips. As such, we are developing homologous technologies to be applied to completely different AI devices and edge AI chip. Although this new business segment is still in the early stage of market cultivation, it is generally acknowledged that AI chip is an important industry in the future with a huge market potential. We hope to be prepared for potential business opportunities in the future. Thank you. Hope this help.

We would like to know how it alerted the next-generation machine progress, which currently are cooperating with and which node are we using, any roughly status for publication?

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

We have the next question. This is coming from the line of Daniel Weiskopf from Toroso Investments.

Unfortunately, I don't speak Chinese. So I'm going to just thank you for trying to give the transparency on this call and to all the great questions. Congratulations on a good quarter.

Thank you.

Let me translate for the management.

That was my only question. Thank you.

We have the next question. This is coming from the line of Craig Ellis from B. Riley Securities. Please go ahead.

Thanks for taking the question and I will ask for help and translating the following. First, regarding the order intake that the Company is seeing, I believe that's leading to the Company believing it can ship 300,000 units this year. But the question is really on 2022, are you taking orders currently for 2022 shipments? And can you quantify the magnitude of orders that you might have taken year-to-date for next year?

Thank you for your question.

Okay. This is [indiscernible] responsible for overseas sales. Yes, the first -- sure. We have taken orders to 2022 quarter one. This answer helps you or not?

It does. But I was hoping you could also quantify the degree of orders that you've taken for 2022 in addition to whether you're taking them or not?

Yes. We have taken orders for impact. And the preorder sales, as Nangeng Zhang, the Chairman and CEO, mentioned in his previous sayings, 2021, we have preorders. But also, we have preorders for quarter one for 2021, every month with a long-term overseas partners as well by monthly pacing, so very well organized monthly pacing orders which, of course, helps us a lot in the allocation of production capacity and also stable our business pipeline.

That's helpful. I have a second question, if I could. In the press release, the Company disclosed there was a RMB56 million order cancellation in the calendar second quarter. And the question is related to that order cancellation, can those systems be redeployed to other customers or would those systems be redeployed to the Company's internal mining operation? Can you just confirm what happened with the systems associated with that cancellation?

A cancellation of one of our customers in the North America, and of course, customers have the right to decide to purchase or to cancel. And also, this cancellation doesn't impact our business. As the miners' sales and demand, you can see from the report, report, stable and healthy. Thank you.

And in light of the current sort of supply situation in the market, it's eventually for the second half of this year. We actually see the cancellation of this certain customer as a positive impact on our full year performance since we already signed a contract with a new customer at a higher price. Thank you.

That's very helpful and kind of opportunistic. Finally, I just wanted to get some further color on some of the supply dynamics in the market. The Company indicated that its pre-booked capacity with foundry suppliers in the back half of the year. If demand continues to grow through the year, can you get upside to your current capacity for this year and exceed the unit shipment target of 300,000 rigs? Thank you.

So let me take a second to translate for the management.

Yes. Actually, we don't see a further potential for increasing manufacturing capacity in this year given the supply and demand situation on the market. What we can do actually is to increase and improve the performance and yield of our products, so that will enable us to deliver more terahash to our customers. In terms of the manufacturing capacity, we hope we will be able to lock in more capacity to address the increasing market demand in the next year. Thank you.

There are no further questions at this moment. I will hand the call back to the management for any closing remarks. Take over.

Thank you, everyone, for joining us today. If you have any further questions, please do not hesitate to contact us. Thank you. Bye-bye.

Bye-bye.